Crocs (CROX -0.52%) has a profitability challenge. Yes, the casual footwear specialist recently reported solid sales growth for the selling period that ended in late June. Demand held up despite new pressures like accelerating inflation, and the company is still winning market share. But investors weren't thrilled to see sharp declines in Crocs' profitability, especially when combined with surging inventory levels.
While these factors are potential warning flags, they might not mean it is time to abandon the stock. Let's take a closer look.
Crocs is still seeing solid demand
Crocs' reported sales figure contained lots of noise thanks to its recent acquisitions and the strengthening U.S. dollar. Strip out those factors and growth still looked strong, however. Revenue for the core Crocs brand was up 19% in Q2, reflecting likely market-share gains in a choppy industry. That's roughly even with the 20% rate that Wall Street was hoping to see.
Executives said the new Hey Dude brand is beating their early targets and is on pace to contribute roughly $1 billion in revenue this year. "I am very proud of our second quarter results," CEO Andrew Rees said in a press release.
What went wrong
The news wasn't as good around Crocs' finances. Adjusted gross profit margin fell to 55% of sales from 62% a year ago. Crocs was able to offset some of that pressure by cutting expenses in other areas of the business. Still, the operating profit margin shrank to 26% of sales from 31% in mid-2021.
It's no surprise that profitability is dropping compared to soaring results through most of 2021. Crocs is facing higher costs on things like raw materials and freight, and there is a delay between those spikes and the positive impact of rising product prices.
How worried should investors be?
Investors are also looking at rising inventory levels, which raises the risk of potential price cuts ahead in the second half of the year if demand trends worsen. That's a real concern given that management is lowering the 2022 sales outlook. Revenue is now on track to rise by between 10% and 13% for the core Crocs brand, executives said, rather than the more-than-20% rate they projected back in early May.
Combined with the declining profit margin, that growth slowdown amplifies the pressure on Crocs' earnings over the short term. Yet much of that worry has already been priced into the stock. It was down 40% in 2022 heading into the Q2 earnings report. Crocs' valuation sat at under two times sales compared to four times for Nike.
Sure, Crocs doesn't enjoy nearly the same global reach and brand power as Nike does. And the more focused portfolio leaves it exposed to shifting consumer demand trends.
While those trends have worsened in the past few months, Crocs is still aiming to grow its core business at a double-digit rate while winning market share in casual footwear in 2022. Investors shouldn't abandon the stock simply because that expansion rate is slowing, but they should brace for more volatility in the share price ahead until profitability starts rebounding.
