Cate Gillon
In the final days of 2021, I looked at Crocs (NASDAQ:CROX) and offered some thoughts post the Heydude deal. The company has seen a real boom in the years 2020 and 2021, when fashion was not so important, and renewed management confidence inspired the team to set some ambitious future targets and to announce a big deal for Heydude.
Former Take
In December, I went back all the way to 2014, when Crocs was struggling with a $1.2 billion revenue base on which operating earnings of a mere $50 million were reported. Despite a comfortable net cash position, Blackstone got involved and made an investment as shares rose to $16, for a $1.1 billion operating asset valuation at the time, as the involvement of Blackstone provided a boost to the investment thesis.
This investment followed a boom in the year 2006 when shares rallied from $10 to $70 a year later, only to see shares trade at single dollars during the crisis. Despite the involvement of Blackstone, shares have been lagging for quite a while and traded at just $6 in 2017, rallied to $40 ahead of the pandemic and briefly hit the $10 mark again during those panicky weeks when the outbreak was in full swing.
Ahead of the pandemic, Crocs posted a 13% increase in 2019 sales to $1.23 billion, which is the same revenue number as 2014, but unlike 2014, operating profits were posted at $128 million, for margins around 10%. The 70 million shares traded at $40 ahead of the pandemic. A $2.8 billion equity valuation came in at 25 times earnings, as the company guided for further improvements in the 2020 results. Despite the pandemic, or perhaps thanks to it, sales rose 13% to $1.4 billion in 2021 as operating margins jumped to 19%. This was the result of over half of sales being generated from digital channels, as earnings per have doubled to $3.22 per share.
The company guided for further improvements in 2021, with earnings originally seen around $4 per share, prompting a continued rally in the stock. That momentum was a bit overdone, fueled by management which set a hugely ambitious $5 billion revenue target for 2026, accompanied by sky-high margins, creating a roadmap for earnings to rise to $15 per share. This made that shares rallied to the $180 mark towards the end of 2021. I called this ambitious based on extrapolation of current trends, as there was not much evidence to back up this momentum.
With a share count of 63 million shares trading at a high of $180, the company supported an $11.3 billion equity valuation with earnings trending at $10 per share, resulting in reasonable earnings multiples, but I wondered how sustainable the earnings, or better said margins, were. Crocs furthermore announced a $2.5 billion deal for Heydude by year-end, a deal mostly comprised out of cash in a deal set to add $570 million in sales and coming in at 15 times EBITDA.
Net debt would jump to $2.25 billion, or about 3 times EBITDA, as this left me wondering a bit given that leverage could increase rapidly, certainly if margins would revert. Investors thought alike as shares fell from $140 to $120 upon the deal announcement, cutting the valuation by more than a billion on a $2.5 billion deal, being a very clear sign of their discontent. Given the momentum at the time, I found that this could be an overreaction, as perhaps a small position might be warranted, yet I failed to have conviction on the thesis to consider holding a substantial stake.
That Escalated Quickly
Forwarding about half a year in time, we see shares trade near their lows, trading hands at $54 per share which is down roughly 70% from the peak, and down more than 50% from levels seen by Christmas last year.
In February, the company posted its 2021 results as full year revenues rose 67% to $2.31 billion with adjusted earnings doubling again to just over $8 per share. The company issued a solid guidance for 2022 with revenues excluding Heydude seen up 20%. Heydude is expected to contribute $700-$750 million revenues and adjusted earnings are seen around $10 per share. A few days later, still in mid-February, the deal for Heydude closed which included a $2.05 billion cash component and nearly 2.9 million shares to be issued to the previous owner.
Early in May, Crocs posted first quarter results, interesting as the Heydude deal closed, inflation was raging and we of course are dealing with a global political conflict. Total sales rose 43% to $660 million which does not tell much. An 18% increase in Crocs sales feels a bit short, but a $115 million revenue contribution from Heydude for just one and a half month looks decent and was ahead of expectations. Adjusted earnings came in at $2.05 per share, a touch light. Despite this, the company hiked the full year guidance, now seeing sales around $3.5 billion and earnings at a midpoint of $10.35 per share.
Net debt inched up to $2.7 billion following the deal and working capital requirements. This is a huge number as a share count of 60 million shares values equity at $54 at just $3.2 billion, for a $5.9 billion enterprise valuation, highlighting the degree of the overpayment of Heydude. Net debt is posted at 2.9 times EBITDA, but the main concern of investors is of course a violent reversal in the profitability, for which the first quarter did not indicate any of such happening of course just yet.
And Now?
The main concern in my eyes is that of leverage, as net debt is high, and while earnings power is substantial, the pace of movement in the world is rapid and violent, making me wonder how long the current earnings power can be maintained to reduce leverage, even as the company hiked the guidance following the first quarter earnings report. Comforting, besides hiking the guidance, were sizable insider buys as of late, always a strong signal.
While I am mindful of the leverage, value is apparent enough here, certainly if inflation subsides amidst slower economic growth. Right now I am happy to start adding to a position which I have started initiating in the $60s in recent weeks, believing the current valuation provides an attractive risk-reward here, albeit this is an above risky proposition.
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