Crocs: Tripping on Its Own Brand

A man named Hal asked me about Crocs (CROX). This was a painful question…. ahh Crox, ah dammit, dammit, dammit what the blinkety blink was I doing?

I missed Crox as a stock pick last year and there’s no good excuse. Because I loved Crox. And I knew all about it.

You see, I did an option on it last year, around September, so it’s not like I never noticed. At the time, Crox had moved from a $15 stock to $25. Many of people were saying it was overvalued. I didn’t think so.

There’s a reason for that and it was very similar to what I thought of Jones Soda (JDSA) when it was a $5 stock; bright management, good branding, big potential. In fact, Crox has broader potential than Jones does, but it may have higher costs executing them.

The people who thought Crox was a fad doomed to fizzle when it took off last year missed some important things about the company’s business. It’s fashion, not tires or potato chips.

It doesn’t matter if 25 other companies can make rubber clogs with holes in them—only Crox gets to put the Crox name on theirs. Only Crox can claim real Croslite—a very lightweight plastic resin with a nice grip in case you’re boating and easy to hose down in case you’re mudding. The shoes are not exactly pretty, and to get people to wear something nudging up to ugly, you gotta have a name. No self-respecting teenager or yuppie mom is going to wear Brand X and miss the cachet of clomping around in real Crox.

About a decade ago, there was much talk saying that branding wasn’t a strong strategy anymore. Crox proves the fallacy of that claim. As long as it can keep its brand on the same trajectory that brought it to fame, the brand will protect the business. The brand not only allows Crox to sell its shoes at good prices while beating off look-alikes, it allows it to stretch out to other wear or license the name to other makers. Probably the most in-line development, since Crox looks a lot like the no-name gardening shoes I’ve had forever, is Crox kneepads. There are also armbands, backpacks, hats, sunglasses and socks.

But now my ardor of last year has cooled. I am underwhelmed by the company’s choices so far. It seems like Crox moved in this direction before thinking it through. Sure, ball caps are a must, but the backpacks are just backpacks. White socks with prints on them? Who cares? The spin-off products so far sadly lack the funky style that made Crox shoes so in your face and I dare you to make fun of me. Why isn’t Crox teaming with Swatch to make big, bold watches a comeback? Why don’t the arm and wristbands do something teens and fashion-firsts would value, like hold an iPod? In fact, why aren't they anklebands just to be different? Why aren’t there Crox gummy bears or funny-colored sunscreen that blends into the skin? Crox needs a product designer with a funkier vision and a tighter grip on what it is about Crox that got it to this level. The new products on offer now look like the company borrowed an aging product manager from the Mattel’s Barbie doll division.

The company has acquired a surfer products company to move it into the beach and surfer market, which is good. A fashion designer that it acquired in Italy will help it take its shoes upscale, but I am not convinced that anyone really wants a $200 Crox stiletto. Crox buyers are proud of spending $30 on fairly ugly frankly plastic shoes. Crox has been a street-smarts fashion, not a luxe runway item.

That’s the emerging weakness I see it Crox’ ability to take its branding strategy higher. There’s another issue emerging along with that—profit margins.

Crox has been far more than a hot fad stock; it has had killer return on equity thanks to very wide profit margins. That being so, and because it says the business is not seasonal, I am not pleased to see that the company’s selling general and administrative expenses doubled as its revenues did this past year. A company with strong branding momentum reaching more distribution channels should be ramping sales faster than it adds overhead.

But let’s leave earnings expectations to the side for a moment and look at some other multiples. Crox sells at 8 times trailing twelve months’ sales and 39 times ttm cash flow. For a strongly growing value stock, I would be comfortable with a price to sales ratio of 2.5, maybe even 3 in special cases. I’d prefer price to be under 15 times cash flow, and the closer to 10 the better. For Crox to merit its current valuations, it should be expecting 200% growth again this year, and that is not going to happen. This is a very small company that is settling into a reasonable growth curve as it reaches size.

If you are thinking of a long-term investment, Crox is risky at this level. I would need to see better brand development and fast. But it is very tradable with the momentum it has. I see an upside target of $67 for this stock based on an amended point and figure chart. Be aware, this is not a rise based on fundamentals, but on enthusiasm. And I would put a ground floor under that. Get out of the trade if the stock drops to $44. With the stock at $48, that’s a sweet 4:1 reward to risk.

CROX 1-yr chart

Disclosure: none

Comments

[STLPlace:]

Not sure if the sales/cash flow (operating?) is a good metrics. Look at Under Armour, they got a negative cash flow number if you use that ratio.

2007 Jul 11 10:51 AM