Description

Blackstone's investment, the subsequent management overhaul, and the strategic redirection of CROX have all positioned the company well for a turnaround over the long term and the sell off following the reduced guidance has brought the valuation into a more reasonable range.  The concerns on the sell-side seem to revolve around the shares being considered “dead money” which when viewed in the context of pursuing a strategy focused on their core clog product, profitability and FCF over growth, and rebuilding the brand equity is really not that bad relative to many other names in the retail space.

The lowered guidance was due to FX headwinds and some weakness in China but the Street still seems confident in the long term turnaround potential of the brand.  In spite of the the stock reaction, I thought Crocs did a great job in their Investor Day presentation communicating a coherent and reasonable plan to achieving their 10-12% EBIT margin target coming from 8% sales growth, low 50% GM, and low 40% SG&A.  Some highlights from the presentation were a fully refreshed assortment for spring/summer 2016 with an emphasis on comfort using a 3-tier comfort system, focused product line with 40% fewer SKUs, and a unified global marketing message driven by new story telling initiative.

It's been nearly 9 years since the peak of the Crocs fad and there is still plenty of demand for the core product from what has proven to be a very loyal fan base.  The prior strategy of trying to become more mainstream was ill conceived and Crocs must embrace its iconic brand rather than completely reinvent itself.  There has been encouraging commentary across the footwear industry and in the media on their new product assortment and management highlighted the early success with Isabella, Sienna, and Citilane collections.  CROX’s new management team realizes that it isn’t SKX or SHOO and shouldn’t be competing for customers by designing an endless assortment of product lines but rather by emphasizing the differentiated comfort and look of the Crocs brand.  CROX doesn't need to experience the type of performance seen during 2005-2007 or even 2010-2012 to become a respectably profitable company as long as it continues on the path that current management has laid out. 

Management did a good job presenting their 7 key opportunities last July:

·        Establish global brand position which allows marketing to tell a consistent story across markets - eliminates previous need for multiple agencies around the world to develop various sub-campaigns that resulted in inefficient marketing spend - increasing marketing spend by $10mm and reallocating nonworking marketing spend resulted in a "50% increase in working media spend directed at the consumer"

·        Shifted away from capital intensive and risky retail door expansion (net closed 61 stores since YE2013) in favor of growing wholesale distribution

·        Reclaimed ownership of the product creation process from regional offices while still allowing for collaboration with regional merchandisers cut lead time by 4 months

·        SKU rationalization - Spring 2016 line was able to cut SKU count by nearly 50% while providing the same number of effective offerings to each distribution channel by consolidating multiple non-differentiable regional SKUs into one global SKU

o   Spring 2015 had 30% of the line represented as part of the global line that was offered in all regions - SKU rationalization has doubled that to 60% in Spring 2016

·        Cutting personnel costs (183 positions eliminated last July) by centralizing global organizational structure

The Investor Day Presentation in September went in depth in all these priorities and added an 8^th priority of investing to drive supply chain effectiveness and reliability as Crocs identified that one of the reasons that a pain point amongst retailers was with past management’s history of supply chain issues.

Another relatively unique aspect of their business is the surprisingly high gross margins that Crocs has averaged over time.  Despite their relatively low price point, the inherently cheap costs of manufacturing molded footwear has allowed Crocs to enjoy industry leading 5Y average gross margins (CROX: 52.6% DECK: 48.0% SKX: 43.7% WWW: 39.3% SHOO: 38.2%)

Lastly, the percentage of consumers who outright reject the brand is also much smaller (19%) than one might assume considering all the hate the brand endured back during the fad years.  The reality is that a brand strength study conducted in the US, UK, DE, CN, JP & KR found that 69% were “Considerers” and “Neutrals” which gives Crocs a huge growth opportunity.  My bet is a lot of wall street/investor types might fall into the 19% but if these Rejectors simply tried to approach the product/brand and the company with a fresh perspective they might be surprised at what they find.

Catalyst

Spring Summer 2016 products, new marketing message, $130mm remaining buyback authorization