Crocs Stock: Off-The-Radar Compounder With Great Potential (NASDAQ:CROX)

Crocs (NASDAQ:CROX) seems to be an off-the-radar company and might not appear as an enticing thesis, given its sector (footwear retailer) and debatable products – with several articles about how their brand reached a billionaire status selling “ugly shoes”. It happens that Crocs shares have turned out to be an excellent investment and continue to be attractive.

CROX stock is currently trading at an attractive valuation level, at around 10.7x NTM P/E, which together with a solid track record of execution and growth, makes it an interesting thesis for compounding, considering that the company has an extraordinary track record of growth and good prospects, and may maintain the compounding effect for its free cash flow and consequently for its shareholders.

Great Business Model & Great History

Examining Crocs’ business model, one could sum it up as selling shoe designs like Clogs, Sandals, and other casual styles, with a higher added value due to its brand and several partnerships.

With this brand strength and brand strategy, such as using partnerships to develop themed shoes, for example with Disney Pixar’s Cars movie and even with the NBA, Crocs has managed to strengthen its market over time, as shown in the table below.

The production of relatively ‘simple’ products with a higher added value reflects directly on its financials. Its margins are higher than those of its peers. Gross margin, for example, reached 55.7% in LTM, while Skechers (SKX) was 51.9% and Nike (NKE) 44.3%.

This is also true for Operating Margin, which with its 27%, outperforms its peers such as Birkenstock, Deckers, Steve Madden and others.

One piece of information worth mentioning is that at the end of 2021, the company announced the acquisition of HEYDUDE, for a price of $2.5 billion, to complement its portfolio. At first, the market didn’t give it the benefit of the doubt for the acquisition, which along with some weaker quarters, caused the Crocs Stocks to fall more than 70% from their peak in November 2021. Among the concerns about Crocs was its leverage, which reached around 2.1x. But just as it promised, the company delivered and maintained a healthy cash generation and was able to repay around 1.2 billion since the acquisition, reaching a debt-to-EBITDA ratio of 1.3x in Q4.

Even without the acquisition, the company’s transformation in mid-2017 has already turned Crocs into a compounding machine, its revenue in the period 2017 to 2023 shows a CAGR of 20%, with the brand reaching the $3 billion mark in revenue and $3.96 considering HEYDUDE. In 2023, HEYDUDE accounted for 24% of the group’s revenue.

One indicator that highlights the robustness of the Crocs’ business model and how cash-generative it is, is the Free Cash Flow Yield (Free Cash Flow/EV), which is at 8.18% in the LTM, an attractive level considering its peers or even the Free Risk Rate.

Based on this information, I believe that Crocs has managed to build a very interesting business model in the recent period. The capital allocation priorities mentioned in the company’s presentation seem feasible considering the track record and should benefit the shareholder: 1. Brand Growth Investment, 2. Debt Paydown and 3. Return of Capital to Shareholders.

An achievement already mentioned that illustrates this capital allocation efficiency was its ability to deleverage after the acquisition, using its cash generation to repay its debts. Now that Crocs has reached its target of leverage (debt-to-EBITDA ratio), it was possible to return to buybacks. In 2023 the company paid down $666 million in debt and repurchased $175 million of Crocs stocks (average cost of $104).

Outlook For Crocs

According to the latest earnings call, the company remains confident that Crocs is a scale business and can easily reach the $5 billion brand level, but no longer by 2026, given the changes in the supply chain scenario. Another factor mentioned in the earnings call was the company’s position in 2024. According to the CEO, Crocs has a “strong pipeline of licensed product collaborations” that they will bring in over the course of the year.

But what most influenced my projections, and also guides not only the market’s projections but also the perpetuation of these earnings over the long term, is the guidance for 2024. The company’s forecast portrays a complex 2024, impacted by a more challenging time for HEYDUDE and greater pressure on margins, especially in the first half of 2024, impacted by investments made and growth in SG&A. Although HEYDUDE’s margin is facing pressure, initiatives are already being taken, such as the reduction of this brand’s inventories, which went from $169 million to $104 million in the annual comparison. By taking these actions, the company can ensure that there is not an excess of products sitting in storage, helping the pipeline, sales, and prices.

The guidance still considers an EPS with a bottom of $12.05, which gives us a forward P/E of ~11.1x.

Regarding margins, I believe that Andrew Rates’ speech sums up well what to expect in the medium/long-term:

We still think the operating margins for our company are in the mid 20s. But will not be every single year above the 26% mark. We think it’s very prudent to invest incremental dollars from time-to-time to create the capabilities that allow us to grow in the future.” – Andrew Rees, CEO of Crocs

Some Risks of the Crocs Thesis

While the strength of the thesis is based on its business model (and its attractive valuation), I believe that the main risks are linked to its segment. Crocs, being a retail and fashion business, is very sensitive to certain factors, such as delicate moments in the macroeconomic scenario and changes in trends.

Factors such as increased citizens’ indebtedness, disposable income, unemployment, and inflation directly affect Crocs’ business, and although a recession in the US is no longer the consensus, worse times elsewhere in the world could affect the company’s international expansion, such as a weaker economy in China. Still, this risk is inherent in most theses, and the economy is cyclical.

On the other hand, the fashion trend is something that makes me more conservative in perpetuating Crocs’ financials. The company has managed to create a strong brand in recent years, even driving (and being driven by) some fashions, such as in Asian countries. One that illustrates this is the “clogs follower“ (or dong men), a subculture in China.

So, as much as it’s a niche that can continue to expand, especially given the management’s good work, bringing in new licensed products, diversification and the like, it’s also a niche affected by trends – and if in a few years this trend changes and the company doesn’t know how to redirect its products towards a new fashion, net sales could struggle.

The Market Underestimates Crocs’ Potential

I don’t think Crocs thesis really needs a complex DCF, it may be a thesis to not overthink too much and look at P/E, business model, and prospects. Anyway, to ascertain the fair price of Crocs stocks, I built a DCF.

Most of my assumptions are conservative, based both on the guidance for 2024 (slightly lower EPS in my projections) and on other aspects covered in the “Outlook for Crocs” section. I draw attention to weak topline growth in the long term, even with an acceleration in 2025-2027, with the company (including HEYDUDE) reaching revenues of $5 billion in 2027.

It’s noteworthy that by having more conservative short-term growth assumptions, in my model HEYDUDE loses revenue share until mid-2027, where it returns to 24% and starts to grow slightly more than Crocs, reaching 25% in 2029. This lower growth (and also the lower operating margin) than the main brand is another reason for the market’s distrust.

Other DCF premises include:

• CapEx: ~-3.2% of revenue in 2024 (reaching the top of guidance), declining to -3% (close to recent history) and 2.5% post-2030, to match the lower projected growth and reflect a more mature company.

• Terminal Growth Rate: at 2% reflecting something close to inflation, i.e. reflecting a scenario without growth and efficiency gains, only price pass-through.

• WACC: at 10.16%, found through a Free Risk Rate of 4.43% and an ERP of 5%, leading to a KE of 11.4%.

With these assumptions, discounting the projected cash flow it was possible to find a fair price of $167.4 for CROX Stocks, indicating an upside of approximately 25%.

Even though it’s not a huge upside, it’s already possible to see that Crocs Stocks have a reasonable margin of safety, as well as to see how pessimistic the market’s assumptions are, i.e. they expect timid growth from a company that has managed to deliver interesting growth in recent years.

In terms of multiples, the result is similar: according to the valuation table from seeking alpha, Crocs is trading at the lowest P/E FWD among its peers.

The Bottom Line

Thus, I believe that Crocs’ thesis combines an attractive valuation (in different metrics) with a solid company, which in the recent period has been able to develop huge moats (mainly the brand power/awareness) and should be able to maintain interesting growth in the coming years and may even surprise market estimates.

And this builds the view that Crocs should be a company that returns value to the shareholder in the long term, not only through the growth of its free cash flow but also by using it to make buybacks (and/or dividends). These factors justify my “buy” rating on the company.