A Crocs Update
Q3 Earnings
Disclaimer: This article is for informational and educational purposes only. Do not interpret anything below as financial advice. Always do your own research & speak to a financial professional before making investment decisions.
I thought I’d share some thoughts following Crocs’ most recent third quarter earnings.
A Corporate Cannibal
The good news is that management are staying true to their capital allocation priorities laid out in the investor presentation. Those are: invest in brands, repurchase shares, and pay down debt. In Q3, Crocs hoovered up ~2.4 million shares for $203 million and paid down $63 million of debt.
If we pause here briefly, that’s not bad going. In a single quarter, Crocs managed to repurchase almost almost 5% of its market cap! To put things into perspective, the below bullets highlight how repurchases affect stock price, all else equal.
10% → 1.1x
25% → 1.3x
50% → 2x
75% → 4x
95% → 20x
Clearly, the longer Crocs repurchases shares at depressed prices (current buyback yield = 15%) and reduces the outstanding share count, the higher the chances of outsized returns over the long term.
The Crocs brand also showed decent growth in international markets, growing at ~5.8%. This is encouraging for bulls, since another part of the thesis hinges on international growth.
DTC revenues for the Crocs brand increased 2.0% while wholesale declined.
Cracks In The Foundation
When markets opened, Crocs shares surged initially before crashing down to reality. Top and bottom line “beats” grabbed headlines, but looking under the hood tells a different story. Company revenues and diluted EPS were down 6.2% and 18.9% respectively YoY.
In North America specifically, revenues for the Crocs brand were down ~8.8%. With all the backlash around the poor HEYDUDE (now “HD”) acquisition, the core Crocs brand can’t afford to slip. Sure, the bull thesis hinges on buybacks and international growth, but investors expect stable revenues in the company’s home market.
A Punctured Dream
Crocs can’t seem to escape the bad headlines that loom over the HD business. It continues to disappoint. In Q3, HD revenues fell 21.6% and wholesale dropped ~38.6%. Investors have long complained about the dud acquisition. What once seemed like a business poised for sustained growth and a valuable addition to the Crocs ecosystem has deflated, like a burst tyre losing air on an empty highway. Hindsight is a wonderful thing, but I think many investors (including myself) are wondering how their investment in Crocs would have played out had management deployed the $2.5 billion it spent on HD to repurchase its shares.
The Squeeze Tightens
Gross margins took a slight hit, falling by 1.1%. In my view this isn’t a huge concern. The company is still a profit machine, with gross profit margins almost touching 60%. More concerning was the almost 5% hit to operating margins, which fell to 20.8% from ~25.4% the prior year.
Almost a 5 point operating margin dip! With total revenue falling while many costs (SG&A, manufacturing overhead) stayed relatively fixed, SG&A as a % of revenue increased (37.7% vs 34.2% last year), and Crocs lost operating leverage.
There are a few factors at play here, including fixed costs spread over lower sales and investments in brand marketing but I think HD’s 21% revenue decline was particularly damaging here: that brand still carries fixed costs in distribution and marketing that don’t scale down easily.
Squeezing margins are never good, especially amidst the current tariff environment. The bull thesis hinges on Crocs’ ability to navigate ongoing cost pressures while defending its enviable margins from knockoff competitors. I think they have what it takes to do so.
Croc Pit
Management painted a gloomy outlook for Q4. Management guided an ~8% revenue decline overall, with Crocs brand down ~3%, and HEYDUDE down mid-20%. As an investor in Crocs, this has always been a buyback story for me. If the company can continue to repurchase shares at 15% yields, this could to wonders for the share price. But at what cost? If revenues and margins are slipping and management doesn’t get a grip on HD, this could get messy before the thesis has a chance to play out…