CROX: The Perfect Large Cap Value Stock
Guest post by Shailesh from Astute Investor's Calculus
Hi all, MktContext here. From time to time we look for incredible Substack authors to share their investing ideas with you. This post from Astute Investor’s Calculus is a deep dive on the well-known shoe brand, Crocs. Subscribe to AIC for more analysis like this!
Large-cap stocks are generally not known to throw up a lot of value ideas. For any of these stocks to get significantly undervalued requires scores of Wall Street analysts to be sleeping, at the exact same time.
But CROX -3.43%↓ seems to be undervalued. This company has grown sales on average at 28% rate for the past 5 years and the stock today trades at merely 7.9 times earnings. What gives?
In this article, we will review
Business overview of Crocs Inc
It’s recent financial performance and sales and earnings trends
Balance sheet strength and liquidity
What went wrong and can it be fixed
My estimate of its fair value and whether the stock today is an attractive investment or not
Put on your most comfortable pair of shoes and grab a cup of coffee. We will take a walk through the fascinating journey of Crocs (CROX)—from its humble beginnings to its rise as a footwear powerhouse and what makes it a compelling stock to watch today.
First, a little about me:
I’m Shailesh Kumar, and I write Astute Investor’s Calculus on Substack, where I dig deep into small-cap value stocks, constructing portfolios with the Kelly Criterion to offer long-term value investors the ultimate advantage—a trifecta of potential:
High-performing stocks strategically chosen in the top-performing asset class, small-cap value,
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Please note: I am not a financial advisor and this is not financial advice. You can lose money investing in something you do not understand so please do your own due diligence.
The Croc’s Saga
Crocs was founded in 2002 by Scott Seamans, Lyndon "Duke" Hanson, and George Boedecker Jr., after acquiring a unique clog design from Foam Creations, Inc. Recognizing the product’s comfort and practicality, they launched the company to produce and distribute the sandals, naming the brand "Crocs" to reflect its amphibious utility. Crocs introduced its first model, the Beach, at the 2002 Fort Lauderdale Boat Show, selling all 200 pairs. This marked the start of its progression into a prominent global footwear company.
Key Milestones in Crocs’ Growth
Material Innovation: Crocs uses Croslite™, a proprietary closed-cell resin foam, offering water resistance, comfort, and a custom fit.
Marketing Campaigns: In 2005, the "Ugly Can Be Beautiful" campaign highlighted the product’s unconventional aesthetics and comfort, boosting brand recognition.
IPO (2006): Crocs went public on NASDAQ, raising funds to support expansion efforts.
Global Reach: The company expanded internationally, selling over 100 million pairs of shoes and establishing its headquarters in Broomfield, Colorado.
Collaborations: Partnerships with companies and celebrities, including Justin Bieber, Post Malone, and KFC, broadened its market appeal.
Pandemic Impact: During COVID-19, the demand for comfortable, casual footwear surged, driving increased sales.
Financial Growth and Challenges
Crocs achieved record revenues of $3.6 billion in 2023, reflecting a 54% increase from 2021. However, the company has faced significant challenges, including a steep decline during the 2008 financial crisis, which led to store closures and layoffs. Post-crisis, Crocs streamlined its operations and diversified its product offerings, enabling a sustained recovery.
Cultural Evolution and Market Position
Initially met with mixed reactions due to its unconventional design, Crocs gradually gained acceptance, evolving into a mainstream brand. Its collaborations and adaptive marketing strategies have positioned it as both a functional and fashion-oriented product, appealing to a broad customer base.
Crocs’ Recent Financial Performance
We will start with the most recent guidance that the management provided. This covers Q4 2024 as well as full year 2024.
In Feb 2022, Crocs acquired Heydude, an Italian shoe brand. Integrating Heydude within Crocs is proving to be difficult and the company has seen worsening performance in the Heydude division, even while their eponymous Crocs division is performing well.
Crocs had record annual revenues of $4 billion in 2023, with about $1B coming from Heydude, marking a 54% increase over 2021. This success is attributed to several factors, including the company's global reach, strategic collaborations, and the pandemic-driven surge in demand for comfortable footwear.
The company has seen 6 continuous years of revenue growth, including the pandemic surge when consumers stayed home in comfortable shoes
and their operating margins have been strong
Despite these successes, Crocs has also faced recent challenges, primarily related to the acquisition and integration of HEYDUDE, an Italian shoe company.
Challenges
Declining HEYDUDE Brand Revenues: In the third quarter of 2024, HEYDUDE brand revenues decreased by 17% year-over-year. This decline was observed across both direct-to-consumer (DTC) and wholesale (WHL) channels, with DTC sales down 9% and WHL sales down 23%. This decline suggests potential challenges in integrating HEYDUDE into Crocs' operations and maintaining its brand momentum.
Decreased Operating Margin: While Crocs achieved a 220 basis point improvement in adjusted gross margin in the third quarter of 2024, the adjusted operating margin decreased by 290 basis points year-over-year. This decline is primarily attributed to increased selling, general, and administrative expenses, partly driven by costs associated with the HEYDUDE acquisition and integration.
Impairment Charges: In the full year 2024, Crocs expects to incur approximately $28 million in costs, primarily for impairment charges related to information technology systems and the transition to a new HEYDUDE distribution center. These impairment charges reflect the complexities of integrating HEYDUDE's infrastructure into Crocs' existing systems.
Positive Outlook
Strong Crocs Brand Performance: Despite the challenges related to HEYDUDE, the core Crocs brand remains strong. In the third quarter of 2024, Crocs brand revenues increased by 8% year-over-year, driven by strong growth in international markets (17% increase). This growth underscores the brand's continued popularity and global appeal.
Strategic Initiatives: Crocs is actively investing in strategic initiatives to drive future growth. These include:
Igniting Iconic Products: Leveraging the popularity of the Classic Clog and expanding product franchises like Cozzzy Slipper and Echo Surge.
Attracting New Consumers: Diversifying the product range and targeting new usage occasions.
Gaining Market Share: Focusing on strategic investment in talent, marketing, digital, and retail to capture a larger share of the footwear market.
Strong Financial Position: Crocs maintains a healthy financial position, with strong cash flow generation and a commitment to returning capital to shareholders through share repurchases and debt repayment.
Balance Sheet Strength and Liquidity
Crocs’ business is performing well and the company seems to have a strategy to reverse the declining performance of Heydude brand. Additionally, the company is focused on paying down debt and returning capital to the shareholders.
The Debt to Equity currently stands at 1.73 with $3 B in total liabilities and $1.73 B in Equity. This is a little bit higher than I would like but not necessarily unsustainable. The company’s interest cover is at 8.4 so servicing the debt is not really an issue.
I am a little more concerned about their liquidity. Their Current Ratio is 1.43, which though not too low, is kind of on the edge of what I would like to see as a value investor. They have Current Assets of $990 m and Current Liabilities of $693 m. Certainly Current Liabilities are covered. However a large chunk of the current assets are tied up in inventory (~$367 m). Removing this, the Quick Ratio is at 0.9, which means that if they were in a need to raise cash quickly to pay off their current liabilities, they will likely need to borrow quickly.
As of Sep 30, 2024 they have $559.2 million in available credit under a revolving facility maturing in 2027, with variable interest rate (base+ structure). So I would not worry about their access to credit in the short term.
They are also able to access bond markets for long-term financing needs at favorable terms.
In my final review, the balance sheet is strong.
Fixing Heydude
The company is growing sales and has strong balance sheet, there is sufficient quality here for us to move on to the valuation analysis. However, we do need to satisfy ourselves that the company has a plan to fix the declines in Heydude.
The company calls 2024 and perhaps 2025 as “investment years”. They believe that we will see some operating margin erosion as the company works to stabilize the revenues at Heydude and expand Crocs in APAC countries which is where its recent growth is coming from.
They have reduced the number of wholesalers servicing Heydude products and have refocused their channel strategy to diversifying into Heydude branded outlet stores. The goal is to cut out the middleman and increase DTC percentage - this should improve margins, which should hopefully provide more capital to reinvest.
It remains to be seen if the plan will have the desired effect, but it is important to know that the company is aware of the issues and is focused on finding solutions. There are additional options available to the company, including divestment, if this strategy is not effective. The company paid $2.4 B for the Heydude brand and it generates about $1 B in revenue from this brand every year, so the purchase price was about 2.5 times current annual revenue - this is still a good buy. The company has strong gross and operating margins and this gives them a good runway to make the strategy work.
Valuation of the Crocs’ Stock
Let’s consider the valuation in the following context:
Strong P&L, Revenues growing at 20% CAGR in the past 6 years. This is greatly skewed with a 66% growth in 2021 due to pandemic surge but it is important to note that the company has kept the revenues growing post 2021.
Strong Balance Sheet - small issue with quick ratio but there is enough borrowing capacity available to make sure this is not really a problem
Challenges with Heydude - there is a plan to reverse the declines in Heydude and the strong balance sheet and operating margins give the company sufficient runway to find a fix if the current plan is not effective
Possibility of weakness in the stock this year due to this year being a re-investment year as the company invests in addressing its challenges. This, of course is the reason why there may be an opportunity in the Crocs’ stock today.
There are multiple ways to look at valuation. We will take the simpler P/E route, as the idea here is valuation + quality + growth for a company undergoing temporary hiccups.
The company has a trailing P/E of 7.7 and a forward P/E of 8.3, mainly because while the company expects about 3% revenue growth next year, its EPS may decline slightly by about 0.4%.
The peer analysis shows that a typical P/E range could be in the 12-13 range. CROX itself has had its P/E multiple expand to about 30 during the pandemic surge so 12-13 range is very much possible - once the Heydude issues are fixed.
Of course, once Heydude issues are fixed, the revenue and EPS will be much higher so the price target will then have to be raised.
At the current P&L, this would give Crocs a target price of $172.8. It is currently trading at $106.45, which is a 62% increase. I expect this to happen in less than 2 years.
Here is another data point. The Casual Footwear market is currently around $160 B per year market and Crocs with its $4B revenue has about 2.5% market share. They have significant potential if they were to increase their market share - they certainly have enough margins to make this happen, either by growth or further acquisitions.
They have barely started. To me Crocs today is an opportunity similar in scope as Coca Cola was for Warren Buffett.
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PS. Not financial advice. Please do your own due diligence. You can lose money investing in stocks.