Skullcandy Delivers The First Of Many Blowout Quarters

| About: Skullcandy (SKUL)

Thursday after hours Skullcandy (NASDAQ:SKUL) delivered phenomenal Q3 results, beating EPS estimates by over 21%. During the quarter, sales increased 57.5% and revenue came in just above $60 million, well above the $50 million analysts were projecting. As a result, Skullcandy's future looks brighter than ever.

In my first piece about Skullcandy I outlined the basic premises of their long term growth story and why I believed SKUL presented an attractive valuation. This quarterly report not only confirmed its long-term growth story; it strengthened it further. In the newly filed Q3 report, Skullcandy upped guidance for 2011 revenue from $216 million to $231 million, implying the $271 million projected for 2012 is far too low.

Although this increase was substantial and excellent news for shareholders, Skullcandy's new (but obviously talented) management has already prepared themselves for another blowout Q4. Let me explain. SKUL beat Q3 revenue by $10 million and raised full-year 2011 revenue $15 million, which suggests only a $5 million increase in expectations for Q4 revenue. Although a $5 million increase to already excellent projected numbers is nothing to ignore, it is far too low. Skullcandy beat revenue expectations by 20% this quarter. If it beat its Q4 revenue numbers by 10%, then that comes out to $7.8 million better than expected, which is 50% higher than the $5 million it stated. Essentially the point is Skullcandy was able to up their guidance while still giving themselves an excellent chance at producing a better than expected Q4.

Analytically, Q4 looks fantastic as well. The release of the iPhone 4S will most likely be a major boost to sales, especially with Skullcandy's newest product being voice activated and specifically geared to smart phones. At this point it looks like the booming smart phone trend is providing a sold backing to Skullcandy's growth story. Another interesting thing is that Q4 will be Skullcandy's first full quarter with European distribution rights because of the 57 North acquisition. Growth in Europe in Q3 was phenomenal coming in at 75.9%. If this can continue then this could be another big driver of Q4 revenue growth.

As great as 2011 is shaping up for Skullcandy, 2012 looks much better. After a recent visit to Skullcandy's website I noticed the main product being advertised on their billboard was "new threads" referring to the hoodies and beanies in the picture. It looks like Skullcandy is starting to use its extremely powerful brand name to move beyond the headphone industry and start to tap into the clothing market. A quick glance at the clothing available on skullcandy.com will tell you things are very competitively priced and the potential for an entrance into the retail sector could be very realistic. With nobody taking into account potential income from clothing sales, estimates for the future could prove to be far too low. Another clue to Skullcandy's aggressive long-term business outlook is the recent collaboration it announced via Facebook with DC shoes. It is clear that it is going to make the most out of its brand recognition.

In terms of valuation Skullcandy looks considerably cheaper than after its Q3 report. Although no comment was made on 2012 EPS or revenue in the report, it is very clear that the $1.13 per share number is now far too low. I anticipated something in the range of $1.20-$1.30 before this monster quarter was announced, now something along the range of $1.40-$1.50 is looking much more reasonable.

Shares were trading at $16.65 after hours Thursday (and finished at $17.14 Friday), 15% higher than when I wrote my first article at $14.51. Although this is much higher than the October lows of around $13 per share, Skullcandy is still unbelievably cheap. At $16.65 their forward P/E is 11.1 (using my EPS estimates), with incredible growth at 57% YoY. Other strong brand names with 30-40% growth are trading for at least 30x forward earnings are (see LULU or UA). With growth north of 50% and the possibility of clothing becoming a big source of revenu,e Skullcandy should at least merit a 20x-25x P/E ratio, which puts the fair value of shares somewhere between $30-$37.50.

I will write a more in depth article about SKUL later this month. For now I am still very bullish on shares and strongly believe they are still potentially 100% undervalued.

Disclosure: I am long SKUL.

Additional disclosure: I am long out of the money SKUL March 2012 calls.