Skechers Valuation: As Cheap As It Gets

| About: Skechers USA (SKX)

Summary

Brand perception creates a steeply discounted value.

Rapid 3-year growth provides the financial foundation.

Future growth prospects are strong.

We do not buy stocks based on short-term price movements. We buy stocks when their current valuation is far below what we believe the overall company to be worth. That is absolutely the case with Skechers (NYSE:SKX).

Short-term stock price movements most often defy logic. Why? Buyers and sellers have time horizons that are extremely short. If a stock looks weak, it is quickly sold. If a stock looks like it is rising, everyone jumps on the bandwagon. This can often create wide disparities between companies' valuations. It is most important to always step back and research exactly what you are buying when you are buying a stock. We would argue the vast majority of buyers and sellers do not do this, and it is obvious that they don't.

Let's be clear, we won't tell you what Skechers stock will do in the next month, but we can tell you with pretty good certainty what it will do in the next 3 years. That's a big statement. How can we make that claim? Clear out all the noise of the markets (and we would argue, markets are most often pure noise), stocks are ultimately valued based on their cash flows. It is how every asset is valued: bonds, commercial real estate, privately-held businesses, etc.

But there are often many moving parts to a company, complicating valuation matters even further. That is why research and studying the art of valuation is a tough science. That is also why very few people do it.

Let's start from the top. Here are some company names and what the majority of people would say about them:

  • Nike (NYSE:NKE) - great company, Michael Jordan, behemoth, Tiger Woods, swoosh, undisputed athletic footwear and apparel leader.
  • Under Armour (NYSE:UA) - rapidly growing, dry fit shirts, Steph Curry, Jordan Spieth, cleats, Dick's Sporting Goods, the athlete's trusted brand.
  • Lululemon (NASDAQ:LULU) - yoga pants, category leader, athleisure trend-setter, soccer mom go to brand.

These 3 companies are excellent - great brands, great products, great marketing and very respected names.

Their forward price-earnings multiples:

  • Nike: 24
  • Under Armour: 60
  • Lululemon: 34

Here is what the majority of people would say about Skechers:

  • Lawsuits, shape-ups, Kim Kardashian, cheap-o sneakers, LA Gear, second rate company, knock off designer, bad commercials, bad management
  • Forward price-earnings multiple: 12

So Skechers sells at a multiple half of Nike, 1/5 of Under Armour and 1/3 of Lululemon. On an earnings basis, Skechers is priced at a massive discount to other footwear and apparel companies.

Did you know:

  • Skechers grew sales and earnings 3 times faster than Nike last year?
  • Skechers is projected to grow sales and earnings twice as fast as Nike this year?
  • Skechers is projected to grow sales and earnings faster than Lululemon this year?
  • Skechers has more free cash flow than Under Armour and Lululemon?
  • Skechers has a vastly better balance sheet than Under Armour?

Without a doubt, Skechers has had an incredible 3 years with sales projected to double this year from 2013 levels and earnings to be up nearly 6 fold from 2013 levels. That rate of growth is clearly unsustainable, but it does evidence the fact that Skechers is a completely transformed company from several years ago. We still think public perception is poor in Skechers and hence the steeply discounted valuation.

Okay, so as we stand today, Skechers is selling at a massive discount to its competitors, but what is the forward-looking prognosis for the company?

The future prospects for Skechers are very solid. Its recent Q2 earnings announcement on July 21 was a bit weaker than expected and guidance for Q3 was below analysts' consensus by a small amount. This caused the stock to crater from $32 to $24, where it stood as of Friday.

But it changed nothing for the future prospects of the company. The US footwear market is highly competitive, and combined with a fairly conservative US consumer, growth in its domestic wholesale division will likely be hard to come by in the next year. But that is not the Skechers growth story.

Skechers growth story is first, international, and second, its build-out of company-owned stores. For this year, the company's international sales are a little above 40% of total sales, and the company projects international revenue to be above 50% of total revenue in the next few years, and potentially larger than that over the long term.

China sales are projected to grow from $220 million last year to $350 million this year. The company is using a franchise model in China to rapidly partner with domestic operators to grow their distribution footprint. With current China growth rates at 50-70%, longer term, this could settle into the 20-30% annual growth rates and help make Skechers a vastly larger company than it is today.

While China is an obviously rapid growing region for Skechers, the company is aggressively investing in all areas around the globe. Europe has been much maligned for its economic weakness in the last 3 years, and the macro statistics bear this out. But Skechers has experienced renewed growth in Europe the last several years. The company has invested heavily to grow its distribution footprint and has doubled its warehouse size in Belgium to handle current and future growth. Europe will provide good growth rates for Skechers over the next 3-5 years.

South America is becoming a focus of growth for Skechers. The countries in South America obviously have challenges which Skechers is trying to navigate, but population growth and untapped local markets provide ample opportunity for long-term growth.

Let's also remember that Skechers is not really competing head on with Nike, adidas (OTCQX:ADDYY) and Under Armour in the footwear category. The company's price point is lower than its competitors, so its brand has more appeal at the low end. The low end is where the masses are, and the masses buy hundreds of millions of pairs of shoes per year. The US income demographic keeps higher-end brands in strong demand, while around the world of less wealthy countries, Skechers price points see stronger demand. It would seem fairly clear that Nike and adidas are not going after the $50 sneaker market in Chile, Indonesia and more importantly China and India. In fact, we would be hard pressed to name one company that is aggressively going after the $50 sneaker market around the globe other than Skechers. China and India growth alone are enough to get Skechers to be much larger than it is today.

Financial Metrics

The last 3 years of rapid sales and earnings growth and free cash flow have put Skechers on a very solid financial path. The company has spent $200 million to build out retail stores and build US and global distribution capabilities. Even with that, the company has $620 million in cash and $60 million of long-term debt. By year end, we project the company to have $750 million in cash and approximate annual free cash flow of $250 million per year. That's pretty amazing for a company with a market capitalization of only $3.7 billion.

3-Year Projection

What are the conservative growth rates for Skechers over the next 3 years? International sales can grow 20-30% and China and India potentially faster than that. The company-owned retail store model can grow revenue 15%. Domestic wholesale growth will likely be no more than 5% at best. With an improving economy, growth in the US can be a bit faster, but a weaker economy will hurt growth in the US. Put it all together, we think Skechers can grow revenue and earnings somewhere between 10-15% per year over the next 3 years. Using a conservative 12% annual growth rate, that would bring this year's projected $3.6 billion in revenue to $4 billion, $4.5 billion, and $5 billion over the next 3 years. It would also take this year's per-share profit of $1.90 to $2.12, $2.38 and $2.67 over the next 3 years. Put a 17 times market multiple on earnings in 2019, and you get a $45 stock price - a near double from here.

Maybe by then, the general perception of the company will have improved. Likely not, but we are pretty certain the stock price will have improved.

We will ask you:

Do you want to overpay for companies with higher perceived brand value than Skechers or do you want to invest to make money?

If you want to overpay, then buy Nike, Under Armour and Lululemon. If you want to make money, buy Skechers.

Disclosure: I am/we are 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.