Investors don't seem to believe that the Crocs (CROX 1.83%) stock rally is just a fad. The molded footwear specialist's shares have trounced the S&P 500 so far this year, leaving behind peers like Nike (NKE -0.06%) in the process.
Crocs latest results have been impressive across several key metrics, including sales growth, profitability, and cash flow. Investors will want to balance out that optimism, though, by keeping a close eye on a few potential warning signs.
The good news for Crocs
But let's start with the good news. Crocs grew sales of its core footwear brand at about the same 19% rate that Nike enjoyed into early 2023. The addition of its Hey Dude casual footwear purchase allowed overall sales to soar by nearly 60% to $3.6 billion. Management in mid-February said demand for both franchises has been, "exceptional."
Investors don't have to take executives' word on this point, either. Profitability was stellar, implying pricing power at a time when many peers are resorting to price cuts. Crocs' operating profit margin is holding above 20% of sales, or about 10 percentage points higher than Nike's. These wins suggest that the company enjoys major competitive advantages that it can easily capitalize on.
CROX Operating Margin (TTM) data by YCharts.
The warning signs
Crocs' stock is still cheaper than Nike's despite the fact that it is growing faster and generating stronger earnings. Investors are paying 3.8 times sales for Nike shares today compared to 2.2 times sales for Crocs. But there are two other metrics besides the price-to-sales ratio that investors will want to watch over the next few quarters. Each of these might determine where the stock goes from here.
The first metric is debt, which remains elevated following the early 2022 acquisition of Hey Dude for $2.5 billion. Management is working hard to reduce that debt burden as interest rates rise. But debt is still above 2 times adjusted earnings today compared to around 1 times adjusted earnings before the transaction.
Crocs has also reported spiking inventory, mainly thanks to that purchase. This inventory spike would be a cause for concern even in normal economic times. It's a potentially bigger worry when footwear peers are slashing prices and reducing their inventories. Nike has been working through excess inventory for several quarters, for example, which has pushed profitability lower.
Looking ahead
Crocs might not face the same challenge if demand stays strong across the portfolio. But its industry-leading profit margin could decline significantly in a recession, given its high inventory position. Similarly, the higher debt burden is likely just a short-term concern that will lesson as earnings rise and as debt levels fall into 2024. The challenge would be bigger if a recession strikes.
But investors will still want to keep these risks in mind when they consider buying Crocs' shares. On one hand, they appear cheap even after the growth stock's rally over the last several months.
On the other hand, owning Crocs exposes investors to bigger risks around an industry pullback than they would have by owning Nike due to its wider global sales base and better inventory balance.
