Skechers: Ugly Quarter, But There Is Opportunity

| About: Skechers USA (SKX)

Summary

SKX missed estimates and guided lower, resulting in a share price that is off more than 20% in Friday trading.

Domestic growth through the first half of the year has been disappointing and is indicative of market saturation.

The international growth story remains strong, and that has always been where the upside is.

We see shares as having lots of upside from these depressed levels.

Skechers (NYSE:SKX) announced Q2 results after-hours Thursday, 7/21, and the numbers were quite ugly. Revenue missed, and even fell towards the bottom-end of what is usually conservative management guidance. There were some domestic shipments pulled forward to Q1 which management had already warned about, but 1H16 domestic wholesale growth of 3.2% warns of a saturated domestic market when compared to a 34.9% 1H15 domestic growth rate. Margins compressed dramatically in the quarter, partly due to FX headwinds and other one-off charges, but YTD operating margins are now roughly flat YoY.

The sell-off, though, is likely representative of investors adjusting to a new era of moderate SKX growth. Despite international growth persisting at a high rate, pedestrian domestic growth is forcing investors to reset long-term growth expectations. For us, the most telling point in the ER was that management guided for 12.5% growth in Q3 and called this "positive momentum". In other words, 12.5% is the new definition of a strong quarter, so investors can likely forget the 20%, 30%, and 40% topline growth rates SKX has posted over the past several quarters.

This has caused us to lower our estimates both near-term and long-term. International growth has decelerated but there remains a huge TAM internationally for the company, and we think that business has legs to sustain mid-to-high teens growth over the next several years. Flattish domestic sales should result in high single-digit net revenue growth (versus our prior expectation for double-digit revenue growth). Margins should still be able to expand with SG&A leverage, so we think earnings can grow somewhere in the mid-teens range.

Click to enlarge

Even with all that bearish commentary, we still think the stock is undervalued. We believe a company with solid growth prospects in a proven market and with international expansion catalysts should trade at least at a PEG of 1. We see earnings growing at roughly a 12.5% CAGR from Fy16 to Fy21, and believe the stock should trade around 12.5x forward earnings by year's end. This would still be a dramatic discount to the valuations of athletic apparel peers Nike (NYSE:NKE), Under Armour (NYSE:UA), and Lululemon (NASDAQ:LULU).

SKX PE Ratio (Forward 1y) Chart

SKX PE Ratio (Forward 1y) data by YCharts

A 12.5x forward multiple on our Fy18E EPS implies a price target in 6 months of $30. That is ~20% upside from where the price currently stands.

While the quarter was ugly, we think the sell-off is overdone. The long-term growth story remains largely in-tact though we have struck down our long-term revenue projections. The valuation relative to athletic apparel peers is just too cheap here to ignore. Unless the company just fails to grow revenues or expand margins, we think the stock offers attractive value here. We also think the stock has some technical support right at $25, and expect the stock to rally off this support over the next several trading days.

SKX Chart

SKX data by YCharts

Disclosure: I am/we are long SKX, NKE.

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.