Should You Bet on the Action at Crocs?
Iconic footwear maker Crocs has had a nice sales rebound over the past few years, as management has tried to rekindle its customers' love affair with its trademark clogs and avoid being relegated to a passing fad. Sales growth has slipped this year, though, due to weakness in the company's Japanese and North American wholesale markets.
Nevertheless, Crocs' cash-rich financial profile and brand potential has piqued the interest of private equity firms, most notably Blackstone Group. So, should investors bet on upside ahead for Crocs?
What's the value?
Crocs' colorful clogs burst onto the scene in 2002, proving immensely popular in industries that require comfortable shoes to mitigate the heavy amount of time spent standing, like nursing and food service. However, the maturation of the innovative design, as well as the rise of competitor knockoffs, has led Crocs to diversify toward more traditional materials and styles, including sandals, boots, and sneakers. While the newer materials have hurt the company's merchandise margin, the simplicity of the designs has allowed it to maintain a solid margin above 50%.
In fiscal year 2013, Crocs posted higher overall sales, up 7.3%, backed by a rebound in its European segment and further gains in the Asia-Pacific region, a key source of future growth. However, its relatively large North American wholesale business has been notably weak, requiring promotions to move merchandise, which has negatively affected Crocs' profitability and led to a weak current stock price.
Despite the current-year profit challenges, though, the company still generates solid operating cash flow, providing management with the flexibility to continue building on its retail network expansion strategy and thereby exert more control over the distribution of its products.
Of course, Crocs is still primarily a one-hit wonder, relying on its trademark clogs for the vast majority of its sales. The dangers of this operating model are pretty evident in the fortunes of similarly situated competitor Deckers Outdoor , which generates the majority of its sales from its popular Ugg unit.
After years of double-digit sales gains, the company's showcase product line has come back down to earth lately, hurt by falling average sales prices and rising costs for sheepskin, which jumped 40% in 2012.
In fiscal year 2013, Deckers reported a minimal top-line gain, up 3%, with a strong increase from its retail-store base being offset by broad-based sales weakness in its wholesale channel. Like Crocs, Deckers has been focused on building a retail network to better control its product distribution and to try to capture some of its retail partners' operating margin.
While Deckers' current-year profitability has been hurt by the higher costs of supporting its growing store base, management likely sees the stores as a necessary evolution that should allow the company to showcase its broadening product portfolio, including its Ugg, Teva, and Sanuk footwear lines.
Going with diversification
Given Crocs' limited evolution of its current product portfolio, investors should probably be looking for more diversified operators in the footwear space, like Steven Madden . The company has been riding the so-called "fast fashion" trend of fashionable products at an affordable price, nearly doubling its sales total over the past two years. More important, Steven Madden produces a wide assortment of products for women, men, and children at various price points, avoiding the risk of relying on the popularity of a specific product line.
In fiscal year 2013, Steven Madden also enjoyed a top-line gain, up 6.6%, aided by expansion across each of its business units. Unlike its named competitors, though, the company has been able to slightly improve its operating margin in the current period by successfully upselling its customers into higher price points and by leveraging its brand to generate sales in the higher-margin accessories segment.
Of course, Steven Madden also seems to be cognizant of the dangers of an overreliance on a wholesale customer base, as it has spent time building a complementary network of more than 100 domestic stores, a number that is expected to rise by more than 10% in fiscal year 2014.
The bottom line
Private equity firms may or may not see value in Crocs' story, but small investors should likely steer clear of the company until it stabilizes its operating profitability. Excluding cash balances, the market is valuing Crocs at a relatively low level, indicating some disbelief in the company's future growth opportunities. Instead, investors should buy into the Steven Madden story, as it continues to evolve into a lifestyle brand for its value-conscious customer base.
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The article Should You Bet on the Action at Crocs? originally appeared on Fool.com.Fool contributor Robert Hanley owns shares of Crocs. The Motley Fool owns shares of Crocs. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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