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Falling Knives
Dangers of Crocs

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By whatismyoption
February 27, 2008

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Hi Rich
Thanks for highlighting CROX.
My initial five minute review leads me to believe CROX is certainly worthy of a close analysis.

General Thoughts
I used to sit in the CROX is a fad and overpriced stock camp. Unless I turn up something rotten it now looks underpriced and about six months ago I stopped thinking they are a fad. Footwear is surprisingly important to a lot of people and not just women. CROX have carved out a great niche and appear to be expanding it nicely. Management seem to have made all the right moves in expanding their brand, so I am left wondering why it is now available at such a seemingly cheap price. Personally, after years of mocking Birkenstock wearers, I am slightly embarrassed to report that I am a convert to the German way, but please don't hold that against me. From talking to Croc wearers they feel the same about their Crocs.

Here in Australia the market has expanded very rapidly. First the groovers and practical people like nurses wore Crocs. Then the wanna-be trendsetters, then their kids, then the early majority and their kids and then they all went and bought a new colour.

That Kiwi guy on the Fab15 board has followed Crocs for a while, but he appears to be on holiday.

Valuation
There must be something seriously wrong with CROX or Mr. Market has forgotten to take his Cymbalta.


My earnings based intrinsic value spreadsheet spits out a weighted IV of $70 pricing CROX at over a 60% discount. So if ttm eps of $2 and analysts growth of 24% can be believed CROX is a screaming buy. My spreadsheet is based on Hewitt Heiserman's and weights the growth rates from 12% (half estimates) to 24%.

Trailing P/E: 14.46
Forward P/E: 8.11
PEG Ratio: 0.43
Price/Sales: 3.08
Enterprise Value/Revenue: 2.98
Enterprise Value/EBITDA: 9.503

So where is the hidden danger? Where is the risk at buying at this level?
Cash flows have been decimated by twin perils of rising inventory and rising A/R. Inventory has been blamed on distribution problems, which is totally plausible considering the growth. Rising A/R is not surprising considering the international growth; however, within the current retail environment this deserves a closer look.

Recent Recap
CROX peaked at $75 in October 2007. The sell-off began when they reported Q3 earnings http://www.crocs.com/company/press/2007/4/ I was not following CROX at the time so am not sure why it was punished so much for meeting/just beating estimates and issuing good forward guidance. My guess is that it could simply be the old high priced normally over delivering company getting slaughtered for not hitting the ball out of the park. CROX did have an incredibly high short level prior to earnings. They were also an overpriced momentum stock at that point so had to stumble at some point to let earnings catch up with expectations.

Q4 release appears similar, they failed to crush estimates and have been further sold off by now what is surely worried owners and people who have been trying to catch this falling knife.

Great post on CROX board with some history and addressing the whole fad question http://boards.fool.com/Message.asp?mid=26243849

A good take on rising inventory levels http://boards.fool.com/Message.asp?mid=26263464

Issues
Rising A/R
Fad
Rising Inventories

Looking Forward
I have not seen any academic or other studies on fallen growth stocks, but it would have to be very strong evidence to shake me from my anecdotal position. My experience leads me to believe once a high flying growth stock has been tossed aside it is unlikely to explode higher again in the near term. There is too much resistance from owners looking to get out at break even, too much supply around at higher prices. This is reinforced as once fallen, everyone starts believing the bears whose arguments are lent the credibility of recent price action. The crowing of I told you so is very disconcerting.

However, looking forward 1and 3 years out I see the following:
- Growth continues. Even if Crocs are a fad they still have a few more years left in them.
- The inventory issues are resolved, but expensive enterprise software solution impacts on net margins (total WAG)
- A/R continues to be a problem as growth continues.
- company continues to expand range, reducing likelihood of fad.
- Earnings increase and the market pays a fair price for those earnings.
2008 earnings of $2.70, still growing over 20%, target $50
2010 earnings of $3.50, still growing 20%, target $70

Conclusion
I have not seen anything yet to make this a less compelling investment; however, I have only looked for an hour or so. The greatest long term danger is the durability of the brand, but I have seen no real signs of slowing growth so that is fancy rather than fact. With such a compelling opportunity now I would be surprised if more people here are not looking closely at CROX and I look forward to hearing their views.

Resources
Q4 Transcript http://seekingalpha.com/article/65233-crocs-inc-q4-2007-earnings-call-transcript
Q4 Release http://www.crocs.com/company/press/2007/4/
Q3 10Q http://tinyurl.com/3bcvw2
12 month short interest http://tinyurl.com/327834 still peaking
Big Charts 2 year P/E and eps http://tinyurl.com/3ccq6w
Reuters ratios http://stocks.us.reuters.com/stocks/ratios.asp?rpc=66&symbol=CROX