Crocs: A Tremendous Turnaround Story Being Written Off As A ‘Fad’ (NASDAQ:CROX)

Investment Thesis

I believe the question of Crocs, Inc. (NASDAQ:CROX) comes down to one essential question:

Is the recent success of Crocs simply a temporary fad, meaning financials are destined to deteriorate in the near future? Or is Crocs the beneficiary of a well-executed turnaround plan with more financial success to come? While Crocs’ recent astronomical growth can be attributed to a fad-like Crocs frenzy, much of Crocs’ recent success can be attributed to a phenomenal turnaround.

Crocs has created a lean business with best-in-class margins, a stark reversal from its on-and-off profitability in the early/mid-2010s. With the help of new CEO Andrew Rees, Crocs returned the focus back to their classic clog and returned to relevancy by targeting Gen-Z via celeb collabs, driving high double-digit growth. The acquisition of HeyDude will serve as a growth driver as well as a business diversifier, without diluting the Crocs brand. Additionally, following deleveraging from the HeyDude acquisition, Crocs plans to continue to aggressively buyback shares, with the potential to create substantial shareholder value. Using long-term guidance from management, I generated a 3-statement model with an implied 2027 share price of ~$359, representing an implied IRR of ~27%.

Turnaround Story

The turnaround story of Crocs is one that is starting to receive some more attention in recent months. While Crocs shares are still down 13% over the past year, shares are up ~100% over the past 6 months. Nonetheless, Crocs still trades 40% below its 2021 high.

The turnaround story starts in 2008 when Crocs appeared to be on the verge of bankruptcy, with sales falling and cash burning.

Margin Expansion

In 2009, John Duerdon was appointed as CEO and helped the company focus on profitability. Additionally, he focused on Crocs’ strength, their classic clog. He said they wanted to focus on products that were “recognizable as Crocs.” John Duerdon steered the business away from disaster.

John McCarvel became CEO in 2010, and again began investing in other product lines, away from the clog. As margins began to deteriorate, Andrew Rees was appointed president and assumed CEO responsibilities. Between 2014-2017, Rees eliminated 180 jobs, closed down 75-100 stores, and cut 30-40% of products (Using John Duerdon’s strategy of focusing on products “recognizable as Crocs”). He was then named CEO of Crocs in June 2017. In 2018, Rees didn’t slow down. Rees shut down 160 retail locations and shut down all of their manufacturing facilities to cut costs. Rees also made digital sales a priority, another way for Crocs to improve margins and profitability. As you can see in the chart below, the plan worked.

In my opinion, the margins clearly prove that Crocs is a beneficiary of a strong turnaround execution, and not just fashion trends. While EBIT margins will likely drop to around 26-27% (as guided by management), Crocs has gone from unprofitable to best-in-class margins.

Return To Relevance

The other leg of the turnaround story is Crocs’ return to relevance and how that’s driven top-line growth. Crocs once again turned to focus efforts on their iconic clog. By focusing on Gen Z and other young generations, Crocs utilized social media and brand/celebrity collaboration to regain its prominence. From Balenciaga to Post Malone to Seven Eleven, Crocs managed to return to the forefront of pop culture.

How about KFC? (Last one I promise)

Regardless of your opinion on those swanky KFC Crocs, customers appear to love them (if top-line growth is any indicator). Crocs revenue grew ~67% in 2021 following a pandemic boost for casual styles. Additionally, in Piper Sandler’s “Taking Stock With Teens,” Crocs has consistently climbed the rankings in popularity among teens.

In Fall 2022, Crocs jumped to 5th place among the top footwear brands. Clearly, there are characteristics of a fad within the turnaround story, but the re-emergence of Crocs came about due to its own carefully executed marketing and turnaround strategy.

Growth Strategy

To ensure Crocs’ success isn’t a short-term fad, management has highlighted several areas for growth.

1. HeyDudes
2. Digital Sales
3. Sandals
4. Asia
5. Jibbitz.

HeyDude Acquisition

The $2.5 billion cash and stock HeyDude acquisition was immediately faced with scrutiny by investors and sent the stock price tumbling. Many investors were/are simply unfamiliar with the brand, and were worried that Crocs was moving too far away from its core identity. However, I believe this is an incredible move, and perhaps the only one that really makes sense for Crocs. As seen in Crocs’ troubled past, they’ve struggled to diversify their portfolio of products within Crocs as it’s only managed to dilute the brand. By acquiring an entirely separate fast-growing casual footwear company, Crocs can diversify its product offerings without diluting its brand. Additionally, Crocs can leverage its existing supply chain infrastructure, distribution network, and marketing strategies to rapidly grow HeyDude. It’s already working. HeyDude had revenues of $115 million in Q1 of 2022 and grew them to $269 million by Q3 (130% growth). Crocs initially issued guidance of $1 billion+ revenue for HeyDude by 2024, but now expects revenues to be $1 billion+ by 2023. HeyDude also made its Piper Sandler’s “Taking Stock With Teens” debut at the #8 spot in the fall of 2021. Not only is HeyDude growing rapidly, but they’re generating strong cash flow, with operating margins of ~26%.

While many investors are weary of the HeyDude acquisition, I believe that diversifying Crocs’ portfolio of brands is a great way for management to create shareholder value. If this acquisition continues to go well, I could see management acquiring additional casual footwear brands to further diversify its portfolio. If you take a look at Crocs’ closest competitor, Deckers Outdoor Corporation (DECK), you’ll notice they trade at a premium despite lower growth and inferior margins.

I believe this is due to the relative safety that Deckers’ portfolio of 5 brands offers, compared to Crocs’ 2. By acquiring additional brands, Crocs could reduce some of the risks that come with having somewhat limited diversification.

Other Growth Initiatives

Crocs has repeatedly shared its growth initiatives in order to reach $5 billion+ revenue by 2026 (for just the Crocs brand, not HeyDudes).

The Asian market has already proved to be a strong growth driver for 2022, with the first 3 quarters already far exceeding total revenue in 2021. As most of the world looks to stifle economic growth by increasing interest rates, China is currently trying to stimulate its economy. This could serve as another growth driver in the coming years as most of the world is threatened by a looming recession.

Share Buybacks + Deleveraging

Crocs has told us what its capital allocation priorities are, and I’m very happy to see them committed to rapidly deleveraging following the HeyDude acquisition.

Once Crocs finishes deleveraging, they can return to aggressively buying back shares as they did in 2021 (bought back $1 billion in shares in 2021). Through my 2027 forecast period, I projected that Crocs can buy back $2.45 billion in shares, after deleveraging almost entirely.

This could take shares outstanding from 60.5 million to 45.4 million by the end of 2027, generating tremendous shareholder value.

Valuation

Crocs_Model_Seeking_Alpha.xlsx

The link above is to a 3-statement model for Crocs which is based upon these basic assumptions given by management during Q3 earnings:

1. Crocs revenue to hit ~$5 billion+ by 2026
2. 26% long-term EBIT margins for Crocs and HeyDude
3. $1 billion + revenue for HeyDude by 2023
4. CapEx is 3% of revenues.

I did not deviate much from management guidance, so the question comes down to whether or not management’s long-term guidance can be trusted. I’ll make the argument as to why they can.

First, since Andrew Rees took helm of the company, Crocs has had repeated success in beating earnings (EPS) expectations.

2017 Q3: Beat

2017 Q4: Miss

2018 Q1: Beat

2018 Q2: Beat

2018 Q3: Beat

2018 Q4: Beat

2019 Q1: Beat

2019 Q2: Beat

2019 Q3: Beat

2019 Q4: Beat

2020 Q1: Miss

2020 Q2: Beat

2020 Q3: Beat

2020 Q4: Beat

2021 Q1: Beat

2021 Q2: Beat

2021 Q3: Beat

2021 Q4: Beat

2022 Q1: Beat

2022 Q2: Beat

2022 Q3: Beat.

Maybe it would’ve been easier to say that Crocs has only missed EPS estimates in 2 of the 21 quarters in which Andrew Rees has been CEO. Even more importantly, management has proven to either meet or exceed their own guidance. As mentioned earlier in the article, in Q1 management initially guided $1+ billion in HeyDude revenue by 2024. Last quarter (Q3), management now expects revenue to exceed this target by 2023, with 2022 bringing in up to $800 million already.

If management is able to live up to their promises, Crocs clearly has substantial upside for price appreciation in the coming years.

Risks

The macroeconomic environment is clearly a factor that could negatively impact Crocs in the short term. With the Federal Reserve unlikely to stop rate hikes in the near term, many believe a recession is inevitable. A decrease in discretionary spending could be detrimental for Crocs’ top line growth, as it was back in ’08 and ’09 (-14.8% and -10.5% growth, respectively). However, even with a poor macroeconomic environment, I believe that Crocs is positioned well with strong margins, a strong brand, and a more diversified portfolio than in the Great Recession.

Another risk is the “fad” risk. As I’ve established throughout the article, I believe a lot of Crocs’ recent success can be attributed to their turnaround execution rather than fashion trends. Crocs has executed a very successful marketing strategy and has regained prominence as a top 5 footwear retailer. While Crocs certainly appears to be capable of remaining relevant, if they fail to remain popular among younger generations, Crocs could face some serious trouble.

Lastly, Crocs has taken on $2 billion in debt following the HeyDude acquisition. This debt was issued at the “Alternate Base Rate” + 2.5%. This means Crocs is likely paying an interest rate approaching 9%, as Citi’s prime rate is currently at 6.75%. If interest rates continue to increase, Crocs could find themselves paying more and more interest on the loan. However, Crocs has the ability to deleverage quite rapidly, and keep interest expense from becoming a burden on the business.

Final Recommendation

Crocs, Inc. is a strong business that has executed an impressive turnaround, reestablishing their brand relevance, margins, and growth. The acquisition of HeyDude is a brilliant way for Crocs to diversify its product offerings without diluting the Crocs brand. Additionally, Crocs has a long runway for growth, particularly in the Asian and sandals market. Over the next several years, management plans to de-lever the business and buyback a substantial amount of shares.

Even though Crocs, Inc. shares have run up roughly ~100% in the past 6 months, I believe there is still time to purchase Crocs shares and still achieve a large margin of safety. With an implied 5-year IRR of ~27%, I believe Crocs, Inc. could be a great play in the coming years.