CROX | We’ll Take It – Best Idea Short

Best Idea Short CROX came in with a mixed quarter – enough for both the bulls and the bears to chew on – but the bears clearly winning today. Top and bottom line both beat, with revenues of $1.07bn vs the Street at $1.04bn and EPS of $3.59 vs the Street at $2.98. Revenue for the quarter grew 11%, on a reported basis, slowing from 34% in Q1. The Crocs brand also had decelerating growth from 19% last quarter to 14% this quarter. North America saw an acceleration in revenue growth YY from 10% to 13%. On the call the company talked about the strength in Asia and all the potential growth in APAC, but revenue growth from Q1 to Q2 is decelerating, from +55% to +39%, respectively. The company took up Crocs brand full year revenue guide to +12-13% (up from 7-9%), along with total company revenues to +12.5-14.5% (from 11-14%). The problem from the print was the updated HeyDude guidance. The company took revenue guidance down from up mid-20% to up 14-18%. The company took down guidance mainly due to wholesale orders not being as strong as expected. Wholesalers are being more conservative in orders and are working through inventory overhang from other brands. Also, the company cut ties with some distributors and there has been and will continue to be pressure from the grey market. That’s a big rate of change cut at HeyDude and its negative on the margin given that HeyDude is such an important part of the bull case and forward growth algorithm. Even though we were never convinced about the HeyDude story, we weren’t expecting the company to cut the HeyDude revenue guide. But we’ll take it. One of our core concerns here is that the core Crocs brand is likely overearning, with EBIT margins north of 25% and the company taking up the guide for the full year to 27.5% (from 26-27% initially). Management attributed part of the operating margin increase to the increase in gross margins, which were up 290bps for the quarter and guided to full year margins of above 55.5%. The company saw margin increases due to strong DTC, price increases in the international markets, lower promotional levels in North America, and a recoup of freight rates. As we’ve said before we don’t think companies maintain all of the gross margin benefit from the recoup of freight rates. Over the longer-term, for a faddish company, we’re more comfortable with a high-teens margin today with the company investing more in marketing and R&D to mitigate the potential for a sharp decline in the brand. Despite the HeyDude guide, the overall guidance from the company seems bullish, but we just can’t get behind it. This is a company that’s core product is a fad product that has seen outsized growth over the last couple of years. Fads will change and the margin profile of this company isn’t sustainable longer-term. We’re at $10-$12ps earnings annuity while the Street is building to $17-$18 over a TAIL duration. If growth continues to slow, there’s no reason why we can’t see this stock trade at 5x earnings, which is a solid 50% downside from here. That might sound like a shocking multiple for a footwear brand, but it hit 4.7x earnings last year. Granted, that proved to be a huge buying opportunity, as the market way overshot the fundamentals to the downside. But we think today’s sell-off is appropriate, and wouldn’t be looking to cover – at least not yet.