What We Learned From Skechers' Q4 Earnings

| About: Skechers USA (SKX)

On February 12th, Skechers (NYSE:SKX) reported Q4 results that beat analyst estimates for revenue, gross margin and net income. The key takeaway was not just that they beat estimates, but the reasons why they did so and what that means for 2014 and 2015. We came away more convinced than ever that the company is extremely undervalued and that the positive story will unfold in 2014.

We have written a series of articles on Skechers and have followed the stock from when the company was in the midst of the toning mess and its longer than expected cleanup. Again, those days are more than a year behind the company, and the company currently has some of the hottest products in the footwear industry. Skechers currently has the highest projected revenue and earnings growth rate of any major footwear company.

Let's look deeper at the Q4 numbers that were reported:

1. The company reported Q4 revenue of 450.7 million, representing approximately 14% growth from the prior year Q4. Same store sales in their 390 company-owned stores were up 16% in October and November, but slowed to about 6% growth in December. Against one of the weakest retail Christmas seasons of the last 10 years, these results speak to the strength of the brand and the current product lineup. The company showed roughly 10% increases in its domestic wholesale and international wholesale divisions.

2. Net Income was .28 cents per share vs a .16 per share estimate, but .10 cents of the beat was a lower than expected tax rate. The company had projected a 30-32% effective tax rate, but the final tax rate came in at 26% and looks to be in the 25-30% range for the next fiscal year. General and administrative expenses came in higher than expected, as the company opened 20 new retail stores in Q4 alone.

3. Gross margin was 44.5% for Q4-2013 vs. 42.6% for the prior year Q4. This evidences the stronger pricing power, lower discounting and better inventory position at the company. It also confirms the stronger margin from the near 60% gross profit realized in the company-owned retail stores. Gross margin is expected to trend slightly higher for the foreseeable future.

4. Selling Expenses were 8% higher than the prior year quarter, and considering the 14% revenue growth, this smaller than expected increase in selling expenses shows the company's discipline in controlling its sales and marketing expenses. In years past, the company has gotten the reputation of overspending on advertising with Super Bowl ads and celebrity endorsements. It appears those days are gone, and the company is being run with a much sharper eye on the bottom line.

5. General and Administrative expenses were up 19 million dollars or 14% over the prior year Q4. Higher sales volume contributed to part of the increase, but the majority of the increase was due to the company opening up 20 additional retail stores in Q4. Increased head count, rent and related costs caused the increase. The company is spending aggressively to grow the top line. We applaud management's aggressive stance to growth.

What did the company say about 2014? As is somewhat uncharacteristic of Skechers' management, they actually spoke very positively about their 2014 prospects, the high points being the following:

1. Domestic wholesale and international backlogs increased 30% over the prior year. The read-through of what this means for 2014 is very significant. Retailers have visibility into the 2014 concerning existing and new products from Skechers, and they are planning double digit increases for 2014.

2. The company said that January same store sales were up roughly 6% from the prior year. Considering the extremely weak retail climate in January and the major weather effects, we find this to be extraordinary and a confirmation of how well Skechers' products are selling at retail.

3. The company said they plan to open 60-70 new company-owned retail stores in 2014. Company owned retail is an opportunity to gain visibility with the customer, garner higher gross margins and grow the company all at the same time. All capital expenditures will be paid out of their ample free cash flow in 2014.

4. The company does not foresee any major increases in selling expenses in 2014, and with sales growth projected to be 12% in 2014, the company will leverage its selling expenses, and the company can expand its net margins at a faster rate than its sales growth.

5. The company is planning to pay off $50-60 million of debt coming due in 2014, which will add to its net income from lower interest expense.

6. Inventory was up roughly 5% over the prior year. Considering the company's solid growth rate, we believe this confirms better management, shorter lead times, tighter inventory controls and less risk to gross margin with slow moving inventory.

7. The company stated that it was comfortable with Q1-2014 and full year 2014 analysts' earnings estimates of .30 and 1.75 respectively.

As mentioned in our previous article on Skechers, we attended the company's December analyst meeting at their New York City showroom. Skechers' vast products lines have never been better or more compelling to current shoe buyers. Trend right styles, comfort, assortment, price and color are strongly resonating with the consumer, and the company has the growth rate to show for it.

We think 2014 will be a year of strong growth for Skechers, and at this point, we think the growth will exceed the current analyst consensus sales growth estimate for 2014 of 12%. Strong sales at retail as well as 60-70 new stores and a 30% increase in domestic and international backlog make us conclude that a projected 12% increase in sales for 2014 is too low. Of course, that remains to be seen, as the company reports its quarterly results throughout the year. The current valuation of roughly 8 times 2014 ebitda is far too low in our opinion, given the potential growth rate over the next 5 years. As we have stated many times in our previous articles, investor sentiment toward Skechers stock is still decidedly negative. We believe that if we see the revenue and earnings upside that we expect, investors will finally get on board this growing and undervalued company. This change in investor sentiment from negative to positive will be the fuel to propel Skechers' stock from its current 34 to well beyond 45 by year end.

Disclosure: I am long SKX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.