With Quiver Quantitative’s recent institutional holdings data, we can see that hedge funds and asset managers have been increasing their holdings in Crocs Inc. (NASDAQ: CROX). Firms such as Samlyn Capital, Fuller & Thaler Asset Management, and Coatue Management have all recently added to their CROX positions. Most notably, Samlyn Capital increased shares held by 6.58% (as filed on 9/30), bringing their total CROX holdings to 1,360,171 shares worth around $163.2 million dollars at current market prices. With this in mind, we took a closer look at some of the reasons why many investors may be bullish on Crocs Inc.
In November, Crocs released a strong earnings report for the third quarter of FY23. CEO Andrew Rees had this to say on the quarter “We delivered a strong third quarter, exceeding the high-end of our guidance, led by double-digit revenue growth in our Crocs Brand supported by healthy full-price selling and industry-leading operating margins. Both our brands gained share during the back-to-school season. During the quarter, we took decisive action around HEYDUDE to accelerate our marketplace management strategy to ensure long-term brand health. As such, we are adjusting our full-year outlook to reflect this shift.” Some highlights of the quarter included consolidated revenues of $1.045 billion dollars (6.2% growth YoY), Diluted EPS of $2.87/share (5.5% growth YoY), and $90 million dollars of debt repayments (reducing gross leverage to 1.7x). In addition to this, Crocs resumed its share repurchase program during the quarter, repurchasing $150 million dollars worth of common stock (1.4 million shares at an average price of $107.85/share). $900 million dollars remains authorized for future share repurchases, a positive sign given the fact that the business’ shares are trading below intrinsic value (based on our calculations which we will get to later). With these positive earnings results in mind, we believe that Crocs is an actionable investment opportunity trading at a steep discount to intrinsic value.
Crocs, Inc., a leader in the casual lifestyle footwear and accessories market, serves women, men, and children through innovative design, development, marketing, and distribution globally. The company's mission is to be the top provider of innovative casual footwear, blending comfort, style, and value. A significant milestone in the business’ history was the acquisition of HEYDUDE, a casual footwear brand, on February 17, 2022. This addition enhances Crocs' portfolio, aligning with the global trends of casualization and personalization.
Crocs, Inc. operates in the highly competitive global markets of casual, athletic, and fashion footwear, facing rivalry from major players such as NIKE, Inc., adidas AG, Deckers Outdoor Corporation, Skechers USA, Inc., Steven Madden, Ltd., Wolverine World Wide, Inc., and VF Corporation. While it doesn't compete directly with any single company across all product categories, Crocs contends in portions of its wholesale, retail, and e-commerce businesses. Key competitive factors in these markets include brand recognition, product functionality, design, comfort, quality, price, customer service, and marketing and distribution. Despite facing competitors with greater financial resources, broader product lines, and stronger brand recognition, Crocs distinguishes itself with unique footwear designs, innovative material formulations, competitive pricing, a diverse product line, and a well-established distribution network, positioning it favorably in the marketplace.
Crocs places a high emphasis on growth, as evidenced by its multifaceted growth strategy. Central to this strategy is the expansion of digital sales, which made up 37.8% of its consolidated revenues in 2022, encompassing direct-to-consumer sales through company-owned websites, third-party marketplaces, and wholesale sales to global e-retailers. Another key aspect is increasing market share in the sandals segment, leveraging the brand's unique molding technology to offer comfortable, casual footwear. The acquisition of HEYDUDE in 2022 and subsequent marketing efforts, along with plans for a new distribution center, demonstrate a commitment to growing brand awareness and distribution capabilities. Furthermore, Crocs is pursuing international growth, particularly in Asia and Europe, while continuing product and marketing innovations, including the expansion of its core clog line and partnerships in digital advertising to help drive long-term growth.
Management is solid, and their capital allocation priorities do a great job of creating shareholder value. Management likes to return value to shareholders via share repurchases, something that we are a fan of as well. Considering that Crocs is trading below intrinsic value, it makes perfect sense in our eyes for management to continue to repurchase shares, rather than paying out a dividend. In April of 2021, Crocs’ Board of Directors approved a $712 million dollar increase in the business’ share repurchase authorization. Later in the year, in September, the Board approved an additional $1 billion dollar increase in the share repurchase authorization. As of today, there is still $900 million dollars left for further share repurchases, even after management repurchased 1.4 million shares ($150 million dollars worth) in the third quarter of FY23. While management likes to repurchase shares, they have never offered a cash dividend on their common stock, and there are no plans to do so in the future. We are perfectly content with this capital allocation strategy, as repurchasing shares below intrinsic value offers the greatest shareholder value.
In terms of management incentives, management is incentivized well, with a compensation structure that does a great job of aligning shareholder and management interests. The NEO compensation structure includes a base salary, annual cash incentives, and long-term incentives. The annual cash incentives are based on a variable, performance-based component, along with long-term incentives (which are paid out via equity rewards in the form of RSUs and PSUs). In 2022, the annual cash incentives were based on global adjusted EBIT, Crocs brand adjusted EBIT, and HEYDUDE brand adjusted EBIT performance targets. It also considered adjusted free cash flow. The long-term equity incentives were based on adjusted revenue, adjusted EBITDA operating margins, and ESG progress (which management believes will help drive long-term shareholder value creation). As we can see, management is incentivized to meet critical financial goals important for the business, which helps drive shareholder value creation. Additionally, this compensation structure (specifically the long-term incentives), helps retain NEO talent over the long-term, which is very important for this business. NEO talent has helped reshape and revitalize Crocs as a brand and a business, and it is vital to incentivize management to stay with the business over the long-term.
Crocs is a very efficient business. The business currently operates at a LTM ROE of 73.9% and a LTM ROIC of 26.7%. With a WACC of 10.2%, the business currently operates at a ROIC to WACC ratio of 2.62x, showcasing the business’ ability to generate returns on capital far greater than the business’ weighted average cost of capital. Businesses that are able to consistently generate high returns on capital are considered to be compounders, businesses that are able to rapidly compound intrinsic value and earnings, handsomely rewarding shareholders over the long run. Looking further at the business’ efficiency, we can see some stellar EBIT growth and EBIT margin expansion since 2017 (for context, we will be looking at financials from 2017 to today in this article, as that coincides with current CEO Andrew Rees’ tenure as CEO of Crocs Inc., who was promoted to CEO in June of 2017). Since 2017, EBIT has grown at a CAGR of 73% (an insane metric), with EBIT margins expanding from 2.1% of revenue in 2017 to 25.6% of revenue today.
Analyzing Crocs’ income statement, we can see some stellar sustained growth in revenue, profit, and earnings since 2017. Since 2017, the business has grown revenue at a CAGR of 21.3%, with gross profit growing at a CAGR of 22.3% in that same time period. Crocs benefits from high margins, with gross margins routinely greater than 50% within the last decade. In terms of earnings, Crocs has grown EBITDA at a CAGR of 52.7% since 2017, with EPS growing at a CAGR of 45.2% since 2019* (I choose to measure EPS growth from 2019 onwards since the business operated at negative EPS from 2014 - 2018). This growth in EPS can largely be attributed to share repurchases. Since 2013, Crocs has decreased shares outstanding by 31.6%.
Looking at Crocs’ balance sheet, we can see that the business operates in solid financial health. The business holds around $127.3 million dollars worth of cash and equivalents on the balance sheet, with nearly $2 billion dollars worth of long-term debt and no short-term borrowings. While this low cash to long-term debt ratio may be a red flag for some investors, we don’t believe that it should be a cause for concern. The business currently operates at an interest coverage ratio (which measures a business’ solvency) of 5.79x, meaning that the business generates $5.79 of EBIT for every dollar of interest expense that the business incurs. As we can see, the business has plenty of runway to cover its long-term debt obligations, especially as top-line revenue continues to grow and flow into earnings.
Analyzing Crocs’ cash flow statement, we can see some stellar sustained growth in net income and free cash flow, showcasing the business’ operational improvements under the tenure of current CEO Andrew Rees. Since 2017, net income has grown at a whopping CAGR of 82%, while free cash flow grew at a CAGR of 38.6% in that same time frame. The growth in free cash flow can largely be attributed to expanding free cash flow margins. In 2017, the business operated at a free cash flow margin of 8.3% of revenue, compared to today where the business operates at a free cash flow margin of 21.2%. This free cash flow margin expansion acts as a catalyst for future cash flow generation, which the business can use to further repurchase shares, offer/increase a dividend, and/or reinvest back into the business at high rates of return (as we mentioned above, Crocs is a very high quality business with a high ROIC, showcasing the business’ efficiency at allocating its capital to reinvestment opportunities).
After conducting a reverse discounted cash flow analysis, we can see that Crocs is trading at share prices that imply a -7.6% growth rate (CAGR) in free cash flow over the next decade, using a WACC of 10.2% (Croc’s WACC via Factset) and a perpetuity growth rate of 3% (largely in line with US GDP growth). Crocs is currently a popular deep value play, and based on what we have discussed above, we can see why. Since CEO Andrew Rees’ promotion in June of 2017, the business has done a complete 180, growing at breakneck speeds. Essentially, the market is pricing in free cash flow decreases over the next decade, and with the business’ operational efficiency as of late (just look at their free cash flow margin expansion), we find this to be highly unlikely. While past performance is not indicative of future results, a conservative free cash flow growth rate going forward (based on margin expansion and top-line revenue growth) in our eyes is 5%, which implies a share price of $217.76 and a 115.8% upside. This valuation and analysis is based completely on our proprietary models, and we encourage all investors to do their own due diligence in the business before coming to a conclusion on valuation.
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