Crocs (NASDAQ: CROX ) is having a terrible year. Its 52 weeks stock price performance is minus 23.6% so far. Furthermore, this stock has also showed some extreme historical volatility. In 2007 the stock price reached almost $70. But just some months later, Crocs was trading at its lowest price level, $0.79 per share.
More recently, shares plummeted 20% after the latest earnings call on July 24th. Earnings came in at $0.40 per share, far away from the lower end of guidance ($0.60). Since then, most analysts have downgraded the stock.
Downgraded, highly volatile, trading at its 7 months bottom level and with apparently decreasing margins, Crocs certainly looks like it is in trouble.
So how come it has a 50% upside potential?
Explaining the "poor" quarter
First, we need to start by recognizing that Crocs revenue did increase in the latest quarter: roughly 12.5% on a constant currency basis. Once more, sales in the Asia Pacific region were the main growth driver.
Lower gross margins, on the other hand, originated due to adverse currencies fluctuations and to a $6.1 million one-time charge related to a tax audit in Brazil. Combined with unfavorable tax rates, these external factors stole $0.1 per share in earnings . Crocs simply had bad luck this quarter. If these 10 cents in lost earnings per share had not been taken away, the company would have reported $0.5 EPS, which is much closer to its lower guidance.
Crocs revenue in one year is greater than its total market capitalization
Revenue for the first and second quarter came in at $312M and $363 respectively. Assume that the company manages to keep the same $363M level of revenue per quarter for the remaining of the year. In other words, assume pessimistically that there will be no quarterly growth for the remaining part of the year.
According to this scenario, Crocs would close $1.4 billion in sales this year, Since revenue last year came in at $1.123B, this implies that Crocs could grow at least 20%+ this year!
In a nutshell, a company that can raise its revenue base 20%+ year over year without any trouble shouldn't be experiencing a negative 23.6% return rate.
More bullish reasons
- A well diversified product portfolio: Crocs has shown investors it is not a one-hit wonder stock. Its cash cow, the Clog sandals, still represents 44% of sales according to the latest quarter information, down from 46% last year. However, the fact that overall revenue keeps growing shows the importance of new products.
- Strong growth in key markets: The Asia Pacific region is the main growth driver.
- LBO on the way? With a clean balance sheet and more than $290 million in cash and cash equivalents, Crocs is a potential LBO candidate. The premium paid by the acquiring institution will benefit shareholders immediately.
For this section, I run a discounted cash flow model under moderate assumptions using Oldschoolvalue financial spreadsheets. I assume a 4% terminal growth rate, 12.8% as the average free cash flow growth rate for the next 10 years (which is actually equal to the average of the past 5 years and 10 years free cash flow growth rates) and a 9% discount rate, which is the standard.
Under these assumptions, I obtain a fair price estimate of $18.91 per share, which implies a 43% upside potential. Assuming a 15% growth rate for the next 10 years implies a $21 price target and a 59% upside. Finally, under a pessimistic scenario, even if Crocs grows only 9% yearly for the next decade, the price target would be $15.40. That still implies a 16% upside.
Analysis of competitors
Privately-owned Havaianas, Merrell and Patagonia Footwear from Wolverine World Wide (NYSE: WWW ) and Sanuk and Teva from Deckers Outdoor (NYSE: DECK ) are also in the business of making casual shoes and sandals, and therefore qualify as representative competitors.
Last year, Wolverine World Wide (WWW) acquired Collective Brands and now owns several strong shoes brands, including Keds, Saucony and Sperry Top-Sider. The acquisition clearly helped WWW to increase its revenue 88% year-over-year to $588 million in the latest quarter. And gross margin increased 41% so far.
With 16 strong brands under its belt, marketed in more than 100 countries all over the world, WWW does look attractive as an investment. However, the current market valuation may not represent an adequate entry point. Trading at a 36 price-to-earnings ratio, this stock has one of the highest valuations in the industry. And unlike Crocs, WWW's current market cap is much bigger than its year revenue base.
Deckers, on the other hand, had a mixed second quarter. The company reported revenues of $170 million, which represented a 2.5% decline from the year ago period. And it lost $0.85 per share. The good news is that the street was expecting bigger losses.
Judging from its recent losses and from the volatility of its revenue base, it seems that Decker's business is way more cyclical than Crocs. In particular, its UGG brand could be exposed to weather conditions, simply because they are winter shoes. More importantly, the Teva brand (flip-flops), which directly competes against Croc's clogs, saw an 8.4% decrease in net sales. But not everything is bad news. Sanuk was probably the only main brand that experienced a meaningful sales increase: 7.5%. Distributed across 50 countries, the flip-flops brand could be an early star product in Decker's portfolio.
Notice that both Deckers and WWW have much higher price-to-earnings ratios than Croc's 11.8 figure.
Final foolish thoughts
Crocs shouldn't be experiencing negative returns. The company simply had bad luck in the latest quarter due to adverse currencies fluctuations and a one-time big tax payment. Revenues, on the other hand, keep growing, unlike those of competitor Deckers.
Trading at a very low price-to-earnings ratio and selling more shoes in one year than its total market capitalization, Crocs is clearly undervalued at $13. Considering that the core business remains strong, I expect a meaningful improvement in margins next quarter. The market will wake up then. However, the time to go long is now.