Crocs: More Than Just A Story Of The Clog Sandals

| About: Crocs, Inc. (CROX)

In this article, I will run you through some financial and valuation metrics for Crocs Inc. (NASDAQ:CROX) and its industry peers as I believe that the shares are trading at an attractive price and the firm enjoys better growth prospect, profitability, and liquidity position relative to its industry peers. Although your further research is warranted, I believe this article will serve as a helpful introductory for identifying an undervalued investment opportunity.

Introduction - CROX engages in designing, manufacturing, and distribution of casual footwear and accessories. The firm distributes its products primarily through wholesale channels (60% of total revenues) including department stores. It also sells the products through retail and internet channels (31% and 9% of total revenues, respectively). Although CROX is based in the US, only 36% of total revenues are generated from this market. The firm has strong international presence with 36% of revenues derived from Asia, 17% from Europe, and 9% from the rest of Americas. Although CROX is best known for its plastic-clog sandals, which generated 60% of sales in 2006, the firm has refreshed its footwear portfolio with more than 300 different styles. By now, the clog sandal line only represents less than 10% of overall sales.

The following analysis is based on this table below:

Growth - Top line declined 14.8% in 2008 and 10.5% in 2009 primarily due to an overcapacity issue resulted from financial crisis. Fortunately, the firm has emerged from the distress as revenues increased at 22.3% and 26.7% in the following 2 years after a change of management team and a series of operational restructurings to improve efficiency. Street analysts expect the top line to grow at a slower pace of 17% and 14% in the current and next fiscal years, owing to the firm's 17% revenue exposure to Europe. Impacted by the overcapacity problem and subsequent inventory write-down, EPS was in negative territory in 2008 and 2009. In the following 2 years, EPS recovered to $0.76 and $1.24, respectively. Analysts anticipate a steady growth of 18.5% and 18.4% in the current and next fiscal years. Consensus estimates for both top-line and bottom-line growth are much better than the industry peer averages (see table).

Profitability - CROX has demonstrated solid profitability. In 2011, the firm's EBIT margin, net margin, and ROE are 13.6%, 11.3%, and 26.0%, respectively, which substantially outperform the industry peer averages of 7.7%, 4.2%, and 10.6%, respectively (see table).

Liquidity Position - CROX has $24M debt and $207M cash, amounting to a net cash position of $183M, which is equivalent to $2 per share. The company does a much better job in generating free cash flow relative to its peers. In 2011, its FCF margin is 10.1% versus the group average of 0.8% (see table).

Valuation - The stock is currently trading at $16 with a $1.45B market cap. At this level, it trades at 9.3x the next fiscal year EPS and 7.5x LTM EBITDA. These represent a lower valuation level relative to the group averages of 13.8x and 7.9x. However, I believe a valuation premium of at least 10% on top of the group averages should be warranted given CROX's relatively better performance in terms of growth, profitability, and free cash flow generation. Taking that into perspective, I arrived at a stock fair value of $23 by equally weighting the two price-multiple valuation methodologies. Details are shown below:

I also checked the valuation against my DCF model with the following very conservative assumptions:

Revenue Growth Decline from 15% to 2% over the next 10 fiscal years
EBIT Margin An average of 13% over the next 10 fiscal years
D&A Expense 4.4% of revenue (historical average)
Shared-based Compensation 1.0% of revenue (historical average)
Provisions for Doubtful Accounts 0.3% of revenue (historical average)
CapEx 4.9% of revenue (historical average)
Change in NWC 5.0% of change in revenue
Tax Rate 22.0%
Terminal Growth 2.0%
WACC 11.5%

The model yields a stock value of $20. By blending the relative and absolute valuation methods, the stock should be conservatively valued at $22, indicating a 36% upside potential.

Potential Catalysts - Of the 11 analysts covering the stock, 4 rate it a strong buy, 3 rate it a buy, 3 rate it a hold, and 1 rate it an underperform. Asia and other Americas will continue to be the primary growth drivers as the firm has a plan to expand Asian revenue share from 36% at present to 43% in 2013. In addition, CROX's stronger focus on retail channel has helped doubled the firm's store base, which is considered by the management a better distribution channel as it allows CROX to market a broader product portfolio with flexible pricing and provides greater customer outreach. Given the firm's continued efforts in expanding globally and optimizing the distribution channel mix, I am confident in the company's ability to exceed the consensus estimates.

Risks - Increasing competition in the international markets and escalated commodity prices will likely slow down the firm's growth and erode margins and liquidity position. Failure to stay at the forefront of the product innovation curve will also deteriorate CROX's market position. In addition, the firm will be impacted by currency movement due to its significant international operations.

Tables are created by author and financial data is sourced from company 10-Q, 10-K, press releases, Yahoo Finance, YCharts, Wall Street Journal, Thomson One and Morningstar.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CROX over the next 72 hours.