Crocs Crushes the Bottom Feeders

In today’s market, it can indeed be tempting to bottom feed and make Vegas-like bets on stocks that have gotten crushed in the weak economy. A poor economy not only slams a company’s earnings, it also compresses the multiple an investor is willing to pay for a stock as market risk heightens and the famous “g” in the PE formula withers down. At that point, many will ask themselves: how much worse can things get? And so they bottom feed the market looking for beaten-up valuations and normalized earnings power in 2009, or whenever you think the business cycle inflects.

We ourselves are guilty of bottom picking – we liked semiconductor equipment maker Varian (VSEA) at $38 – that stock is down a quick 10 after guiding Q4 lower late Thursday; clearly, the memory spending area is still soft and Varian investors will have to sit on the sidelines until the multi- quarter trough shows signs of abating.

Crocs (CROX), however, was one we urged potential bottom feeders to avoid. On

May 9th, we put out an article citing an unnamed buy side contact of ours who suggested that management wasn’t pulling numbers down enough.

Taking the ugly economy, a lower run rate to account for weaker international sales, and a below consensus gross margin, we insinuated that Crocs had another shoe to drop:

CROX has not yet put a headlock on its inventory and margin issues, and on top of that, international sales are decelerating: that has us worried, especially because CROX management has pitched the international scene as their main avenue for growth going forward The question we need to be asking ourselves right now is: has management pulled down numbers far enough?” (May 9, 2008)

Late Thursday, Crocs finally ratcheted down numbers, slashing Q2, Q3, and FY08 financial targets due to soft demand for its footwear. Chief Executive Ron Snyder said in a statement that retailers across the board were "extremely cautious" with reorders and that overseas performance was weaker than expected.

Below is a review of management’s new estimates vs. what either they or Wall Street was expecting just a few months ago – clearly, the change in outlook is staggering (click to enlarge image):

There is one other data point we’d like to point out, even though the ~50% sell off in CROX shares late Thursday likely re-priced it into the stock already – and that’s the sharp reversal of fate in sales that is befalling Crocs.

As one can see below, Q208 will be the first quarter in which Crocs sales will be down on a YoY basis – the question now becomes: Is this a one-time event because the economy sucks? Do sales continue to trend lower or re-accelerate sometime in 2009? We don’t know, but given the nonexistent moat characteristic of the footwear industry, we’d argue that Crocs is more of a “has been” than a “could be” security.

We also looked at what the buy side has been doing with this stock, and there are still 122 funds (source: Investors.com) holding this stock, and that’s after the number of funds invested in CROX has declined 30% in the last 9 months. If we were Crocs management, we’d be putting a pretty nice Power point together to prevent those funds still holding the stock from fleeing through the crowded exit.

To no one’s surprise, Crocs is getting creamed in the pre market. Given the inauspicious sales deceleration-to-decline pattern we pointed out above – and the number of funds still holding the stock, which we estimate will be 20-25% lower when fund holdings for Q208 are soon released – the stock remains a SELL.

Disclosure: no position

Comments

[BoulderBiker]

What a poorly run company!

[NormanQ]

Crocs are a piece of crap plastic shoe that looks ugly as hell to wear and are probably the easiest thing to pirate and sell for $3 a pair. International growth will be nil and people here in North America have finally realized how silly they look.

[DM226]

I agree with Norman. Anyone who couldn't see that Crocs was just a tacky fad is just plain dumb. Does anyone think that people were really going to continue to wear those ugly plastic shoes? What a joke!

[Former-CROX-Long]

Daniel – great analysis.

I read your previous articles on CROX and, must admit, didn’t agree with them. That was in May and June.

However, after the stock shot up from $6.75, I sold all my shares in the mid $8 range. Felt terrible after the stock went above $10 but don’t feel too bad now!

Anyway, you were right and all CROX “defenders”, me including, were wrong.

Congratulations,
Ed

[DanielJacome]

Boulder -- I agree, CEO Synder should have stepped down a while ago. Not many execs, except GM's boss, can ride a stock down like that and keep thier job. The least he could have done is buy some stock and put his $ where his mouth is

Former CROX long (Ed) -- thank you for your candor and comments

[MD]

Tattoo this to your forehead and read it every morning brushing your teeth:

I WILL NOT INVEST IN FAD COMPANIES

Great job Daniel.

Steve
magicdiligence.com

[DanielJacome]

MD -- thanks! Stll aghast at how so many smart people got burned on this one...one lesson I learned -- below 10 P/E is NOT EQUAL to good value : ) -

[you_can_call_me_Al]

The original Crocs could certainly be considered a fad, but their comfort is undeniable. The expansion of the line into non-ugly models was also encouraging. Finally, growth for new models in the U.S. was (is) a possibility, and international growth for all models seemed to actually have been happening. These are the traditional points that longs use to counter the short "it's a fad" argument. Recent sales have settled the argument, and now we know who was right. Full disclosure: I wasn't.

What is now confusing is that no one has presented what should be the new short argument: management appears not to have a handle on their business.

You mentioned the size of the changes to estimates, but did not go nearly far enough. All the arguments about potential product demand can only go so far, and none of them are as important as management credibility. This is the second quarter in a row where shareholders have been blindsided. It's doubtful that professional money managers will be there for a third.

[DanielJacome]

"What is now confusing is that no one has presented what should be the new short argument: management appears not to have a handle on their business."

no one had to talk about it b/c mamangement made it clear themselves on the conference call this morning : ) - listen to Tom Duffy's question to mgmt in the call and mgmt's response -- SG&A and its relation to sales is out of whack

[DanielJacome]

CROX down another 11% today! too many funds will have to let go b/c the stock is < 5