Crocs: Making Steps Again (NASDAQ:CROX)

This summer I concluded that Crocs (NASDAQ:CROX) was getting back on its feet after a very strong 2020 and 2021. The strong performance, great ambitions and high share price perhaps inspired a bit of (over)confidence with regard to capital allocation.

Despite some leverage concerns, I felt compelled to shares in July, even as leverage was a bit too high for my taste.

Some Background

Less than a decade ago Crocs was still struggling and somewhat sleeping business which generated $1.2 billion in sales on which it posted low single digit margins, nothing to get too excited about. Blackstone saw the potential (perhaps a bit too early) and got onboard at $16 per share, believing in the thesis after the business had seen a previous boom in the mid-2000s already.

Ahead of the 2020 pandemic, Crocs was still a $1.2 billion business in terms of sales, albeit that margins had recovered to 10% of sales again, driving shares to the $40 mark just ahead of the pandemic. What happened has been incredible operating momentum following the outbreak of the pandemic. Whilst 2020 sales only rose 13% to $1.4 billion, operating margins jumped to 19% of sales, with earnings per share more than doubling to over $3 per share.

The company originally guided for 2021 earnings around $4 per share, actually outlining a roadmap for earnings of $15 per share in 2026, as shares rallied to a high of $180 in 2021 as earnings power for the year was trending around $10 per share, driven by superior sales and margins. With a peak valuation at $11.3 billion, and confidence faring high, the company announced a big $2.5 billion purchase of HEYDUDE late in 2021.

Shares fell to the $120 mark upon the deal announcement, as the company would incur quite some debt, as they were trading at just $54 in July. While 2021 sales did eventually rose 67% to $2.3 billion and adjusted earnings came in at $8 per share, the company guided for further improvements in 2022. The company guided for 20% sales growth, excluding a $700-$750 million HEYDUDE contribution, implying about $3.5 billion in sales as this should support earnings around $10 per share.

The reason for the decline to $54 had everything to do with first quarter results and increased uncertainty on the macro front. First quarter sales rose 54% to $660 million, including a $115 million contribution from HEYDUDE for part of the quarter. The company now guided for 2022 sales at $3.5 billion and earnings at $10.35 per share. A $2.7 billion net debt load was a bit high, as the 60 million shares were valued at just $3.2 billion at $54 per share.

The $5.9 billion valuation for the business at large revealed the extent of the overpaying of HEYDUDE at a $2.5 billion price tag. Being a bit mindful of the leverage incurred, I was pleased with the guidance for 2022 and recent insider buys, as I believed the overall situation was reasonably compelling.

Stagnation – And Improving

After voicing an upbeat tone on the business at $60 in July, shares have rallied a third again, now trading at $80, still down a lot from the highs seen last year. This optimism is remarkable as markets have seen some turmoil and oil prices have been creeping up again, while the dollar has been only strengthening over time.

In August, Crocs did post second quarter results with revenues up 50% to $965 million. This sales number included quite a few components, including a 5 points headwind from dollar strength, 14% reported growth at Crocs towards $732 million in revenues and an impressive $232 million HEYDUDE contribution.

Margin contraction was limited with adjusted earnings up 45% to $3.24 per share, trailing sales growth only by a modest margin. The company now sees full year sales around $3.45 billion with adjusted earnings seen at a midpoint of $9.90 per share. Whilst this marks a small cut to the guidance, in part the result of the strong dollar, the extent of the shortfall is manageable. Moreover, meaningful profits will be generated in the meantime in order to deleverage the balance sheet.

Net debt has already fallen to $2.58 billion with adjusted operating earnings trending around $900 million, leverage has fallen below 3 times already. With leverage concerns quickly evaporating and earnings power still trending around $10 per share, the resulting 8 times multiple is not too demanding, in fact the opposite.

The issue is that pressure on earnings is likely seen for some time to come, yet I expect that if Crocs can maintain some of this momentum, it has room for retained earnings to keep relative leverage ratios in check. While the third quarter growth looks solid, the implied fourth quarter guidance (given the full year guidance given) is what looks a bit soft.

Looking at the quarterly guidance, The company sees second quarter sales of $965 million fall to $935 million in the third quarter, as the implied fourth quarter guidance runs at a midpoint of $890 million. With Crocs posting $587 million revenues in the final quarter of 2021 and HEYDUDE’s sales comfortably running above $200 million a quarter, the reality is that the very modest growth seen in the fourth quarter marks a slowdown. That being said, this should be expected given the tough comparables and worsening economic conditions.

What Now?

After having seen a roughly 30% return in the time frame of about four months, I find myself performing a balancing act. On the one hand the returns are solid and one could be lured into profit taking. On the other hand the valuation is cheap, yet the company is not completely out of the woods yet with leverage still being a point of attention.

Weighing it all together, I am deciding to hold on to my position, not feeling an urgent need to either cut or increase my position here.