Crocs (CROX -0.35%) has been banished to the penalty box. As of this writing, shares of the foam clogs maker are down 55% so far in 2022, despite beating its own financial expectations in the first quarter and raising full-year guidance. The market clearly isn't buying the growth narrative this shoe business has established, reflected in a lowly price tag of just five times trailing 12-month earnings per share and 9 times trailing 12-month free cash flow.
Crocs is far from perfect. It went shopping and came home with a big $2.5 billion purchase of casual footwear brand Hey Dude late in 2021, just in time for a global economic slowdown and cries of possible recession on the way. The company is also trying to expand during a period of high inflation in key areas like shipping and transportation. Poor timing aside, though, there's enough good stuff happening that makes me think this is a screaming deal for the long haul.
2022 starts on the right "foot"
Crocs blew away Wall Street analyst expectations in fiscal 2022's first quarter. Revenue increased 43.5% year over year to $660 million (or 46.7% growth when excluding foreign currency exchange rates). Excluding the $115 million in revenue from Hey Dude (after the acquisition closed on Feb. 17), Crocs stand-alone sales were up 18.5% (21.7% ex-currency exchange rates) to $545 million.
As a reminder, Crocs is on a mission to reach at least $5 billion in annual sales by 2026, a goal that is becoming increasingly likely if it can maintain its recent momentum. Management reiterated its outlook for 2022 Crocs brand sales to be up at least 20% compared to 2021, pegging the expected revenue from the comfy-but-quirky foam kicks at $2.78 billion or higher.
And then there's the new Hey Dude brand, perhaps a new name for many consumers, but a popular brand among younger consumers. In Piper Sandler's "Taking Stock With Teens" Spring 2022 report, Hey Dude ranked as the No. 9 favorite footwear brand, where it first made an appearance last autumn (Crocs moved up two spots to No. 6 on the list). On a full-quarter stand-alone basis, Hey Dude revenue was up 81% to $205 million in Q1. By plugging Hey Dude into Crocs' existing distribution channels and riding young consumer momentum, management believes the Hey Dude brand can achieve at least $1 billion in annual sales by 2024.
Challenges that need to be overcome
This isn't a "too good to be true" stock value. Crocs is facing headwinds as it seeks expansion, including increased production expenses as freight and shipping costs soar due to supply chain constraints. A strong U.S. dollar is also weakening the value of international sales. But Crocs stock has been punished for a scenario that is nowhere near reality -- at least not yet.
Case in point: CFO Anne Mehlman said on the earnings call that 20.6 million pairs of shoes were sold in Q1, a 1% decline from a year ago. However, Crocs brand average selling price was up nearly 20% over that same span of time. This is only a single quarter of performance, and the flatlining of shoe sales is definitely worth keeping an eye on. However, the fact that Crocs is able to raise prices and maintain unit shipments is notable. Crocs' brand power among its fans is for real.
This pricing power speaks to the company's ability to maintain its best-in-class operating profit margins, even as freight and related expansion expenses rise. Adjusting for one-time Hey Dude integration costs and $5 million in bad debt write-off from putting a halt on shipments to Russia, adjusted operating margin was 26.6% in Q1. Keep an eye on this metric to make sure the footwear business is able to maintain a healthy level of operating profit as inflation pressures persist.
And one more item, this one pertaining to the balance sheet: Cash and equivalents were $172 million at the end of March, offset by debt of $2.88 billion relating to the Hey Dude acquisition. Management expects to reduce its balance sheet leverage to less than two times net debt to adjusted EBITDA by mid-2023 (currently it's at 2.9 times net debt to adjusted EBITDA). There's a risk the indebtedness to purchase Hey Dude eventually backfires on Crocs.
Nevertheless, these risks are now priced into this shoe stock. With $3.5 billion in total sales expected for full-year 2022, all the while maintaining high-20% range adjusted operating profit, Crocs looks like a long-term bargain to me. Of course, the company is going to have to prove it and deliver on its ambitions, but Crocs and Hey Dude have young consumer momentum working in their favor. This stock remains a buy in my book.