This Stock Still Might Be a Value Trap

As a value investor, I'll be the first to tell you that on the surface shares of Skechers (NYSE: SKX  ) do seem compellingly cheap according to most metrics. For example, its enterprise value/EBITDA of 3.0 is significantly lower than that of just about all of its competitors. Timberland (NYSE: TBL  ) and Wolverine World Wide (NYSE: WWW  ) trade at 8.4 and 9.4, respectively. In addition, it's not often you can find a stock touted by many as a growth stock that also fits nicely into the value category. However, I am still having a difficult time getting excited about the company even at these low price levels, and the same type of growth that other investors are clamoring about -- specifically its toning shoes -- I believe is just another fad.

But Kim Kardashian wears Shape-ups
We have witnessed numerous bubbles over the last decade on a macroeconomic level, but shoe industry fads have created some pretty spectacular bubbles as well.  First was the collapse of Heelys (Nasdaq: HLYS  ) , as parents realized that buying shoes with wheels on them was probably not the safest purchase for their kids. The stock traded as high as $40 at the beginning of 2007 before collapsing below $6 in the same year.

Even more spectacular was the collapse in the all-rubber shoe bubble that saw shares in Crocs (Nasdaq: CROX  ) drop from $75 to below $1 in just about a year. Investors in Skechers need not worry about similar declines as the company was never awarded the extreme valuations that these "growth" favorites once were. However, I find it troubling that many are expecting this toning line to be the growth engine of the company's future.  

Toning shoes have helped early innovators like Skechers and Reebok take some market share from Nike (NYSE: NKE  ) , which dominates the athletic shoe market. It also helped that Nike has refused to enter this gimmick market that produced sales of just $17 million in 2008, but skyrocketed to $145 million in 2009. Sales in the first four months of this year produced sales $252 million, surpassing the last two years combined.

Reebok advertises research that its toning shoes will tone the gluteus muscles by up to 28% more than regular athletic shoes, while Skechers goes as far as saying that its shoes will help you "get in shape without setting foot in the gym."

It's not as if more independent research is needed to refute these claims, as my colleague Alyce Lomax recently pointed out there are plenty of these reports to go around. Just in case you needed some more evidence that this toning shoe craze is a fad, Skechers even has Kim Kardashian, the hottest fad in Hollywood, endorsing its shoes.

Already discounting?
Another bad sign for Skechers investors is that the company has already begun selling its toning shoes in discount retailers like Ross Stores (Nasdaq: ROST  ) and Costco (Nasdaq: COST  ) . Distributing product through these channels is something I would expect to see in the late phases of a trend and points to the increasing competition in a fading space.

The big question for investors is whether or not Skechers can continue to grow sales in its toning line. If not, is there another line of growth that will pick up the slack? Analysts at leading athletic shoe researcher SportsOneSource believe that more than half of Skechers retail sales this year have been toning shoes, so if this trend does die, the company has quite a hole to fill.

Skechers is most definitely a value if it can maintain its growth in the toning shoes segment, but to me the evidence suggests it's more of a value trap than a value stock.

Andrew Bond owns no shares in the companies listed. Costco is a Motley Fool Inside Value selection. Costco, Nike, and Timberland are Motley Fool Stock Advisor picks. The Fool owns shares of Costco and Timberland. You can follow Andrew on Twitter @Bond0 or on his RSS feed. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy.


Read/Post Comments (7) | Recommend This Article (11)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 23, 2010, at 12:40 AM, lnkrgn wrote:

    I know very little about SKX, but one thing in your article puzzles me. You say SportsSouceOne estimates over 50% of sales this year was from toning shoes. You also say that in the first four months of 2010 toning shoe sales from all companies totaled $252 million. I tried to estimate SKX total sales for the first four months of 2010. I got data from Yahoo finance. The first quarter total SKX sales were $493 million. The second quarter total SKX sales were $505 million. I divided quarter two by three and used $168 million for the fourth month sales estimate. Therefore, my four month sales estimate for SKX was $661 million. One half of $661 million is $330 million. It seems like things likely don't add too well if over half of SKX's sales supposedly come from toners since total toner sales for the first four months of 2010 were only $252 million for all companies in the space per your data.

    I only have toner sales for the first four months as supplied by you. It would be much appreciated if you could prove your information with numbers for the remaining months where I don't have any information.

    Thank you.

  • Report this Comment On December 23, 2010, at 10:18 AM, TMFBond007 wrote:

    Hi Inkgrn,

    Just for clarification I wrote, "more than half of Skechers retail sales this year have been toning shoes."

    Skechers also has a significant wholesale business both domestically and internationally, as well as a much smaller e-commerce business. It's retail sales fall in the middle. In the most recent quarter for example, Skechers retail sales revenue totaled $111 million.

    That is why your calculations don't add up.

    Thanks for reading, and Merry Christmas.

    Fool on,

    Andrew

  • Report this Comment On December 23, 2010, at 2:21 PM, OilFriedn wrote:

    This stock may indeed be a "value trap" as the market does not always reward performance and stocks at times can be unjustly punished.

    However, if you are going to attempt to evaluate the performance of the company, you should consider more than the latest analyst report.

    Tone-ups may indeed be a "fad" - however, previous fads have remained profitable even after the initial momentum plays out. With Sketchers, they have had about a "fad" a year - Tone-ups, Twinkle toes, Cali line, etc. - which is really a sign of product inovation. Sketchers has consistently created new products and grown distribution to become the second largest shoe company in the US. They have accomplished this growth without levering the balance sheet.

    The inventory may been a near-term issue, but it will hardly crater the company. It may negatively impact margins for a quarter or two, but will not interfere with what I believe to be the true value creater - the Sketchers innovation.

    On a fundamental basis, this is the cheapest stock in the sector - quite a penalty. I do not understand why the management team is not looking to LBO this Company or a private equity firm take it out ala JAS, GYMB, JCG....

  • Report this Comment On December 23, 2010, at 3:27 PM, p2i wrote:

    You don't get it. SportsOneSource says that Skechers has more than a 50% market share in the toning area. It is not 50% of Skechers revenue. They also expect that toning shoes could reach $1B in sales this year in comparison to the $300M of last year. Skechers revenue is expected to be $1.96B this year. SportsOneSource also stated that toners are still selling well and has even picked up sales lately as the prices have declined slightly over the past few months due to too high inventory. Skechers expects their inventories to be righted over the next two quarters.

    Now for the history of toners and whether they are a fading fad. The original rocking sole design was invented by a Swiss company named MBT. Their shoes were designed to relieve pain and pressure to the foot, knee, hips, and lower back. People noticed a slight side effect, toning of the muscles. European studies have shown that they do relieve pain and that there is a slight toning effect. Others here in the USA have attempted to "refudiate" those claims (as Sarah Palin would say). Health care insurance companies in many European countries fully pay for MBT's pricey shoes. Look here for more information on the American Academy of Podiatric Sports Medicine about their value:

    http://www.aapsm.org/toningshoes.html

    Even thou producers' claims may be overblown about toning, they do have substantial value. If you would research these shoes, you will find rave reviews from people who are on their feet all day on concrete, such as nurses and warehouse workers.

    By the way, you can see Nikes at Ross, Marshals, and Costco. Nike hires celebrity athletes as spokes-people. Does that mean that Nike is in dire trouble? Skechers is cheap even without Shape-ups. It is entering into a new phase with international expansion. Sales of toners will slow at some point but won't go completely away unless there is a better alternative.

  • Report this Comment On December 23, 2010, at 4:54 PM, TMFBond007 wrote:

    @p2j,

    Thanks for the comments and good use of Sara Palin humor.

    The SportsOneSource analyst Matt Powell is very bullish on toning shoes, and has been for a while. He has done a great job covering the trend, we are just in disagreement on how long it can last.

    I encourage you listen to recent comments by management at Finish Line. Nike is winning this market without even entering it. The fad is being enveloped into the training segment which Nike dominates. More on this in an upcoming piece.

    Yes, Nike also sells some product at the same discount stores, but they are not discounting premium products. It is just another point of sale source to distribute entry level product

    Finally, indeed Nike does have athlete endorsements. However, there is a big difference between Michael Jordan, Lebron James, etc... and Kimmy Kardashian.

    Nike products are proudly endorsed by the finest athletes in the world, not celebrities that are famous because, well they're famous.

    Let's Go Caps!!!

    Andrew

  • Report this Comment On December 27, 2010, at 6:21 PM, OilFriedn wrote:

    Andrew,

    I am not questioning your enthusiasm for Nike - although I do not share it. However, it seems a pretty weak argument to question the valuation on Skechers with a comparison to Nike's approach to "toning" and their athletic endorsements. [Not sure how successful Lebron James would be marketing pretty toning shoes to housewives? Although I really do not know who Kimmy is, I assume that the target market for shape-ups does].

    The point is that the marketing is going after target markets - Nike is focusing on athletes whereas Skechers has always targeted at a casual market (ie. the Skechers profile is a lifestyle footwear v. Nike being athletic footwear). I assume Skechers marketing shape-ups with Karl Malone (with a cameo from Karim Abdul Jabbar) and Joe Montana - you can not watch a football or basketball game without seeing these commercials - is because they are targeting a casual sports fans. Both commercials joke about making a comeback because these shoes make you feel so good. My guess is that this appeals to a bunch of couch potatos more than replays of Michael Jordan dunks from the 90's. It hardly seems to be a weakness in the Skechers story.

    On a fundamental basis, comparing Nike and their opportunities with Skechers seems a bit disingenous. As growth companies, Skechers seems to have more upside given that it has 1/10 the revenue and 1/50 the enterprise value cap - it is less of a challenge to double $2 billion in revenue and a $730 million enterprise value than to double $19 billion in revenue and a $37 billion in enterprise value.

    From that perspective, I would expect, NKE to have more of a "value" type multiple and SKX to carry a growth multiple.

    Your raise the issue that toning shoes are potentially a fad which may slow Skechers grow rate. This is an issue worthy of debate. However, Skechers has faced issues of slowing product lines repeatedly and countered this with innovation - another sign of a growth company. Its been along time since Nike invented a new market. Even if the Shape-ups went to 0 growth, Skechers would still be cheap on a fundamental basis.

    Comparing Skechers to Heely's and Crox by insinuating that the whole Skechers growth story is limited to a shape-ups fad is a backhanded slap. Skechers has a diverse product line targeted at diverse consumer markets.

    I will grant you that Skechers are not going to compete with Nike in the competitive sports arena with their current line up just as Nike is not going to compete with Skechers in the casual footwear market. People who "train" will probably continue to wear Nike and people trying to casually add some benefits will continue to wear "toning" shoes.

  • Report this Comment On December 28, 2010, at 10:25 AM, Roadrunner2010 wrote:

    Everyone here makes valid points and I know Skechers has become a hated stock, but it can't be compared to Heeley's or LA Gear. The company has been around since 1992 so this is no flash in the pan. I believe the toning shoes are nearly priced out of the earnings considering the insane sell off it's had over the last 4 months. Bottom line after 18 years in the business they still have a very successful childrens line, men and womens casual wear, tv show featuring their charactars, law suits they are sure to win, and luggage deal, not to mention good endorsement through celebrities. There's a reason hedge funds are increasing their stake in the company. All I ask is that we try and be realistic hear. Nobody is saying they are trying to take on Nike, that would be a stretch. They have their own nitch and still remain the second largest shoe company in the US.

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