Since their IPO in 2006, shares of a shoe company Crocodile (CROX 2.34%)manufacturer of these famous foam clogs, increased by 259%, beating the yield of 198% of the S&P500 over this same period. Yes, Crocs is a market beater.
However, I don’t think it’s too late to invest in Crocs. In fact, the company is the latest addition to my portfolio as I believe it might be the best combination of growth and value available for purchase right now. Here’s why.
The monster value proposition
For the first quarter of 2022, Crocs grew revenue by 44% year over year. This growth is not temporary. For the year, the company expects to grow its revenue between 52% and 55% compared to 2021. Part of that will come from its recent acquisition of peer Heydude. But management is still expecting organic growth of more than 20%, which is exceptional for a shoe stock.
Crocs is not only growing its revenue at an exceptional rate; it is also very profitable. For 2021, the company posted operating profit margins of 27.3%, roughly in line with what it expects in 2022 and beyond.
By 2026, Crocs management expects to generate more than $5 billion in annual Crocs brand revenue, more than $1 billion in annual Heydude brand revenue, and an annual free cash flow (FCF) of over $1 billion. This speaks to the potential for future growth and profitability.
Stocks that are growing fast and have strong profit margins typically trade at higher valuations. In contrast, Crocs shares trade at a price-to-earnings (P/E) ratio of less than five, compared to an average P/E ratio of 24 for S&P 500 constituents. This combination of revenue growth, cost effectiveness and cheap valuation is why I recently called Crocs the most obvious in the market.
Crocs is not without risk
That said, to say that Crocs is a given is hyperbole. In reality, investors always have risks to consider – there is a bearish argument for every bullish argument. And indeed, Crocs faces the following three risks that should not be overlooked.
1. Reduction of discretionary spending
Gasoline prices are at an all-time high in the United States and inflation is the highest in 40 years, putting pressure on consumers. According Moody’s Ryan Sweet, senior analytics economist, these dynamics are costing households $460 more per month than a year ago. And it’s fair to say that most households don’t have an extra $460 monthly income to offset inflationary pressures.
This means that many households will necessarily reduce their spending somewhere. I think they are more likely to cut back on extravagant items than Crocs shoes. That said, he is possible for Crocs and other consumer discretionary stocks to see a decline in revenue as people spend more money on bare necessities.
2. Rising input costs
Inflation isn’t just hitting consumers like you and me, businesses are also being hit by rising manufacturing costs. Crocs management has already implemented price increases in anticipation of rising input costs. However, we don’t know if management raised prices enough. And we also don’t know if it will be fast enough to increase prices if costs continue to rise in the coming quarters.
If Crocs cannot or does not pass the costs on to its customers, its revenue will suffer accordingly. Therefore, Crocs stock may look cheap right now, but that cheap valuation is entirely justified if its earnings evaporate.
3. Acquisition risk
Crocs just spent $2.5 billion buying casual shoe company Heydude. At more than four times sales, this is an expensive acquisition. Management likes Heydude because it is growing fast, profitable, and increasing the company’s overall market opportunities. However, integrating one company into another is not easy.
Moreover, valuations have fallen since the announcement of this transaction. With more than $642 million of goodwill on Crocs’ balance sheet, it’s possible the company may have overpaid and need to write off that goodwill in the coming quarters. And the market will certainly not react favorably.
The good news
In my opinion, the three risks I have described for Crocs would be temporary setbacks if they materialized. Discretionary income will likely recover, Crocs will eventually be able to pass on higher costs to the consumer, and the potential negative impact of the Heydude acquisition would fade over time.
As long as the Crocs brand remains popular with consumers, operating results should be strong. Of course, past results do not guarantee future results. However, Crocs’ revenues have increased tenfold over the past decade, suggesting that this brand is more than a passing fad.
Therefore, I am comfortable predicting that Crocs is sustainable, meaning it can overcome its challenges and create lasting shareholder value. As we have seen, it is possible that the results will be negatively affected in the short and medium term by exogenous factors. However, the market put this stock up for sale in light of these uncertainties.
This is a bargain that I think long-term investors should take advantage of. I think Crocs stocks are a great addition to a diversified portfolio today.