Is Crocs Doomed For Failure?

I must preface this with the fact that I believe Crocs (CROX) are a fad, and I'm personally short the stock (at an average cost of approximately $62). The shoes have many unique attributes (easily-washable resin material, incredibly comfortable). However, one must ask a few questions:

1) Do these attribute create a defensible market position?

2) Has penetration reached a saturation point?

3) What are reasonable margin and revenue growth assumptions?

Regarding (1), while I don't know enough vis-a-vis the chemical attributes of their product (and, subsequently, how easy/difficult replication would be), I have a feeling their underlying product is fairly easy to replicate.

Regarding (2), this is a very difficult (and extremely important) question to consider. CROX has annual revenue [TTM] of $590 million. Nike (NKE), on the other hand, has annual revenue of $16.8 billion. Thus, one could assume that there is ample room for potential opportunities for CROX. This assumption, however, rests upon a belief that (1) children's fickle tastes will continue to demand Crocs shoes, and (2) the company can somehow take market share from other shoe companies who make markedly different products (i.e. Nike, Addidas (ADDDY.PK), Steve Madden (SHOO), Sketchers (SKS), Healys (HLYS), Timberland (TBL)).

Question 3 contains assumptions that drive the largest components of the company's value. CROX has an enviable 28% operating margin (compared with 13% for Nike and almost 6% for the industry, according to Yahoo's finance site). Is this sustainable? Regardiless of revenue growth, empirical evidence tends to support a thesis that long-term margins revert towards the industry/market. This may take a few (or many) years, but it will occur. This margin decay will seriously impact profitability.

My enterprise DCF analysis, given CROX's TTM financials (as of 6/30/07), operating under the following VERY ROSY assumptions, gave a value of roughly $55:

1) ROIC maintains in the mid 30% range IN PERPETUITY

2) Revenue growth over the next 5 years of 25% per annum

3) Terminal growth (after year 5) of 10%

4) WACC (assuming no debt, essentially mirroring their existing capital structure) of 11.75%

I'll grant that revenue growth could be much higher, but I feel I was way too optimistic in my ROIC and terminal growth assumptions (particularly terminal growth), and still only came up with $55 as a share value.

I'm fairly new to these types of critiques, so I welcome any commentary.

Disclosure: Author has a short position in CROX

Comments

[Jay:]

Thanks for all of the criticism and commentary. Perhaps they can make the long-term, sustained jump to a defensible market position, and perhaps "fad" is the wrong term. I note, however, that all of those in defense of the stock tend to defend how great the product is, nothing about valuation of the underlying stock. I think it's important to differentiate between a good company and a good stock (at least at current levels). I also agree that it can be scary to attempt to short what has thus far been a rocket ship, and perhaps the more risk-averse short strategy would be to wait for an earnings miss. At that point, however, the folks whose job it is to punish stocks who miss earnings will have made most of the money.

Thoughts?

2007 Oct 03 07:02 PM

[JJ:]

The "defense" of the product you mention is warranted and not just people saying it to defend their long position. Have you ever tried wearing the shoes? You really should so you can understand how comfortable they can be for long hours on your feet. The company is becoming disruptive in the shoe space because they are superior in comfort and they also can get product to retailers faster than any other company. The styles are also expanding and the original clog that everyone wants to say is "ugly" and a "fad" is becoming less and less of the growth of the company. The margins are the best in the industry and are not slipping in the short term. The stock is good and so is the company. Management is smart and on a mission. They don't flood the market with a product until they are sure it will sell. This is because of how fast they can produce and ship them as I mentioned. The company has proven themselves time and again over the history of the stock. True that you might miss some gains on an earnings miss and if you short afterward, but you will get clear signals that growth is slowing beforehand. I would suggest you listen to the conference calls from last week to see how well business is going. They will not miss earnings anytime soon. I am not trying to be arrogant at all, but I believe you will be badly hurt if you try and hold a short through earnings. Wall St. will be ready to pay up for growth and as of now, Crocs is continuing to hit home runs. You may not understand the phenomenon fully, but many people do and you need to dig deeper to see the story is for real and still has many, many months to go.

2007 Oct 03 07:26 PM

[pingish:]

I wonder how many shorts write about their positions from a domestic point of view.

Anyone here been to Shanghai or Taipei or anywhere else where Crocs craze is in full fury and the market penetration is still 10%??

Crocs will one day be a short. I'd be surprised of Crocs is a short within the next two quarters.

And somehow, the fad labels come out before earnings...

2007 Oct 04 12:45 AM

[croozn:]

I happen to live in China. I bought CROX about 7 months ago, when I noticed that in all of the huge malls here, the one store that seemed busier than the rest was Crocs'.

Then I thought...1.3 billion people, 2.6 billion feet (though I doubt anyone buys these one foot at a time). I have yet to see a copy of these things here.

They could someday go the way of the Pet Rock, but people like them and are standing in line to buy them.

Good analytical work, but it turns out that my stroll through the mall was a more profitable study.

2007 Oct 04 12:20 PM

[croozn:]

One more thing...I'm glad I bought the stock 7 months ago, but I would not be a buyer today. I agree that it is carrying a very high price for the underlying fundamentals. I would rate it a hold, and certainly not a short - yet.

2007 Oct 04 12:25 PM

[Scott Weitz:]

JJ-

All you talk about is margins and how comfortable the shoe is. How do you explain that the company is valued at 1/5 the price of Nike with only 5% of the revenue.

Its a great product....my wife and kid both love them...its just tremendously overweight from a valuation perspective.

How do you explain all the insider sellling...its off the charts. Do you think you know something the board members don't???

And what about all the knock-offs? Is that going to hurt the company?

2007 Oct 05 12:45 PM

[JJ:]

You can't go with just a quick look and comparison to Nike. Nike had its huge run and made people tons of money. But Nike is not a growth company any longer. It is a simple fact that the street pays for growth and will do so much more in a time where there is talk of decelerating growth. Crocs is accelerating in its growth phase and that commands higher prices. The revenue and earnings growth is going at 200% right now, something Nike can't touch. This growth makes the company relatively cheap because we are not talking about astronomical PE's. Under Armour is a great example of a company that is not growing as fast as CROX and it has a much higher PE, yet there isn't as much hating on UA as there is with Crocs. The insider selling argument is tired. Sorry if that sounds arrogant, but you need to dig deeper and research. Insiders are paid through options and that is part of their paycheck. They have sold throughout the entire history of the stock, go look for yourself. They were selling at 13 split adjusted, and that didn't mean a thing. It actually has signaled blowout earnings are coming. They were selling before reporting in late July and the report was amazing. They are not bailing from the company because they don't believe things are good any longer, c'mon. The knockoffs are a non-issue as well because they are not as comfortable, they don't wash as easily, and they wear out quickly just to name a few things. The knockoffs have been around just like insider sales, and both have signaled nothing. People want the real thing and the product is not that expensive to begin with. I am not trying to preach or sound arrogant, but I have done my homework and all of these concerns don't mean a thing right now. No doubt, CROX will become a good short in time. But the company is in its growth phase in a bull market and the growth is not slowing at all yet. It may take 12-18 months at least before it is a good short and at that point, there will be hints to signal things might be turning. That point isn't close yet, bank on it.

2007 Oct 05 07:38 PM

[Scott Weitz:]

I understand the growth vs. Nike and that you can’t compare on P/E’s alone. But, market cap 1/5th of Nike….seems outrageous. In my opinion, they seem to be a one horse wonder. Maybe it’s just where I live, but I have yet to see other shoe models (aside from an occasional flip-flop) or their clothing out on the streets.

I guess time will time. However, if I were long this stock, I would be more concerned than most of you. Insider selling (which admittedly is always an issue in most stocks) is abnormally high; here’s a list of sales in the past week alone: 1) Director: 53,000 shares sold; 2) VP: 61,369 shares; 3) CEO: 9,734; 4) CEO’s wife: 64,464 shares!!

Check out Director Raymond Croghan: He owned a little more than 350,000 towards the end of ’06 according to my calculations. Since then, he consistently sold share with the pace of sales picking up exponentially in the past couple months. Today, Raymond is left with 9,960 shares….are these the acts of a man confident in where the stock is sitting?
Granted, Raymond may have circumstances that I don’t know about, but this raises a big red flag to me.

You can tell me how fast CROX is growing until you’re blue in the face, but I would listen to the people who really know and whose actions speak louder than words.

2007 Oct 06 08:56 AM

[Scott Weitz:]

I understand the growth vs. Nike and that you can’t compare on P/E’s alone. But, market cap 1/5th of Nike….seems outrageous. In my opinion, they seem to be a one horse wonder. Maybe it’s just where I live, but I have yet to see other shoe models (aside from an occasional flip-flop) or their clothing out on the streets.

I guess time will time. However, if I were long this stock, I would be more concerned than most of you. Insider selling (which admittedly is always an issue in most stocks) is abnormally high; here’s a list of sales in the past week alone: 1) Director: 53,000 shares sold; 2) VP: 61,369 shares; 3) CEO: 9,734; 4) CEO’s wife: 64,464 shares!!

Check out Director Raymond Croghan: He owned a little more than 350,000 towards the end of ’06 according to my calculations. Since then, he consistently sold share with the pace of sales picking up exponentially in the past couple months. Today, Raymond is left with 9,960 shares….are these the acts of a man confident in where the stock is sitting?
Granted, Raymond may have circumstances that I don’t know about, but this raises a big red flag to me.

You can tell me how fast CROX is growing until you’re blue in the face, but I would listen to the people who really know and whose actions speak louder than words.

2007 Oct 06 09:01 AM

[JJ:]

Sorry man, I've tried to help you by laying things out, but you still want to harp on insider sales. They get awarded new options for exceeding sales goals and they have always sold. They sold before Q2 earnings, they were selling a year ago...it is NOT a sign the company is suddenly going to go under. Under your theory, you should be saying they are stupid for leaving money on the table if they were selling weeks and months ago. Oh and on your statement of "listening to people who know"...ummm, have you bothered to listen to the CCs from late september? Ron Snyder was bullish as hell. Here's a good quote as one example: "You want to hear that we need air freight if you are a long investor". Bottom line, that means demand is crazy and I'll let you figure out why. You may not understand the phenonmenon, but you are foolish for not doing an ego check and realizing that millions of other people are catching on. If you want to short, don't say you weren't warned and I will give you a thanks for helping to push the stock up when you are forced to cover. Sorry again for sounding over confident, but your arguments are months and months old and they continue to be a short sighted and ill informed look at how the stock is supposed to perform.

2007 Oct 06 11:52 AM

[Scott Weitz:]

You see what you want to see. I'm not denying that CROX is a good company. I am arguing that they are trading at unsustainable valuations and the stock will crash on the first sign of bad news.

As for the CC, what do you expect them to say? 'Domestic sales are slowing and our stock is overvalued'? I don't hear many executives that are bearish on their own company.

2007 Oct 09 01:35 PM

[JJ:]

"You see what you want to see". So you are speaking the absolute truth and not twisting it yourself? Where is your bad news coming from? That is all you shorts have is wild opinions and saying the end is near. You will get a clear signal when it is time to leave the stock and it isn't now. And no, I don't expect them to be bearish on a CC, I expect them to tell the truth on how business is going. Again, I'd love for you to listen and honestly pick out where the bad news is. Funny you stick in the little blurb about domestic sales slowing. You keep believing that is what he said. Again, more spin and misinformation that a short would try and spread. Listen, I'm not saying the stock is going up forever and growth will never slow. But in the short term, all you shorts have is a hope and a prayer something bad happens. So bottom line, please keep shorting now if you think that news is coming. I won't mind watching you get squeezed when earnings are announced.

2007 Oct 09 11:26 PM

[Scott Weitz:]

I guess this argument was just settled...down 20% in afterhours.

2007 Oct 31 05:33 PM

[andy patel:]

I read through all the comments made by Sweitz and I commend him for making the right call. Today even Cramer said this stock is a sell and the air is taken out. I just bought 2000 put contracts and I think I agree with Cramer and Sweitz that the stock is going to be under 40 in the very near future. This is what happen to Crispy Cream and many other companies.

2007 Nov 02 12:00 AM

[Scott Weitz:]

I guess this argument was just settled...down 20% in afterhours.

2007 Oct 31 05:33 PM

[rbg62361:]

Well, are you still holding that short position? Crox closed over $70 today. They will absolutely destroy 3rd quarter estimates of 63 cents. Probably closer to 81 cents. Revenue will also be up over 200%. Those two numbers are the fuel for the price explosion upwards. The match that will light the fuel will be the raised guidance for the 4th quarter. Right now the estimate is 47 cents- this is a joke! Ron Snyder will probably give raised guidance of 65 cents and the stock will explode. But the stock will continue to rise all the way through to the earnings announcement for the 4th quarter because the results will be more like 77 cents(EPS). Please save your money and cover your short position now at $70 before you have to cover at $80, $90, or $100.

2007 Oct 15 11:21 PM

[Jay:]

yep, still short. the last few days have been pretty painful though.

2007 Oct 31 05:37 PM

[Love to short:]

CROX just crossed below 5 bucks! Great call, I hope you were still short!

2008 Jul 25 03:05 PM