Shares of Skechers (NYSE:SKX) plunged 25% after the footwear maker reported its second quarter earnings on July 19. Skechers' revenue rose 11% annually to $1.13 billion, but that merely met estimates and represented its slowest growth in five quarters. Meanwhile, its net income tumbled 24% to $45.3 million, or $0.29 per share, which missed expectations by $0.12.
Those numbers were weak, but its guidance was worse. For the third quarter, Skechers expects its sales to grow just 9%-11%, and for its earnings to decline 7%-15%. Analysts expected both its revenue and earnings to rise about 15%.
Skechers attributed those declines to the softness of its domestic wholesale business, rising overseas marketing expenses, new store openings, and higher distribution costs. The company noted that it was still growing internationally, but investors seemed fed up with this stock, which already tumbled 12% for the year before its second quarter earnings.
Should investors move on to more promising footwear stocks like Nike? Or should they take a breath and see if Skechers can still be saved?
An evolving business
Skechers was once considered a hot growth stock in a sea of slow-growth players. Its sales rose 32% in 2015, 13% in 2016, and 17% in 2017. It carved out a high-growth niche in the crowded footwear market with its emphasis on casual footwear instead of high-end athletic shoes. Skechers seemed insulated from the meltdown in sportswear retailers in the U.S., as well as the ongoing celebrity endorsement battles between Nike, Adidas, and Under Armour.
Nonetheless, demand in the U.S. and Canada -- which accounted for over half its sales in 2017 -- started tapering off. In response, Skechers aggressively expanded into overseas markets via joint ventures and new store openings.
This strategy weighed down its operating margin, even as its gross margin held steady. That's why Skechers' gross margin rose 180 basis points annually to 49.4% during the second quarter, but its operating margin contracted 120 basis points to 7.2%. Its total operating expenses jumped 20% during the quarter.
Skechers' investments are certainly paying off -- its international wholesale revenue rose 25% during the quarter, fueled by a 23% jump in subsidiary revenue, 43% growth in joint venture revenue, and 13% growth at its company-owned global retail stores. Its total revenue in China, its highest-growth market, surged 44%.
Yet much of that growth was offset by a 7% drop in its domestic wholesale revenue and a 6% drop in distributor sales, mostly caused by a slowdown at its largest distributor in the Middle East. That leaves Skechers in a similar predicament as Under Armour -- both companies need to expand their overseas presence (particularly in China) to offset their softer North American growth, but that expansion comes at a heavy price.
Looking for the silver lining
Skechers faces a lot of challenges, but investors shouldn't overlook the bright spots. First, the company's comparable sales at its company-owned stores rose 4.5% globally, with 2.2% growth in the U.S. and 11.3% growth in international markets.
By comparison, Nike reported 4% comps growth at its brick-and-mortar and digital channels last quarter. Adidas' namesake brand posted 5% comps growth during the first quarter, while its Reebok comps dipped 1%. Therefore, it's too early to claim that Skechers is falling behind the competition. Looking ahead, Skechers believes that new retro looks, stronger demand for its D'Lites shoes, and new golfing shoes could bring more shoppers back to its domestic stores.
Skechers also repurchased $15 million in shares last quarter, and has about $132 million left in its current buyback program. The buyback wasn't well-timed and the cash would have been better spent on the expansion of its overseas business, but it could help Skechers buoy its earnings and prop up its stock if the sell-off continues. At $25, Skechers trades at just 11 times this year's earnings (although those estimates might be too high) -- so its downside potential seems limited.
The verdict: Avoid Skechers (for now)
I recently compared Skechers to Nike, and concluded that Nike's better sales and earnings growth made it the better buy. Skechers' latest earnings report reinforces that call, and I think the footwear maker has a lot to prove before its stock can rebound.