End Of Crocs, Or Great Buying Opportunity?

 |  About: Crocs, Inc. (CROX), Includes: DECK, SHOO
by: Bill Maurer

After the bell Monday, footwear retailer Crocs (NASDAQ:CROX) plunged 35% after it downwardly revised its earnings guidance for the quarter, which it will report fully next Thursday, the 27th. The new guidance calls for revenues of $273 to $275 million and earnings of $0.31 to $0.33 per share. The company's previous guidance was for $280 million in revenues and $0.40 in earnings, which was exactly where analysts had pegged the quarter. We've seen this kind of fall from Crocs before, so the question remains, is this the beginning of the end, or does the massive drop in the stock provide an excellent buying opportunity?

Before we start the debate, I'll throw out some assumptions for my argument going forward. I'll take the midpoint of the guidance, so we'll assume for now that this quarter will be $274 million in revenues and $0.32 per share. Next quarter had been forecasted for $220.8 million and $0.13 for EPS. I'll revise that currently to $215 and $0.11 (pending the guidance next week). I'll take my full year number down by $10 million in revenues and the corresponding $0.10 in earnings. Since I think this might be a trend, I'll take down next year's numbers too, but not by that much. You can see all the numbers in the following table.

Click to enlarge
Estimates 3Q* 4Q FY 2011 FY 2012
Old Number - Revs* $280.5M $220.8M $1.02B $1.20B
New Number - Revs $274M $215M $1.01B $1.19B
Old Number - EPS* $0.40 $0.13 $1.38 $1.66
New Number - EPS $0.32 $0.11 $1.28 $1.63
Click to enlarge

*Actual Numbers, all other numbers are my estimates/opinions.

So now that I've taken down my expectations for this year and next, let's determine the impact on the stock going forward.

The End: On Halloween of 2007, Crocs made a similar announcement. They were slashing guidance. At that time, Crocs was a great growth story, and the chart was up, up, and away. And like we've seen so far this year with Sodastream (NASDAQ:SODA) and Netflix (NASDAQ:NFLX), that one trip up costs you dearly. Crocs closed that day just under $75 a share. The next day it closed below $48, and it's never seen those levels again. Crocs is in a very competitive industry, where they are a specialty retailer. Their products are not exclusive. Other companies, such as LL Bean, make similar products, and often are cheaper. Crocs was the greatest thing going. Until it wasn't. And we've come to see this disappointment before. Crocs hasn't seen those $48 levels again, so does that mean it won't see the $17 level it's trading at now again, or the $26 plus it closed at before the announcement?

This announcement wiped out 10% of the expected revenue growth and two thirds of the expected earnings growth. What does that say going forward? It certainly is not a good sign. Crocs was expected to do its first billion dollar revenue year in 2011, is that now in question? That 8 cents in net income is a huge number. Will we have to take down next quarter's even more (than I already have)?

Crocs was expecting 29.6% growth in revenues this year and 81% in EPS growth. Those numbers will obviously be coming down. Next year, we were expecting 17.5% revenue growth and 20% EPS growth. If those numbers are revised lower, that doesn't leave a lot of room for positive growth. The company may be topping off sooner rather than later.

And those are all valid points for "the end" and its followers. Crocs did not do itself any favors with this quarter, and next week we may get a glimpse into what they expect going forward. There will be analyst downgrades coming, probably some as early as tomorrow morning. The only question is, was this a one quarter miss or a sign of things to come? And that's the million dollar question. Now that we've looked at the glass half empty, let's look at the other side. Perhaps, this 35% drop is an overreaction.

A Great Buying Opportunity: We'll admit that this news was negative. But a 35% drop in share price? That's overdoing it, my friends. Even if you take 10 cents off for this year and apply the 22.5 trailing P/E, that's only $2.25 it should be down. Okay, we'll take another $1.00 off for next year's possible downward revision. Still, that's only $3.25. We're down over $9.50!

We think this is a minor bump, let's look at some fundamentals.

Click to enlarge
After Hours Price $17.25 $32.84 $101.00
After Hours Drop -35.25% None -3.23%
Price/Sales (ttm) 2.63 2.02 3.84
Price/Book (mrq) 5.14 3.53 6.31
P/E (2011) 19.30 15.06 21.61
P/E (2012) 16.05 12.68 17.81
Priced/5 Yr EPS Growth 0.78 1.05 0.98
Click to enlarge

Now those 5 valuation numbers were before the 35% drop. As you can see, Crocs beat both Deckers Outdoor (NYSE:DECK) and Steve Madden (NASDAQ:SHOO) in some of those metrics. With the 35% drop, those valuations will drop further, as the earnings and revenues hit is sure to be less than 35%. And if you look at growth, Crocs has the most potential growth of the three.

The "great buying opportunity" camp will make you believe that this was just one bad quarter, one little bump in the road, and that a 35% drop is an extreme overreaction. They will point out that the valuation make sense, and that before this announcement, 6 of 7 analysts had buy recommendations, with one hold. The average price target was north of $36, more than $10 above where the stock was at the close (implying about 36% upside). This camp will lead you to believe that the fourth quarter won't be as bad as many will now think, and next year will be fine as well. So where do I stand?

My Take: Both sides have valid arguments. I agree with some of the points of each. Yes, this was not the news Crocs investors were looking for. The revenues number was disappointing, but the EPS hit was even more troubling. I think there is a 75% chance that you will get a downward revision for the 4th quarter during next week's earnings report. I don't think this was a fluke. Crocs have always been a trendy product, and at times they're literally out of style. Like I said before, companies like LL Bean make similar holed shoes, and I'm sure you could find other Crocs products that have replicas out there.

That being said, I'm not ready to call this the end of Crocs as we know it. Until the revenues completely top off or the earnings start declining consistently year over year, I won't be in that camp. However, I've seen this kind of news before in Crocs. The stock dropped 36% the next day, and another 20% from that point in the next week. I don't see it out of the question that Crocs touches $15 at some point this week. Investors like growth stories, but when fears arise of that growth, they lose 50% quickly. Longer term, I could see Crocs going to $10 before it puts in a bottom. It will need to do some work to get people back in, and that may be at the expense of 4th quarter revenues, earnings, or both.

So here is my final opinion from what we learned yesterday: I don't think this is the end for Crocs, but I will not be lining up to buy at 9:30 tomorrow morning.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.