Crocs: It's the Product, Not the Economy

After yesterday's earnings warning it looks like the Crocs Inc. (CROX) story is headed to an end.  With revised 2008 expectations of revenue undperforming 2007 figures and EPS at breakeven, at $4-$5 per share, CROX is still grossly overvalued.  In addition, there's been very little action by management over the past few months to suggest that insiders have any belief that CROX shares represent a bargain.

What was laughable was the spin management tried to put on some questions on today's preliminary Q2 conference call.  For example, one analyst discussed potential customer attrition in terms of a possible reduction in retail doors.  Management suggested that CROX was looking to "create attrition" as though this was the Company's decision.  So the interest level in CROX shoes is slowing in the U.S. and retailers don't want these products, but CROX ending relationships with some of these retailers is the Company's own decision?  International growth also came in below the Company's expectations, indicating that demand for its product is waning overseas.  On top of that the CROX kiosks are experiencing declining comps.  Management was able to blame the economy, but the reality is the products have no competitive advantage and there's little doubt the Company's products were part of a short-term fashion trend (fad).

Rather than the high-growth, high-margin business that management presented to investors while aggressively dumping shares last year, investors are now realizing this is a negative growth, declining margin business and management is now "sizing our business to be profitable on lower projected sales volumes..."  Better said, it looks like CROX is following a "shrink to grow" strategy which is unlikely to work.  Based on today's conference call, management is still not utilizing total production capacity at existing factories through Q3 08 and doesn't expect full utilization to occur until spring production occurs.  This seems like a contradiction given that the business has to be reduced for lower sales volume, yet management is currently maintaining the existing facilities which will supposedly be at full capacity heading into the spring production season.

CROX had a terrific run from 2006 through the fall of 2007 but things have changed markedly since Q3 07.  Management has no credibility as it continuously misses its own estimates, and the Company's capital market handlers like Piper Jaffray have no credibility either.  Piper was lead underwriter on the Company's IPO and secondary offering where insiders sold off a considerable amount of their shares, so my skeptical side was not too surprised to see Jeff Klinefelter and other analysts consistently echo management's sentiments and voice strong support for the Company.  As recently as June 20, 2008, he reduced his rating on CROX to $17 from $20 but maintained a "Buy" rating on the stock.

It's perfectly acceptable to be a contrarian, but the risk with CROX was quantifying how much of its growth was due to a short-term hysteria surrounding the products and that eventually children, who accounted for a good portion of sales, would move on to the next trend.  With negative expected sales growth in 2008 CROX should now be valued at a much more severe discount, particularly when these sales are coming at the expense of profitability.  The Company is expecting a slight reduction compared to 2007 sales yet profits are down significantly, even when accounting for various one-time charges.  Table I presents my estimate of where 2008 revenues shake out and what the market could value CROX at based on the latest information provided by management.

TABLE I: CROX VALUATION ANALYSIS

Given the problems facing CROX, I stand by my seemingly laughable valuation range.  However, someone could doubt this and suggest CROX must be worth more than $1-$2 per share, after all, as of Q1 08 CROX had roughly $5.50 in book value.  The problem is that book value is inflated due to the valuation of inventory and various intangible assets on CROX's balance sheet.  Even on today's conference call, analysts appeared concerned with the Company's inventory levels despite these inventory levels being worked down.

Q2 08 book value will not be changed much from Q1 as at the mid-point of Q2 08 guidance, only $4MM of earnings will be added to the Company's book value.  So assuming CROX hits $0.05 in EPS for Q2, book value is roughly $5.54 per share.  Inventory will be around $230MM but will still be high on an absolute basis.  The true economic carrying value of these rubber shoes could be 50%-65% of that figure or $115MM-$150MM.  In addition, CROX carries about $57MM in goodwill and intangible assets.  These various patents and trademarks appear to have little value as there are a number of imitations sold globally.  When writing these phantom assets off and combining them with the midpoint of the inventory's  more realistic value, CROX's book value could be overstated by $155MM meaning the economic book value of the Company is really about $3.60 per share.

Also, that is based on the book value of CROX as of today.  For Q2 08 management is expecting a slight gain but by year-end 2008, the Company will be at breakeven, meaning no gains in book value will occur.  Management believes 2009 sales growth will be in the mid single digit range, but what kind of credibility do they have when they missed their revenue goals by over 10% for this quarter and EPS estimates by over 90%?  I suspect sales will probably decline in 2009 and margins will continue to suffer, which means that everyday CROX operates is a day that futher erodes the Company's value.  This is because retailers have leverage with CROX in terms of ASPs for the Company's shoes while production facilities are not being run at full capacity.  A glut of production facilities and those associated costs of under-utilization combined with potentially declining ASPs will mean subsequent quarters of operating losses which will eat away at CROX's value.  Also, this does not even factor in the transition steps management will be taking to right-size the business which will surely result in other additional charges.

While CEO Ron Snyder states that "we remain confident about the long-term prospects of this business" in the latest Company filing, he and other insiders have been reluctant to demonstrate any interest in the Company as an investment.  As Form 4 Oracle illustrates, management was all too happy to cash out, selling hundreds of millions in CROX stock when share prices were inflated and the Street was pumping the stock.  Now, at prices some couldn't imagine just 10 months ago, management has just one open market purchase to its credit, which in all fairness is one more than any investor should have at this point when it comes to CROX.

Disclosure: Author manages a hedge fund that owns puts on CROX

Comments

[Dan Jacome:]

great analysis

2008 Jul 25 02:02 PM

[Gumby:]

Other shoe makers use sweat shops overseas where there is a lot of VOCs associated with glues used to make Nikes, Reeboks and New Balances. Try entering one of the sweatshops there... Crocs use finest material called croslite that resist bactera growth. Crocs doesnt make beach types only... Crocs also make loafers, winter shoes, hiking shoes and work shoes without the holes... Also kid shoes... I beleive that it is your last day of hurrah with your naked short selling on Crocs as you very well know that the SEC chairman is going to ban all , I mean all, naked short sells on all stocks on the Board... You are outta luck.... It is interesting that Crocs got hit in the same time frame that the SEC chairman want all naked short sells banned. Very interesting, tsk tsk....
You are nothing but a little kid throwing off tantrums... Here is your teddy bear, tyke..

2008 Jul 25 02:31 PM

[Egg:]

But, but, but....

CROX makes plastic shoes. Plastic shoes, I tell ya!

Doesn't everyone want plastic shoes!?!!?

2008 Jul 25 02:33 PM

[Gumby:]

Didnt you hear that Medicare will provide Croc shoes to diabetic patients ? Croc shoes is not plastic, Crocs is made of croslite. Read more about croslite on the web... Also check out the website crocs.com for exciting shoe styles ranging from hiking boots to loafers and even lady shoes... One more reminder.... naked short selling is dead!!! Forever.... I be Amit the author of this article is packing in his office.. he is laid off... He is just a pissed off prude...

2008 Jul 25 02:42 PM

[Gumby:]

Crocs make quality products not stuff put together with smelly glues of all sorts that knocks you out at stores...

2008 Jul 25 02:43 PM

[Gumby:]

Wall strreet hates quality stuff very much!!!! Wall Street is being beat up for its decadent thinkings...

2008 Jul 25 02:44 PM

[Dan Jacome:]

again, excclent article -- you don't see teeth grinding work like this on the sell side -

quick question, and apologies if it is an ignorant one -- you mention "Inventory will be around $230MM but will still be high on an absolute basis. The true economic carrying value of these rubber shoes could be 50%-65% of that figure or $115MM-$150MM..."

how did you get to that 50-65% discount?

thanks ~ DJ

2008 Jul 25 02:55 PM

[Kashi's King:]

@Gumby - you, sir, are a baboon

2008 Jul 25 03:40 PM

[cusman:]

Seems to me that the Medicare endorsement for Crox shoes for Diabetics is an automatic boon to their sales base. About 22 million pairs more shoes to sell.

Also Crox has growth overseas in europe and is expanding to other markets.

Their US retails sales growth has stagnated or declined doesn't mean the company is dead.

I wonder why this company was trading at $70/share just a year ago and now at $5 it is not considered under-valued?

2008 Jul 25 05:16 PM

[ValueInvestor:]

Crox are simply a fad item. As we all know, fad's only last a few years until something else comes along.

2008 Jul 25 05:41 PM

[Wez:]

Lol, Gumby you could not look more like an ignorant fool. Amit, great job and looking back at your previous articles, you were on this early. I had puts for the ride today, but you've given me renewed desire to buy them back and ride this thing into the ground, where it deserves to be.

2008 Jul 25 06:05 PM

[Steven Hansen:]

i would hate to be in this line of business. where i live the croc knockoff costs 2% to 10% of the real thing. they have to keep changing and changing to keep ahead. based on their sales, they need a new tactic to beat their competition.

2008 Jul 26 03:40 AM

[jdspain:]

crocs has terrible management , first no inventory, then production of huge amount of product and then they go into a style change and make the product obsolete.

crocs problem not shoes, i loved them very comfortable.. it is the managers of the company..

2008 Jul 26 09:14 AM

[borisb:]

One thing no one cares to touch on is that before they put a US marketing spin on these shoes, the Crocs company was selling them for $12.99 retail in Canada, the fact they jacked this up to $30 -$40 in the US was unsustainable. Now they may have to lower those prices back down and the gross margins are going to go kaput, and the retailers arent going to promote $12 shoes as much as $30 shoes.

2008 Jul 26 10:27 AM

[Mexx:]

What is up with Gumby, sounds like he bought the stock at $70 and is blaming Wall Street for his massive losses. Shoes made of the "finest" materials won't necessarily make you money you fool -if that was your investment thesis for Crocs, I can see why you are so pissed off.

And do you think that seeing a bunch of medicare patients wearing crocs is going to raise the coolness quotient for the fashion conscious?

Enjoy your "bacteria free shoes..." that is real fashion statement if I every heard one!

2008 Jul 26 11:39 AM

[Mexx:]

Amit, great write up and analyisis. Prior to yesterday, I thought Crocs was hitting a slump due the economic woes just like all other apparel brands. I thought their inventory problems was a short term snaffu that could be fixed. Furthermore, their positive int'l growth and brand extensions seemed favorable drivers for a potential bump up in the stock price to the mid-teens from the $9 levels prior to yesterday. But hearing the incompetence and misguidance of management in their earnings call yesterday, I realize I was dead wrong. I was long on CROX and will be cutting my losses very soon as I no longer see any real catalysts for this stock to go up anytime soon, not this year or the next.

I anticipate the trickling of bad news will continue quarter after quarter and the stock will continue its downward slide.

2008 Jul 26 11:48 AM

[notsosmart:]

my wife bought them when the stock was app.$35(no connection) & as time went on she bought othercolors until 2 things happened. she noticed they were now made n china instead of here(different feel & texture) & ordered a pair on the net.i had to hang them in the garage for 3 weeks till the sweet pungent odor was gone. we called headquarters to find out if they still made some in the usa & we were told that there was no way they could give us that info.so our buying of this product has come to an end.a good quality,odorless item made here might have saved the day for them.but then again maybe the insiders made enough money for their children,grandchildren etc to not really care.from enron to worldcom to gm to ford to hedge funds just pay up while i ruin the co.-that seems to be the way alot these days.sad

2008 Jul 26 01:43 PM

[jimsep:]

Beware any IPOs where there is significant insider selling. Shame on the underwriters who allowed it. There is no question which customer they were on the side of. It was the company and certainly not their individual brokerage clients. Surprise! Surprise!

2008 Jul 26 07:56 PM

[notsosmart:]

shame-a word usd a lot on this site & others. its become meaningless.get as much money as i can regardless of how i do it-thats the theme of today.who needs ethics as long as its legal & if illegal who cares cause few get caught.

2008 Jul 26 09:22 PM

[Dan Jacome:]

Piper Jaffray was pumping this ALL the way down...if anyone should be ashamed, it is them...the bankers @ Piper did not only the Crocs IPO but also their secondary...of course, the bankers/Ron Snyder made off like bandits while those holding the common got wiped out to the tune of 90%

2008 Jul 27 04:26 AM

[connie:]

I do not know much of the money side of Crocs but I can say they are very comfortable and colorful. I have many styles to wear. When one pair wears down I just buy another. Understandable the croslite wears in time but the comfort is what's important. If management can not run the product then change the management. I believe it is a good shoe and I plan to keep wearing them. Comfort..Comfort..comf... Good Luck to Crocs!

2008 Jul 28 01:06 PM

[connie:]

Thanks you Crocs. I love your shoes.

2008 Jul 28 01:11 PM

[He who walk...:]

What about all the lawsuits that crocs will loose any time soon? They have sued God and everybody. Why is it so hard to understand that crocs is a copycat. It is not the orginal!!! In reality they don´t have immaterial rights even worth the paper it is written on. Best was when they lost an utilitypatent in europe and was sued by an italian company owning the "orginal patent" for trying to steal thier patent!!! Crocs are crooks. I think SEC should challange Crocs IPO. It was a one of the biggest scams in recent days.

My 2 cents...

2008 Jul 28 07:31 PM

[ketchup:]

One thing is for sure. Don't listen to analysts. They're hypocrites. Read their articles last year. Buy Crocs! All the way!! They only write for the now. They rarely ever get the future right. My thoughts are the following: If Crocs can get focused on the medical aspect like this new deal they signed with the diabetic folks. If they can get focused on better copyrights. If they utilize their product for its material v.s. fashion they may still have a chance. The only people wearing them now are people that like them, people who accepted the new versions, medical people like my mom, and soon to be 23 mil. diabetics I hope. In reality thats not very many people. Johnson County bimbos arn't going to be wearing them anymore that's for sure. They are not in style by any means. Clothing? What? If they don't get focused they will truly go under. Maybe they sell. Who knows. I'm not an analyst.

2008 Aug 05 10:40 PM