Investment Thesis
- Shares of Crocs, Inc. (NASDAQ:CROX) trade close to a 52-week low with the potential to double from current levels.
- The selloff appears to be due to concerns related to its HEYDUDE acquisition, but the market is short-sightedly ignoring the growth acceleration that could come from this highly accretive buy, which Crocs plans to grow into a $1 billion+ brand by 2024.
- Crocs raised annual guidance recently, but the stock reaction at best was lukewarm. However, this may change as Crocs leverages its strong brand equity across new growth categories.
Growth and Value
This is an incredible company that has grown revenue at a 29% CAGR from $1.09 billion in 2018 to $2.31 billion in 2021 and sees FY22 revenues of ~$3.5 billion, representing YoY growth of 52-55% with long-term goals of achieving $6 billion in revenues and annual free cash flow of > $1 billion by 2026.
Yet, the stock is down ~60% this year and trades at a forward P/E of ~5.3x (based on the midpoint of management’s FY2022 EPS guidance of $10.05-10.65). This is an incredibly cheap valuation compared to its historical numbers, as the stock has traded at a TTM P/E of ~11-20x in the past 2 years. The value is appealing compared to peers as well.
Forward P/E Peer comparison
CROX
5.4x
Skechers U.S.A (SKX)
12.1x
NIKE (NKE)
25.8x
Under Armour (UA)
11x
Steven Madden (SHOO)
12.2x
(Table created by US.stocks.ideas based on data from Yahoo Finance)
Why is CROX trading at a dirt-cheap valuation?
Actually, no solid reason. With some research, it appears to be due to the following concerns
1. Buybacks at a higher price – In 2021, Crocs spent $1 billion to repurchase 8.2 million shares (equating to ~$122/share). The current stock price makes the buyback price look ridiculous in retrospect. Well, if CROX had a crystal ball, it could have saved itself the trouble and the money.
2. Overpaying for the HEYDUDE acquisition and increasing debt load in a rising interest rate environment – Crocs funded the HEYDUDE deal with a $2 billion term loan, and a $50 million draw from its revolving credit facilities, notwithstanding the 2.85 million shares (worth ~$450 million) issued to HEYDUDE ’s founder Alessandro Rosano. The stock is down ~50% since the HEYDUDE acquisition announcement on Dec 23, 2021. So, let’s try and address these issues.
Why these concerns seem overrated?
Let's consider the buybacks at a higher price. Crocs has steadily focused on shareholder yields via buybacks and reduced its outstanding shares from ~91 million in 2012 to ~61 million in 2022. When it repurchased shares last year at more than double its current price levels, the company had no clue that the stock was going to plunge. If it did think that it would have waited for a better buyback opportunity. Don't you agree? Well, the past 2 years have been completely unpredictable for the entire world. So, punishing Crocs for paying a higher price to buy its own shares seems a tad unfair.
Now, let's do a deeper dive into the opportunistic and highly accretive HEYDUDE acquisition. Did Crocs overpay and was it wrong to take on debt to fund the HEYDUDE buy, because debt in a rising interest rate environment could lead to higher interest payments.
Last year, when Crocs saw an opportunity to combine with another fast-growing footwear brand that more than quadruples its Total Addressable Market or TAM to ~$160 billion, and is accretive to revenue, margins, and earnings, the company seized the opportunity. In conjunction with the acquisition, it has decided to pause buybacks, until it brings the gross leverage ratio to <2x by mid-2023 from ~3x currently. This demonstrates responsible capital allocation priorities and a commendable ‘make hay’ strategy.
Did it overpay for the acquisition at 4.4x (HEYDUDE's) 2021 sales of ~$570 million? Let's do the math here. HEYDUDE is already exceeding expectations. Even as the integration process is underway (the acquisition closed in mid-Feb), it represented $115 million or ~17% of total Q1-22 revenues of ~$660 million and is expected to contribute $750-800 million on a reported basis, or $840-890 million on a pro forma basis for the entire fiscal 2022. This should bring the acquisition multiple to ~2.9x FY22 proforma sales from the ~4.4x in 2021.
Besides, when Crocs actually leverages its legacy playbook and unlocks synergies, HEYDUDE should be set to grow into a $1 billion+ brand by 2024 (bringing the multiple further down to ~2.5x). In two years, if Crocs can almost halve the acquisition multiple, HEYDUDE should become a free purchase in a few more years. The market seems to have missed the forest for the trees here, by discounting the significant growth acceleration potential from HEYDUDE and obsessing on the price instead.
Why believe in the CROX growth story?
History may not repeat itself but is certainly a good reference point. After a close shave with bankruptcy in 2008, the company has not only resurrected itself but transformed into a fashion shoe brand with innovations like Jibbitz (charms to personalize shoes), and partnerships with influencers like Justin Bieber, and DJ Questlove, while unleashing its collectible clog figurines taking advantage of the Gen Z’s fascination for collectibles.
The demand for its clogs rose so much during the pandemic that copycat versions began to emerge. Determined to banish these fake clogs, Crocs is suing ~21 companies, including Skechers, Loeffler Randall, and even Walmart for trademark infringement. A most recent legal win was against USA Dawgs and Double Diamond Distribution in an infringement suit that awarded Crocs ~$6 million+ from these two companies for selling imitation clog shoes. This verdict may set the precedent for the outcome of other lawsuits.
Crocs is also dipping its toes into the world of NFTs or non-fungible tokens. Earlier this year, it submitted a trademark filing with the United States Patent and Trademark Office that requests the right to use the Crocs name on NFTs of "footwear, clothing, bags, accessories, and charms”. Although the raging NFT fever in 2021 has cooled off considerably, NFTs aren’t going anywhere in a hurry. Crocs NFTs will leverage its brand value equity and play a key role in marketing strategies.
So, we see Crocs taking purposeful strides towards its goals to achieve ~$5 billion in namesake brand revenues for 2026. With all these initiatives, it’s kind of hard not to believe in the growth story. This is even more true when it defines a path to achieve this projection, including
(1) Plans to generate ~25% of revenues from Asia (from ~18% in Q1-22) and grow China to ~10% of Crocs brand revenues from <5% now. (2) Expectations for Sandals revenue to quadruple to $1.2 billion+, and Jibbitz revenues to double. With opportunistic collaborations like the latest Saweetie one, I think why not? (3) Investments to drive digital to represent > 50% of Crocs brand revenues.
Valuation & Risks
This immense growth potential makes the bargain valuation even more compelling. If the market awakens to the value proposition and a mean reversion of the P/E multiple to ~11x (the low end of the two-year TTM P/E range of 11-20x) with the 2022 EPS guidance midpoint at $10.35, CROX may trade at >$110 (11 X $10.35 = $113.85). Expectations to be a $6 billion+ brand in 2026 (Crocs = ~$5 billion + HEYDUDE = ~$1 billion), would bring the price/sales to ~0.60x at current levels, vs. TTM price/sales of ~1.3x.
Any way you look at it, CROX is a growth opportunity available at a terrific discount now.
The downside could be limited, as most concerns seem priced into the stock at current levels. However, if Crocs fails to execute on its growth initiatives (which should be uncharacteristic), and macro conditions deteriorate further (at which point not just CROX will be affected), there could be further downside. Of course, there is the danger of fickle teenage customers, who can make or break a brand. (Remember the downfall of Abercrombie & Fitch in 2013.) But, Crocs has so far navigated this thin ice challenge quite adeptly with strategies like influencer endorsements, personalized shoe charms, etc...
Other Catalysts
- In a vote of confidence, institutional investors have been steadily adding positions in CROX and own about >80% of the stock now.
- The ‘Back to School Shopping’ trends should be a litmus test to validate the recession-resilient nature of this shoe business and set expectations for the upcoming, all-important holiday season.
- The most recent legal win in an infringement suit may set the tone for other suits.
Takeaway
CROX is a growth story that continues to unfold on a clear strategy of capitalizing on pop culture trends relevant to its teen and young adult buyers, with the paradigm shift in perspective to ‘Comfort Vs. Beauty’. With the valuation lingering at 2-year lows, the stock is available at a deep discount, while its clogs aren’t. On an interesting side note, you can buy 1 Crocs share now at a price slightly higher than what you pay (~$50) for its classic clogs.
Thanks for Reading!
Disclosure: US.stocks.ideas is not a registered investment advisor, So, this article should not be construed as investment advice. Readers are asked to do their own due diligence before investing. US.stocks.ideas will not be responsible for the investment decisions made by anyone based on this article. **
