Crocs (NASDAQ: CROX)
Ah yes, Crocs (NASDAQ: CROX). We know them as shoes that look like clogs but are crafted using rubber and foam. They can switch from “relaxed mode” to “sports mode” by simply flipping the back heel strap in to place. Consumers can add accessory pieces, Jibbitz for the uninitiated, to customize a pair to their heart’s content. They’re hideous. Yet, I’m one of the few who don’t seem to love them. This writeup, while shorter than usual, will be about the business and its intriguing valuation.
Crocs’ business model is straightforward. They produce their shoes using third party manufacturers and sell them both online and through company-owned stores and retailers such as Wal-Mart, Target, Kohl’s, Macy’s, DSW, etc. Crocs are sold in the United States and internationally. Moving on.
Risks
Charlie Munger referenced using “Grandma’s rule” to get ahead in life, so let’s start off with the veggies before moving on to dessert. Said veggies come in the form of four notable risks facing this business: decreasing revenue growth, the HEYDUDE acquisition and its subsequent performance, debt related to the HEYDUDE acquisition, and manufacturer concentration.
Decreasing revenue growth – Total year-over-year revenues increased 7% in Q1 2024, 5% in Q2 2024, and only 2% in Q3 2024. 2024 full-year revenue guidance is an increase of ~3%. This will be the lowest revenue growth rate since 2018 when receipts increased by 6.30%.
HEYDUDE acquisition – The HEYDUDE shoe brand was acquired by Crocs in February of 2022 for $2.5 billion.
HEYDUDE’s 2023 revenues increased to $949.39 million which was only a 6% increase versus 2022. Do note that HEYDUDE’s 2022 listed revenues of $895.86 million were for the period after the business was acquired representing about 10.5 months of revenue, not the full 12. This means HEYDUDE’s 2023 revenue increased less than the 6% rate listed in the 2023 10-K. Operating income in 2023 increased by a measly 0.5% to $212.39 million.
2024 hasn’t been a banner year for HEYDUDE either. Q1 2024 revenues decreased 17% year-over-year to $195 million. Q2 2024 revenues were down 17.5% year-over-year to $198 million. Q3 revenues clocked another 17% year-over-year decrease to $204 million. The most recent management guidance is for HEYDUDE’s 2024 revenues to decrease 14.5% versus 2023.
Time will tell how this acquisition works out, but it appears that Crocs substantially overpaid for this business. That’s not to say that it won’t or can’t work out, but I don’t expect it to be in the black for quite some time.
Debt related to the $2.5 billion HEYDUDE acquisition - The HEYDUDE acquisition was financed mainly through debt and the issuance of $450 million of Crocs’ stock. The debt consisted of a $2.0 billion of notes and a term loan plus an additional $50 million revolving facility. Crocs’ current debt situation is described more in the Valuation section of this writeup.
Manufacturer concentration – Crocs’ largest third-party manufacturer for the Crocs brand produced approximately 47%, 42%, and 34% of production in 2023, 2022, and 2021. The second largest third-party manufacturer produced approximately 26%, 27%, and 30% of production in 2023, 2022, and 2021. That totals to 73%, 69%, and 64% of production from its two largest third-party manufacturers in 2023, 2022, and 2021. In 2023, ~83% of HEYDUDE’s production was in China.
CEO
Andrew Rees is the President and CEO of Crocs. Per Crocs’ 2024 Proxy Statement, “Andrew Rees, age 57, has served as a member of the Board since June 2017 and is currently the Chief Executive Officer of Crocs, Inc., overseeing the brands’ global strategy and operations. Mr. Rees joined Crocs as President in June 2014, and became Chief Executive Officer in June 2017. Mr. Rees has more than 25 years of experience in the footwear and retail industry. Prior to joining Crocs, Mr. Rees served as Managing Director of L.E.K. Consulting in Boston where he founded and led the firm’s Retail and Consumer Products Practice for 13 years. While at L.E.K., a consulting firm, Mr. Rees served as a consultant for Crocs from 2013 to 2014, supporting the development and execution of the Company’s strategic growth plan. Previous to L.E.K., Mr. Rees served as Vice President of Strategic Planning and Vice President of Retail Operations for Reebok International, an American footwear and clothing brand. He also held a variety of positions at Laura Ashley, a British textile design company, from 1994 to 1996.”
CEO Compensation
Deciphering the changes in Crocs’ executive compensation plans over the last few years was one hell of a mental workout. They’re described in detail below.
Mr. Rees’ compensation is comprised of a base salary, annual cash incentives, long-term incentives, and severance/change-in-control programs. I’m only writing about the first three elements of his compensation as they are most material to his day-to-day functions.
Base salary – Mr. Rees’ base salary has been $1,100,000 since 2021. There was no mention of it being increased in the 2024 Proxy Statement.
Annual Cash Incentives - As a quick aside, I won’t focus on the weightings of each performance metric or how well the executive team performed. The point is to show how much the language around Annual Cash Incentives has changed over three years. It’s a classic example of “moving the goalposts”.
Per p. 29 of the 2022 Proxy Statement, 2021 Annual Cash Incentives were based on financial and “strategic operating goals to provide focus and incentive to achieve key strategic non-financial objectives during the Company’s continued growth.”
The financial metrics were “adjusted EBIT” and “adjusted free cash flow”.
The strategic metrics were associated with sandal and charm growth, digital growth (whatever that means), and “continued progress on our China Long-Term Growth Plan…”
Per p. 40 of the 2023 Proxy Statement, 2022 Annual Cash Incentives were again based on financial and strategic goals. The weighting of strategic goals was decreased due “to their relative importance to the business.”
The financial metrics were “global adjusted EBIT” and “global adjusted free cash flow”. Both metrics were calculated differently than “adjusted EBIT” and “adjusted free cash flow” in the previous year.
The strategic metrics were objectives associated with Crocs, Inc. Enterprise strategic initiative performance and objectives associated with integration efforts. The integration efforts were related to the acquisition of the HEYDUDE brand. The definitions of each strategic metric are highlighted in the screencap below which was taken from p. 41 of the 2023 Proxy Statement.
Per p. 44 of the 2024 Proxy Statement, the Annual Cash Incentives were based again on financial and strategic goals.
The financial metrics were “enterprise adjusted EBIT” and “enterprise adjusted free cash flow”.
The strategic metrics were the Enterprise strategic initiative performance and “ESG progress”. There was no further description of what “ESG progress” meant during that fiscal year or will mean going forward.
To wrap up this subsection, it’s crystal clear that the Compensation Committee is just moving the goal posts every year to make sure the CEO and other executives get their Annual Cash Incentive bonuses.
Long-Term Incentives – We have a similar situation here to what happened with Annual Cash Incentives. The point is to show how the language has changed and how the goalposts have been moved.
The three screencaps below were taken from p. 40 of the 2022 Proxy Statement, p. 42 of the 2023 Proxy Statement, and p. 47 of the 2024 Proxy Statement. They tell you all you need to know regarding Long-Term Incentives at Crocs. Take a peek at the “Performance Goals” of each screencap.
Like the previous subsection, it’s clear that the Compensation Committee is moving the goal posts so that the CEO and other executives can get their long-term bonuses.
Crocs’ 2023 Summary Compensation Table is shown in the screencap below and was taken from p. 51 of the 2024 Proxy Statement.
Per TIKR, Mr. Rees owns 1.35% of Crocs which equates to 789,020 shares. The value of his shareholding is ~$89 million. That is quite a bit of skin in the game which is what I want to see.
On the other hand, insiders at the company collectively own ~2% of the entire business. I’d like to see the other executives at Crocs have substantially more skin in the game.
Valuation
Quick note about this section: I’ve included data going back to 2005 because Crocs IPO’d in February 2006. I feel this is close enough to the end of 2005 to include it in the results even though the business technically wasn’t publicly traded then.
Revenue
Crocs’ revenues from 2005 – 2023 are shown in the screencap below. The data were taken from TIKR.
Crocs was able to increase revenues more than 36x between 2005 and 2023. For those keeping track at home, that is a CAGR of 20.84% per year. Most impressive.
The full year 2024 revenue guidance from the Q3 Investor Presentation was a ~3% increase from 2023. That would push revenues to ~$4.08 billion. That drops the revenue CAGR down to 19.88% which is still white-hot growth over that long of a time frame.
Crocs trades at ~1.63x 2023 revenues given its current market capitalization of ~$6.45 billion at the close on 1/6/2024. Assuming 2024 revenue guidance is accurate, the business trades at a revenue multiple of 1.58x.
Real Free Cash Flow (RFCF)
Crocs’s RFCF, defined as Operating Cash Flow minus Stock-Based Compensation minus CapEx, is shown in the screencap below. The data were taken from TIKR.
RFCF at Crocs has been kind of all over the place. It struggled for a few years after going public, then had a run of positive RFCF until 2014, and hit some trouble over the next two years. What is apparent is that RFCF has taken off like a rocket since 2016. Crocs has hit its stride. The business trades at ~8.2x 2023 RFCF given its ~$6.45 billion market cap at the close on 1/6/2024. Remember, that’s including all the CEO incentives mentioned earlier. Per TIKR, RFCF for the last twelve months was $910.23 million. That knocks the RFCF multiple down to ~7.08x.
Balance Sheet
The asset side of Crocs’ balance sheet is shown in the screencap below. I used data going back to 2014 instead of 2005 because it was too difficult to format and read. The data were taken from TIKR.
A few things stood out on the asset side. The first two are accounts receivable and inventory. Both have increased substantially since 2016. Accounts receivable CAGR’d at 18.56% while inventories increased at a CAGR of 12.79%. Revenues over this same period CAGR’d at 18.25%, roughly in line with accounts receivable. No alarm bells with these two items for now.
The two other line items that stuck out were goodwill and intangibles. You’ll notice huge increases starting in 2022. Both are related to the HEYDUDE acquisition. Per Q3 2024 10-Q, Crocs has taken ~$24 million in impairment charges related to the HEYDUDE acquisition. $18.2 million of this impairment was for technology systems and a further $5.5 million was for HEYDUDE’s former warehouses in Las Vegas, NV.
The liabilities and equity side of the balance sheet is shown below. The data were taken from TIKR.
The biggest concern here is Crocs’ debt load.
Let’s revisit the $2.05 billion in debt Crocs took on to acquire HEYDUDE. Per Q3 2024 10-Q, long-term debt as of 9/30/2024 was reduced to $1.422 billion. The structure of long-term debt included:
$350 million of notes maturing in 2029. The effective interest rate is 4.64%.
$350 million of notes maturing in 2031. The effective interest rate is 4.35%.
$575 million Term Loan B Facility
$190 million Revolving Facility
I’d obviously like a business with no debt, but Crocs has made substantial progress in paying down its debt load since acquiring HEYDUDE.
Returns on Invested Capital (ROIC)
Crocs’ returns on invested capital are shown in the screencaps below. The data were taken from TIKR.
Like its RFCF, Crocs’ ROIC started out well and hit a rough patch from 2013 – 2017. Results since 2018 have been outstanding. The numbers don’t lie. Management has been very efficient with its capital and deserves a ton of credit here.
Returns on Incremental Invested Capital (ROIIC)
Crocs’ ROIIC and value compounding rate are shown in the screencap below. I included the calculations starting from 2005 and 2006 to quell any concerns about starting from an artificially low base rate.
Crocs has done an outstanding job of compounding its value since going public. By my estimates, the business has compounded its value by at least 26% per year since it IPO’d in February of 2006. Its stock price performance is shown in the screencap below and was taken from TIKR.
Per TIKR, Crocs’ stock price has compounded by 12.5% per year, indicating a huge spread between stock and business performance. This is one of the largest spreads I’ve come across since I started the newsletter.
Additional Takeaways
Buybacks – 2.3 million shares of stock have been repurchased through the first three quarters of 2024. The business still has a remaining authorization to repurchase $548.9 million of common stock, subject to restrictions under its Indentures, Credit Agreement, and Term Loan B Credit Agreement.
Interest and income tax expenses – I noticed interest and income tax expenses were down significantly through the first three quarters of 2024.
After perusing through the Q3 10-Q I found that interest expenses were down 31.2% compared to the same period in 2023. This was due simply to having lower outstanding balances and lower weighted average interest rates on the Term B loan.
Income tax expenses were down $9.2 million. Crocs’ effective tax rate decreased to 21% through the first three quarters of 2024 from 23.3% through the same period in 2023. Per p. 24 of the 2024 Q3 10-Q, “This decrease in the effective rate was primarily driven by a shift in the mix of the Company’s domestics and foreign earnings. Our effective income tax rate, for each period presented, also differs from the federal U.S. statutory rate primarily due to differences in income tax rates between U.S. and foreign jurisdictions.”
Conclusion
I think I might have found one here. There are risks facing Crocs and I’m not crazy about the CEO’s incentive structure, but its valuation of <8.5x 2023 RFCF and ~7x last-twelve-months RFCF seem too cheap. Adding to that, the stock price hasn’t come close to matching the value compounding rate of the business since it went public. The probabilities indicate the juice is worth the squeeze.
Thanks again as always for reading.
Please reach out to me at possiblevalueresearch@gmail.com, @PossibleValue on Twitter and @Heshy on MicroCapClub with any comments, concerns or questions. Lastly, don’t forget to tell someone that you love them.
*** Remember that this isn’t investing advice. Consult a trusted financial or investment advisor before making any kind of investment decision. ***
Disclosure: I do not own shares in Crocs