Crocs: Strong Buy Ahead Of Q3 2023 Earnings

Investment Thesis

Crocs Inc (NASDAQ:CROX) has had a rough 2023, with shares tumbling 43.50% from their 52 week high of $151.32 with a YTD performance of -20.70%.

This poor price action primarily stems from the market disliking their 1Q2023 and 2Q2023 earnings. While the company boasted incredible revenue growth and profit margins, Wall Street was laser focused on their shaky guidance and punished CROX for their meager 3-5% YoY revenue growth guidance. I first covered the stock back in March, rating it a strong buy due to its strong top line growth and best in class profitability.

Despite the poor price action, I reiterate my rating of STRONG BUY. By diving into their strong 2Q2023 numbers and utilizing a DCF model, I'll help explain why I believe CROX is an amazing buy ahead of their 3Q2023 earnings.

Revisiting their Income Statement

Looking at their revenues, we can see that CROX has grown revenues substantially since 2016. After CEO Andrew Rees joined the company, revenues have skyrocketed from a meager $1.036B to a staggering $3.55B in 2022. It is of course important to mention that FY22’s 53.70% revenue growth is inorganic due to the HEYDUDE acquisition. That being said, organic growth has been superb over the past 6 years.

Using the company’s updated guidance after their 2Q2023 earnings, we have an estimated $4.065B for FY23 revenues at the high end of their guidance. Looking at their earnings history, we see that CROX has consistently provided conservative guidance and beaten said guidance during their earnings release.

Even more impressive has been CROX’s operating income. Operating Income has grown from a mere -0.2% margin to a shocking 25.3%. Furthermore, CROX has guided for an adjusted operating margin of 27.0% for the FY23. Their long term guidance is 26.0% for future years. While this may seem unbelievable to wall street, CROX has consistently proved quarter over quarter it is consistently capable of best in class profit margins.

Looking at other shoe competitors such as Deckers Outdoor Corp (NYSE: DECK) and Skechers (NYSE: SKX), we can see that CROX has the highest profitability, easily beating out the competition. This high profit margin stems from the low cost of goods to create their core goods such as Clogs and Jibbitz charms.

Maximizing Shareholder Value

Finally, CROX has shown its dedication to shareholders, buying back 16% of their outstanding shares over the past 6 years. Management understands how to allocate capital and how to properly reward their shareholders through the usage of buybacks.

To summarize, CROX is firing on all cylinders: incredible revenue growth, incredible profit margins, and incredible management.

2Q2023: The Disappointment That Never Was

CROX had a disappointing price action after their 2Q earnings, with shares tumbling 14.9% after the earnings release. Let’s take some time to break down this earnings report.

The Crocs brand was incredible this quarter, contributing mostly to the top line growth with 15% CC growth. HEYDUDE was incredibly disappointing, only growing 3% YoY. Andrew Rees addresses this in the earnings call, attributing this to wholesale worries due to the lack of brand history but says that this is a slight blip in a very bright future. Rees has grown CROX exponentially over the years so I’m inclined to believe this and will not read too much into this.

Since then, while our wholesale partners are very pleased with the performance of HEYDUDE and a number have called us out in their recent earnings, many are cautious in terms of future bookings based on their overall market outlook and lack of historical data on HEYDUDE's performance. Finally, as we previously shared, we anticipate constrained distribution capabilities, particularly related to at once in the back half of the year due to ERP and warehouse transitions. Even with this lowered near-term revenue outlook, the HEYDUDE brand is acquiring new customers and is gaining penetration in strategic accounts and on the coasts. We remain incredibly optimistic about the long-term potential of the brand on a global basis.

Looking at 3Q guidance, I understand why the market sold off CROX as growth is looking very anemic at just 300 to 500 basis points YoY:

Looking at how the Crocs brand is performing, I’m inclined to believe that HEYDUDE will most likely be negative YoY and Crocs will remain an outperformer and carrying HEYDUDE’s weight. Despite this, my main focus is on their profitability. Their strong 27.0% adjusted operating margin means CROX will remain flexible, allowing them to pay down their debt or buy back shares heavily undervalued shares.

Finally, I’m reassured by Rees raising their FY23 outlook: increasing top line guidance and even raising their adjusted operating margin by a whopping 150 basis points. While 3Q may seem like a disappointment, it’s suffice to say that CROX as a whole will have their best year ever.

Turning towards valuation, I’ve used a DCF valuation to see where CROX stands. Using conservative expectations, my model shows that CROX is currently 38.69% undervalued. My assumptions were 14% top line growth and 26% EBIT margins. I kept D&A, CapEx, and NWC at the 5 year averages of 1.8%, -2.5%, and -0.5%, respectively. My terminal growth rate was 3% due to the strong business revenues and my WACC was set at 12% due to high yields, high debt with high effective interest rates, and CROX’s high beta.

As a reminder, CROX has pledged to reach 6B in revenue by FY26 while maintaining their operating margin at 26% and my model assumes CROX’s management will execute their intended plan.

I also created a sensitivity table showing multiple outcomes for CROX. Should revenues exceed management expectations or interest rates decrease allowing for a lower WACC.

As we can see in many situations, CROX is extremely undervalued, possibly 94.63% undervalued if CROX executes at the highest level. In an unlikely scenario where CROX underperforms, we would see slight downside of -2.37% to fair value.

Risks

The most obvious risk for CROX would be the company going bankrupt. Their balance sheet is highly leveraged, with $2B in debt (as of the most recent quarter) vs their $166m cash on hand. They raised roughly $2B in debt due to the HEYDUDE acquisition but have been incredibly diligent in paying it down. Management understands how crippling debt interest is with today’s rates being high. As such, they’ve allocated most of the profit generated towards paying it down. As CROX continues to deleverage, I believe their growth story will become less riskier and the price action will most definitely reflect that.

Minimal Volume Growth

When we look further into 2Q earnings, we see that the Crocs brand 15% revenue growth was not truly organic. Volume growth was only 2%, and 13% of the growth was attributed to Average Selling Price raises across the board. While this can technically be seen as bullish due to customers continue to buying despite the ASP increase, it is not sustainable and the Crocs brand will need to show increased volume generation to support their growth narrative.

HEYDUDE

Finally, the biggest risk is HEYDUDE continuing to disappoint. As aforementioned, their revenue grew only 3% YoY and their operating margin shed a whopping 500 basis points. It is not entirely surprising given the tough environment but nevertheless, CROX bought HEYDUDE as a growth lever and it is performing quite poorly. Again, I have complete faith in Rees to turn around HEYDUDE but for now, it is dragging down the CROX. If CROX is able to show in 3Q2023 HEYDUDE is pulling its weight, I'd imagine the narrative around CROX would change entirely.

Summary

CROX continues to outperform. Its core business, Crocs brand, has shown remarkable growth. Management continues to diligently pay down debt, grow revenues, and remain highly profitable. While HEYDUDE is currently a risk to the business, it's important to remember that Crocs is 75% of CROX's total revenues. Management has shown time after time they know how to perform at the highest level, and I believe they will turn HEYDUDE around.

My DCF valuation shows that CROX is significantly undervalued and the current share price does not adequately reflect their strong revenue growth and best in class profitability. As a result, I continue to reiterate my STRONG BUY rating ahead of 3Q2023 earnings.