Is Crocs a Crock?

I wear my deep blue Crocs daily, and that's saying something, because these little resin shoes that are half-sandal and half-clog put the "ugh!" in ugly. But, man, are they ever comfortable. I hardly notice them anymore. In fact, they might be the only pair of shoes I own that I'd be willing to stand in for hours on end. So, Fool that I am, I wonder: Is the stock of parent company Crocs Inc. (Nasdaq: CROX  ) as good a fit for my portfolio as the shoes are for my feet?

A company with sole
Let's begin with some background. Crocs was founded in July 2002 after a Caribbean boating trip during which time shoe creator Scott Seamans and friend George Boedecker introduced Seamans' rubbery invention to entrepreneur Duke Hanson. By the time the three had made their way back to the Florida coast, the idea for a company had been born.

Soon after, the first model of the iconic shoe was debuted at the Fort Lauderdale Boat Show. That led to a remarkable surge in popularity that allowed Crocs to acquire its distributor -- Foam Creations -- and begin the trek toward a public offering that was completed in February with 9.9 million stubs sold for $21 each, according to IPOhome.com. Today, Crocs is using the $200 million in proceeds it earned to market 18 different styles of casual footwear at prices ranging from $29.99 to $59.99, resulting in a firm valued at more than $1 billion.

Wall Street: Still slippery
Not many investors have bought the hype, though. Indeed, unless you were one of the rare few granted an opportunity by Crocs' bank to buy shares at $21, it's very likely that if you own shares, you're in the red. According to data on Yahoo! Finance, the stock opened on Feb. 8 at $30, zoomed to $32.50, and then settled at $28.55 a stub. Crocs trades for $26.45 a share as I write today.

But that may be nowhere close to the bottom. Yahoo! Finance says that roughly 30% of the available shares of Crocs are sold short, which means at least one-third of investors believe the stock will fall and hope to profit as it plummets. That's a surprisingly large number for a company experiencing outrageous growth. Net income, for example, more than tripled in the most recent quarter. Wall Street is expecting Crocs to continue growing the bottom line by at least 25% over each of the next five years.

The four-question test
My guess is that the skepticism comes from viewing Crocs as a fad. That's certainly what my wife thinks. She says that Crocs are likely to be no different from mood rings or jelly shoes. Or, for that matter, Ugg boots, which are offered by Motley Fool Hidden Gems pick Deckers Outdoor (Nasdaq: DECK  ) . Deckers, however, has managed to diversify its line of products. Crocs has ... kneepads.

Of course, not all one-product companies are terrible investments. Consider Google (Nasdaq: GOOG  ) . Even though it has created many different flavors of software, its focus is still on search, which provides roughly 90% of revenue. Crocs isn't much different. The company makes different styles of multicolored shoes with varying degrees of air conditioning (each shoe has holes), but does that really constitute a great business? Let's use a three-question test called a sustainability analysis to find out.

1. Can a competitor easily duplicate Crocs' competitive advantage? Knockoffs are starting to appear. One brand, "Gators," sells for $9.99 typically, but they aren't getting good reviews. Still, if the Uggs trend has proven anything, it's that imitators can have a debilitating effect on sales and profits.

But since Crocs' competitive advantage lies in the design of its shoe, a better question is whether a competitor can create a more comfortable shoe. The answer to that must be yes, even if we have yet to see how. But in the meantime, Crocs has gone to the trouble of filing for several patents related to the design of its footwear. Four have been granted in relation to the company's Beach, Cayman, Nile, and Highland models. Those patents could help raise the barrier of entry into Crocs' business and keep this company on top -- at least for a while.

2. Can someone prevent Crocs from executing its strategy? Here again, knockoffs could get in the way, or a fashion maven could suddenly declare Crocs the most awful piece of footwear on the planet. Fortunately, it's already a well-known fact that Crocs are ugly, and that makes them endearing. It's also just as possible that Oprah could declare Crocs to be one of her "Favorite Things," which would send the shares through the roof. One of the risks in a company like this is that it's at the whims of fickle fashion trends.

3. Is there wasted energy inside Crocs that stands in the way of effective execution? It's certainly possible. Crocs is still a young, local firm in Colorado. Youth can create inefficiency, and gross margin in the most recent quarter was down nearly 10 points year over year. Yowsa. But as companies grow, they can take advantage of economies of scale to improve their efficiencies. That's something to keep an eye on as Crocs continues to grow sales.

The Foolish bottom line
Plenty of uncertainty surrounds Crocs. That's probably the chief reason for its extraordinary short interest, but I also find it extremely interesting that a company experiencing triple-digit growth is somehow a contrarian pick by Wall Street standards. That just smells Rule Breaking. But is it really a Breaker? Its so-called competitive advantages are far from fully defined, and none of them may be sustainable.

Nevertheless, the stock trades for roughly 25 times 2007 estimated earnings, which is at worst reasonable when you consider that analysts believe the bottom line will grow by 26% next year. Consider, too, that Crocs have only recently been introduced in California. Management has prepared for new markets by expanding production capacity by 20 times -- from 100,000 pairs per month at the beginning of last year to a projected 2 million a month by the close of 2006. That could make for a dramatic overestimate of demand.

But if it isn't? Crocs may be the worst call short sellers have ever made, and that's no crock.

High tech. Biotech. Nanotech. Any tech. David Gardner and his Foolish band of analysts cover it all for Motley Fool Rule Breakers, and they've uncovered four multibaggers as of this writing. Get a closer look by asking us for an all-access pass to the service. Go ahead. You've got nothing to lose. Your pass is free, and it's good for 30 days.

Fool contributor Tim Beyers didn't own shares in any of the companies mentioned in this story at the time of publication. You can find out what's in his portfolio by checking his Fool profile. The Motley Fool has an ironclad disclosure policy.


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