Skullcandy: 9 Times Forward Earnings, Yet 42% Of Outstanding Shares Short

| About: Skullcandy (SKUL)

Short sellers profit by taking large short positions while creating a market environment designed to panic shareholders into selling their holdings. They have mastered the ability to create panic, which leads to the selling flow of stock required to cover their large short bets. In the rare instances where companies perform and the shorts are unable to create institutional selling, the continued institutional accumulation of shares will eventually overwhelm the shorts and create a perpetual short squeeze. As the Institutional and insider holdings approach 100% of the outstanding shares, today's suppressed stocks often become tomorrow's high flyers. I believe this will be the case for Skullcandy (NASDAQ:SKUL).

2 Quarters to Paradise

In the second quarter, as 14 of the top 15 fund holders were buying more stock or holding their positions, the professional shorts were busy selling another 25% of the company they don't own. Clearly with these shorts willing to short 78% of the float, we are looking at the potential for a historical short squeeze. The last reported institutional holdings of 21.174 million shares and the insider holdings of 10.1 million shares add up to 31,274 million shares in a company having only 26.5 million shares outstanding. There are only 5 million shares not held by institutions, and the declared short position is 11.7 million shares. With Scullcandy projected to make $0.87 in the next two quarters, I say grab your popcorn and get ready for the squeeze of a lifetime.

What Kind of Fad Has Numbers Like This?

Skullcandy is a lifestyle products company selling distinctive audio branded headphones and other smartphone accessories. Skullcandy brings color, character, and performance to what has been a monochromatic space, co-branding products with the NBA and other sporting venues.

While the shorts have made a point of dismissing the value of their brand, I suggest they check out Nike and Lululemon Athletica. Neither company designs and manufactures a product that can't be copied and reproduced; however, each company is a master at marketing their product and placing it in the correct channels to maximize revenue. Skullcandy has the same type of branding appeal and with the massive short interest, is poised for a classic short squeeze.

Net sales in the second quarter of 2012 increased 38.2% to $72.4 million from $52.4 million in the same quarter of the prior year. In the second quarter of 2012, domestic net sales increased 34.1% to $50.6 million, international net sales increased 59.9% to $16.5 million and online net sales increased 22.8% to $5.3 million.
 Gross profit in the second quarter of 2012 increased 33.1% to $35.7 million from $26.8 million in the same quarter of the prior year. Gross profit as a percentage of net sales, or gross margin, was 49.2% in the second quarter of 2012 compared to 51.1% in the second quarter of 2011. The decrease in gross margin is mostly due to a shift in sales mix to higher price point products with lower gross margin structures.

  • Skullcandy is followed by 11 analysts. 10 of them have buy recommendations with a consensus price per share estimate of $22 and a high of $33.
  • The last three years' revenue was $118 million, $160.5 million, $232.4 million, and projected revenues for 2012 are $280 million.
  • Skullcandy has beaten the consensus earnings estimate in the 5 quarters they have been public.
  • Earnings were $1.00 per share in 2011 and are projected between $1.15 to $1.20 in 2012. Earnings are projected at $1.43 in 2013.
  • "For the full year 2012, the Company is reiterating its net sales and adjusted diluted earnings per share outlook of $280-$300 million and $1.10-$1.20, respectively. The adjusted diluted earnings per share outlook excludes $0.4 million of after-tax expenses related to the Monster litigation in the first quarter and assumes an effective tax rate of approximately 36.5% and diluted weighted average common shares outstanding of approximately 28.7 million."

  • The PEG ratio for SKUL is 0.56.

  • For a great operational overview of SKUL, see here.

Previous Distorted Fads Are Now Household Names

Nike (NYSE:NKE) was a company that had a lot of skeptical shorts early on. The shorts bet heavily against Nike's ability to compete with the established sport shoe brands. Phil Knight had a vision of co-branding through top athletes and sponsored sporting events. He understood the influence these idolized athletes had among the market he was trying to reach. Today, Nike is worth $40 billion, and the shares have appreciated from $21.70 to the $97 NKE is trading at today.

Priceline (NASDAQ:PCLN) was a fad that was supposed to die in the dot com bubble. Who could have guessed a reverse auction on the internet could transform the travel and hotel industry? Only the people that needed to find discounts truly realized the value of Priceline. Today, Priceline is worth $37 billion, and the shares have appreciated from $54 to $756 in the last 5 years.

Lululemon Athletica (NASDAQ:LULU) is a sports clothing brand that specializes in yoga clothing. The shorts failed to grasp how large the yoga market would become. The upscale demographics of the yoga clothing buyer destroyed the rationale for shorting this stock. To this day, shorts are still wondering who is buying these $60 t-shirts. Lululemon has branched into selling other product lines, and has become the highly valued brand it is today.

Monster Energy (NASDAQ:MNST) has captured market share in the energy drink market. The shorts never believed Monster Drinks could compete and take market share from Red Bull. More importantly, how could any small company compete with Pepsi or Coca Cola? Monster developed a successful marketing campaign centered around sporting venues, and now all the major drink companies realize how big the energy drink market is.

A Convenient Truth

Morgan Stanley slammed the company with a downgrade from overweight to equal weight and a cut in its price target from $21 to $15. If Morgan Stanley is right in their $1.40 EPS estimate for 2013, how could they lower the price target to $15? If Skullcandy makes the $.87 cents projected in the next two quarters, Morgan Stanley can join the shorts as roadkill on the way to $40.

Disclosure: I am long SKUL, LULU. 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.

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