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With its recent success of the Shape-Up toning shoes, Skechers USA Inc. (NYSE:SKX) has re-entered the footwear picture as a company with potential. The company is set to have its best FY in 2010 among the wildly popular shoes that are supposed to help individuals lose weight while they walk. The shoes are designed with a sole that is curved that makes standing and walking more strenuous than a normal flat sole. With how busy Americans are, the line has become wildly popular as an alternative to exercise or an auxiliary to a workout routine.
The stock saw its highest stock prices ever in 2010, but this is a highly cyclical stock that most likely has topped out on its Shape-Ups potential. It is not a good Buy at this point and will stay in this range until the shoe can rebound. With a cyclical path of four years, the five-year outlook is that in the 2014-2015 range, Skechers should rebound. Other companies have caught onto the Shape-Up phenomenon and it has not propelled SKX into a place where the stock can take its Shape-Up popularity and transform it into a brand popularity.
Shape-Ups’ popularity and potential appears to be already drying up. Speculation that the actual ability of the shoes was not quite up to the marketing that toning shoes companies have been releasing has recently been confirmed.
NPR did a report on the shoes and pointed out that two studies done by the American Council on Exercise have both proved that the toning shoes add no additional benefit of a regular shoe. If the shoes lose legitimacy in their claim to actually be more beneficial than a regular shoe, Skechers would definitely lose a key angle that is acting to its advantage. Yet, as time goes by, Skechers is losing market share on these shoes with Reebox and Adidas among others releasing their own style.
Even if the company can maintain its advantage as a viable alternative to regular shoes, we must remember the cyclical nature of shoes. At one point, no one would have ever thought that Crocs would ever run awry with popularity. Style and the sense of style changes in the American consumer. While being healthy doesn’t change, diet and exercise techniques change rapidly. The Shape Ups much like any other fashion trend are just that a trend. Whether or not Skechers can leverage this opportunity to create a solid niche and brand recognition is still to be seen.
One positive is that the company is introducing new lines that are more aesthetically pleasing and are more advanced than the first model. The production of new lines and creating lines that continue to be more pleasing to the eye are crucial to the success of Skechers' Shape-Ups. The fad, though, lasting much past 2012 will be definitely tough to manage. The company will need to leverage this opportunity into helping the brand image in order to maintain its success. Otherwise it will lose P/E and valuation past 2012 and not be able to maintain stock prices at their current and future levels.
The company is getting the athletic world behind it. Already Joe Montana has been a spokesperson for the shoe. Kareem Abdul-Jabbar, Wayne Gretzky, Evander Holyfield, and Karl Malone are all now spokesmen for the company as well. Adding legitimacy through veterans like these men is definitely a great positive for the company. If they could add some more female spokespersons then the company would definitely helps its marketing scheme. Yet, even with these marketing the shoe, it still has to be remembered as a fad.
Financially, the company poses some initial risks when digging into the balance sheet, income statement, and cash flow statement. The company has not in the past been consistent in producing free cash flow and has never dealt with such high amounts of orders and popularity. Some fears are whether the company will be able to have as strong of inventory turnover and deal with such drastically larger amounts of shipments. Looking at a growing company, one key metric is that we want to see accounts receivable and inventory staying close to sales. In the past year, the company has seen its A/R grow 57% and its inventory grow 14%. The company's sales have risen 60%. One issue that I see is that the company is taking on too much A/R and not increasing its inventory great enough to match its A/R. If the company cannot up its inventory, there is fear they will face order cancellations.
One positive is that the company has increased its gross margins each year for the past three years to the current TTM, increasing from 41% to 47%. The company also is very well off in the financial health categories. The company has less than 2% of its liabilities as long-term debt. The company's net debt is a positive because they have more cash on hand than short-term and long-term debt. Inventory turnover has increased from 2009 to the TTM, which is not a good sign of efficiency.
Competition is heavy for Skechers, and for this reason, the company has no economic moat whatsoever. They were first to the scene, but the shoe literally has become commoditized and Skechers seems the least aesthetic and priced in the similar realm as competition. The company has been helped by the fact that Nike has decided not to enter the picture, but other competitors eat into market share. The company has built a small economic moat with the shoe, but that moat could dry up very fast if these shoes lose value or popularity and they do not leverage it into another opportunity.
The risks are definitely high with Skechers. The company has financial issues on the balance sheet, low free cash flow, stiff competition, a cyclical success, and mounting issues of whether their shoes are even beneficial. The company definitely has some potential, but the highs the company saw earlier in 2010 could be the height of this phase of success for Skechers.
Valuation
The Oxen Group's fair value estimate for Skechers is $24 per share based on a discounted cash-flow analysis. The company has seen in the past year, but the future ability for sustained growth versus a cyclical high are very real for Skechers. The risk of the company seem to outweigh speculative nature of the company, and unless the stock can move back another 10-15% from its current levels, it does not present a significant play. The company should see growth in operating income through 2011, but after that point, much more growth presents significant hurdles. Estimated available cash flow starts at $82 million for this year and ends at $49 million in 2015. The company has a WACC at 8.0%.
Stock is a Buy below 16.
Risk
Risk is medium to medium-high with Skechers. The company, in the last year has been able to gain its fifteen minutes as a leader in the toning footwear industry. The question and risk comes from the fact that no one knows if toning shoes are the next Crocs or the next Birkenstock. The company has risk associated with its financial statements and will need to do a better job of building inventory to match A/R. Additionally, the company has not diversified itself well enough into foreign markets

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Source: Will Skechers Keep Pace With the Shape-Up Trend?