Does Crocs Have More Room To Run?

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About: Crocs, Inc. (CROX)
by: Ryan Waldoch
Summary

Explain how CROX is deploying a new business model to decrease expenses while focusing on e-commerce.

Detail how expensive their stock is relative to other high growth retailers.

Communicate why there may not be any room left for Crocs to grow.

Intro:

Over the last 52 weeks, CROX is up over 100%, but it seems that nobody is looking at this funky footwear maker from Boulder, Colorado. In this article, I will break down their business model, explain why they may have doubled in price, and investigate if there is still more room to grow while conveying why this stock is not a long-term buy.

Business Description:

Crocs is a global company that operates 389 stores, selling in three main areas, North America, Europe, and in the Asian Pacific. They’re focused on increasing their e-commerce presence and have had success selling in 90 countries through their 13 e-commerce sites. Crocs have seen their e-commerce presence increase the past three fiscal years, 14.6% of revenues were from e-commerce in 2017, 12.6% in 2016, and 11.1% in 2015. Transforming to accommodate the growing secular trend of e-commerce is important for Crocs and they even plan to reduce stores and increase their online presence.

Currently, Crocs plans on shutting down additional stores as they plan to trim lower performing stores. They have closed 30.3% of their retail stores in the past two fiscal years, from 558 stores in fiscal year 2016 to 389 as of Q3 2018, which signals this is an integral strategy of the company to transfer away from the brick and mortar model. Aside from their retail channel, they operate out a wholesale, and e-commerce division.

Their wholesale unit accounts for the majority of revenues as they have received 52.4%, 52.7%, and 54.2% of their revenues from this segment in the past three fiscal years 2017, 2016, and 2015, respectively. Their retail unit, which includes wholesale and storefronts, have attributed revenues of 33%, 34.7%, and 34.7% over fiscal years 2017, 2016, and 2015.

Annual Report

As seen in a snapshot from their full-year 2017 data, their e-commerce sector has grown 14.2% y/y, retail has fallen 5.9% y/y, and wholesale has fallen 1.8% y/y. All this data does not seem congruent with a company that has over doubled in the past 52 weeks when looking at the numbers at face value.

Even the revenues fell 1.2% in that time frame, but Crocs business plan clarifies as to why this stock has seen a parabolic increase. As mentioned before, it is their goal to reduce their brick and mortar footprint and push their e-commerce platform. So, a decrease in 10.9% in retail does not seem that bad when one considers that they closed a total of 30.3% of retail stores in fiscal years 2017 and 2016.

Crocs were guilty of oversaturating their market and seemed to even be cannibalizing their own sales. They plan on cutting additional stores over the next year and management even believes that wholesale and e-commerce should more than make up for any additional store closures.

I applaud Crocs' management team if they can accomplish this. Cutting back expenses while maintaining, or increasing revenues, is incredibly difficult and they should be rewarded for that. But here is the thing, the stock has run up over 100% so investors are clearly aware of the benefit this should bring to the bottom line. Adding on decreasing costs, management believes they can generate an additional $30-35 million in earnings by reducing their SG&A costs. This seems to be working as the team has released a message saying in 4th quarter 2018 they expect SG&A of 54% compared to their expected 60.6%.

YCharts

The reduction of SG&A is immense considering the significant portion of revenues it eats up.

Crocs doesn’t exactly boast crazy year over year growth in revenues, but again, that’s not their current business plan. Management still sees a 6% growth in revenues for fiscal year 2018 and even sees high-to-mid single digits for 2019. Modest growth, decreased expenses, and a more streamlined business model is all Crocs has needed to grow so far.

In conclusion, decreasing a significant amount of stores over two years and not seeing a massive slowdown in their retail unit is incredible, wholesale is planning on reducing underperforming stores but is expected to grow, and their push for e-commerce and reduced SG&A expenses are all positive and point to a well-managed stock that seems to have solid footing.

Valuation:

Although I sound very sanguine about Crocs, we need to remind ourselves that it has doubled its price in the last year and don’t want to reach for a stock that has run out of fuel. (CROX) trades at an incredible 113x earnings but that is irrelevant when one looks at predicted future EPS.

YCharts, Author

Compared to two other high growth retailers that I have covered, Crocs forward P/E multiple is at a more reasonable 24.71x earnings. Lululemon and Canada Goose are priced for growth, while Crocs is priced to maintain a healthy revenue stream and is being valued as a more mature company. Investors are acknowledging that CROX is maturing so that is what derives a valuation of 24.71 times earnings instead of a trailing P/E of 113. 24.71x forwards earnings are still high compared to the broadscale market, but some of Crocs competitors, such as Nike and Under Armor have forward multiples of 31.4 and 54.77, respectively. It seems as if investors see more growth opportunities in Crocs’ competitors like Nike and Under Armor where they are more expensively priced.

My theory for valuating this company is three folded.

  1. Crocs will have low single-digit growth in revenues due to their historically stagnant revenues
  2. Crocs can successfully cut SG&A costs in the coming years
  3. Crocs will grow its net income, but primarily because it is able to cut costs

The third point is the most important and probably the reason they were able to run up over 100% in a 52-week period. Investors realized that Crocs will increase its bottom line over the coming years, but after they remove any non-vital retail stores, cut costs, and have firmly established their e-commerce presence, Crocs has little growth drivers. Over the past seven years, Crocs’ revenue has ranged from 1 billion to 1.19 billion, conveying it has exhausted most of its growth potential and is becoming stagnant. The only hope management had to boost net income and raise their EPS was to cut costs. E-commerce could bring additional revenue, but they already operate online in 90 countries and even that revenue stream may become stagnant because in the next few years management is decreasing spending in advertising, which is a byproduct of their vow to reduce SG&A costs.

From what I see, there is little growth potential in the physical products Crocs sells, and any increase in net income and EPS will be derived from cost cutting.

Expenses can’t be cut forever, and when Crocs reaches a point in which they cannot cut any more expenses, I would not rely on their revenue stream to keep this company growing.

Therefore, I acknowledge that this stock could continue to grow in the next few years as a result of its cost cutting initiatives, but in the long run, this company simply does not have the revenue stream to sustain growth in the stocks price.

Rating

So, in the next 12-24 months, I believe that Crocs could start seeing a substantial positive impact on its bottom line which would result in a higher stock price. In these months, Crocs should be able to implement the majority of their business plan and thus start seeing tangible results by this time.

I would rate CROX as an outperform in this timeframe but would not recommend it becoming a core position.

In the long run, as I mentioned before, there are no significant growth drivers and revenues have been stagnant for the past seven years. I would rate CROX as an underperform.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.