In this week's Small-Cap Spotlight, Frank Curzio and Larsen Kusick revisit Crocs (CROX) - Get Crocs, Inc. Report, which is up more than 60% since they first covered it on May 31. In light of the big rally, should investors be taking their profits and moving on, or is there further room for upside?
Kusick: Great Companies Always Have Upside
When Frank and I started this weekly feature a few months back, we figured there would be a lot of instances in which we would highlight a stock that both of us liked. (As it turns out, it's a lot more fun for both of us when we cover stocks we disagree on.)
Crocs was a perfect example of a company that was knocking the cover off the ball and had a stock that had room to run as the story played out. I'd been singing the praises of the company since late in 2006, and even Frank's sensitivity to insider selling wasn't enough for him to deny that this was a great play for investors.
But after five months and another 60%, what do we do with this name? Declare victory and move on? We all know the Cramer adage, "Bulls make money, bears make money, pigs get slaughtered," so if you bought Crocs earlier this year and are sitting on a nice gain, then, yes, please, take some off the table. But that would be an exercise in proper investment management rather than any knock on the stock. The Crocs story is as strong today as it was five months ago.
Let's look back at some of the reasoning I used then, which included the company's growth rate, a differentiated product line and the major potential coming from continuing international market penetration. The only part of the story that has changed is that we have increased visibility into how the company has proceeded on the international front over the past five months. Not surprisingly, it's been great.
Since May, the company has shown continued progress as it expands into international markets while introducing new styles in the U.S. During Crocs' blowout second quarter, announced on July 26, international sales were up 294%, with Japan and the U.K. leading the way. The international component of the Crocs story remains extremely important, especially with the U.S. dollar trending lower.
International sales made up 49% of total revenue during the second quarter, and I expect this percentage to rise steadily as the company continues to penetrate other important markets this year, particularly Brazil and its South American counterparts. Surprisingly, China has yet to be mentioned as a major opportunity, but I believe Crocs is at least a year away from capitalizing on the potential of the world's largest nation.
The other facet of the Crocs story I targeted was the continuing criticism of the stock based on valuation. Looking at trailing 12-month earnings, shares were trading at a lofty 38 times earnings back in May, but I contended that it was more useful for investors to look at Crocs' forward
multiple, which was around 20 times 2008 earnings estimates.
New styles continue to be a focus for Wall Street analysts, but the commentary has been subdued. Croc's new Mammoth line, a fleece-lined version of its traditional clog, is aimed at reducing the seasonality of the company's overall product line.
Other new products include a fashion-oriented "You by Crocs" collection, some of which are actually high-heeled. Recent analyst coverage has also focused on the company's foray into apparel by offering simple cotton shirts, shorts and pants with the familiar Crocs emblem.
I can't say that I'm bullish on the stock because of these newer models and entry into the apparel market, but thankfully neither are the analysts, most of whom use words like "modest" and "uncertain" when discussing their contributions to future sales.
Given that customer demand for Crocs' products always exceeds expectations -- no matter how ugly I, or anyone, may think they are -- I'd bet on generally positive uptake of these newer offerings.
In short, the Crocs story has not changed. Rather, it is unfolding as well as investors could have hoped. Combined with the fact that there are so many skeptics (and traders who are shorting the stock), it's not surprising that shares have remained in a strong uptrend since May.
As I said back in our original story, valuation will always be a concern, and sure enough, shares are trading at 80 times 2006 earnings.
But I've maintained that Crocs' valuation is justified by its amazing growth rate (as well as the scarcity of growth in the footwear sector). The company is on track to post a 143% increase in earnings during 2007, putting its 2007 multiple at a much more reasonable 33 times earnings.
Meanwhile, I expect 2008 estimates to be adjusted upwards following each of Crocs' quarterly earnings announcements, and I show a conservative forecast for 28% earnings growth next year.
While I see further upside in shares of Crocs, investors need to keep an eye on results to make sure the story remains intact. It's imperative that the company beats estimates each quarter, as any shortfall would indicate a major problem with the bullish thesis.
In addition, the international story is much more important than Crocs' U.S. results, and investors should watch to make sure international sales as a percentage of total sales remains in a strong uptrend.
Finally, selling shoes to adults is obviously important, but not as important as maintaining popularity among children, who replace their shoes much more frequently than adults, and thus can have an outsized effect on sales. That's why it's important that Crocs continues signing licensing agreements with the likes of
, Warner Bros. and other child-oriented brands.
Curzio: Time to Take Some Profits
As Larsen points out, Crocs has had a nice run since our recent article. This is surprising given that its shoes are dangerous when worn on escalators, they generate enough static electricity to knock out medical equipment, and they are labeled by many as being just another fad.
Over the last the last six months, bears have struggled looking for ways to bash this high-growth company, which now sports a market cap of $5.3 billion, and have been beaten down hard. But I believe the tides may be turning, as several risks could result in an earnings miss in the coming quarters.
Most of the shoes that Crocs produces are worn during warmer seasons or in generally warmer climes. This has been great for sales over the latest quarter and will be reflected when the company reports its third-quarter earnings early next month. But the following quarters may be challenging as much of the U.S. heads into colder weather.
Management believes that its new fall line of fleeces and long-sleeve shirts will offset seasonal trends, but I find this hard to believe because most of the apparel items are not yet available on the company's Web site. Second, why would a company that has dominated the casual shoe market want to get into the highly competitive apparel industry, which has been under pressure due to a slowdown in consumer spending?
I applaud efforts by management to diversify its business, but Crocs' brand is built on comfort, and I find it hard to believe that its apparel will be more comfortable than its competitors'.
Larsen mentions the huge growth potential on the international front, and that was one of the key factors for my buy recommendation 30 points ago. Japan and Europe have been huge growth-drivers, and China could be next. But most of this is priced into the stock, with shares trading at 30 times 2008 earnings -- or higher than its long-term growth rate of 27%, according to Capital IQ.
Also, insider selling should not be ignored. I have read numerous stories since our article on how insiders have been selling the stock but shares have been rising. To put the selling in perspective, over the last six months, there have been 44 individual insider sales totaling nearly 2.8 million shares, compared to zero buys.
Many suggest that this is not a major factor, and they may be right considering that Crocs is trading close to its all-time high. But I heard the same thing when
CEO Angelo Mozilo dumped shares of his company through his prearranged plan in October 2006. Shares initially went higher, but I don't have to tell you how the stock is doing today.
Crocs has had a very nice run, and shares may move higher from the current levels. However, the company may struggle to meet its estimates during the colder months. A slight miss in earnings, or lower-than-expected guidance, could result in a selloff of more than 10%, being that this high-growth play could be considered in the same league as
, in terms of high expectations and overdelivering.
With shares up more than 60% since my recommendation back in May, I believe that the risks, which include insider selling, valuation and seasonal trends, outweigh the rewards. Crocs may be hard to cut loose for some investors, but past performance should not be a reason for holding this stock.
I think the prudent move is to take some profits off the table after a 60% gain in the stock in just six months.