Description

With no epidemiologists on staff, and not wanting to take significant factor bets on opening economy / second wave in the Fall, we’re looking to add to - or initiate - positions in businesses that were accelerating pre-CORONA-19, and have a reasonable likelihood of emerging on the other side in a more advantaged competitive position.

One name we’re long that fits the above criteria is Crocs (CROX).

CROX was founded in 2002 and has had a wild ride as a public company going from high-flyer to falling 95% in a few years in the latter half of the last decade.  The company is often used as a case study in fads but we believe that under new management the company has created a sustainable business with an on-trend high-quality products appealing to all ages.

Crocs is a global, casual footwear and accessories business best-known for its classic clog shoes.  The company has smaller businesses in sandals, personalized Jibbitz and comfort technology.  Crocs sells its products in more than 125 countries, through three distribution channels: wholesale, retail, and e-commerce.

CEO Andrew Rees took over the top job in the middle of 2017, and has re-invigorated the brand through partnerships and collaborations while allowing the consumer the ability to personalize the product.  Rees was a consultant working on a growth plan assignment for Crocs and soon thereafter moved to the company in the Role of President, before ascending to the CEO position.  As CEO, he has refocused the company on core lines, slimmed down the company owned store portfolio and done an impressive job on the marketing and branding front.

Much of the marketing and branding efforts have focused on partnerships and collaborations with musicians, actors and brands.  Special product launches with celebrities like Post Malone sellout in hours, and create a brand image that resonates with 18-34 year olds.  The comfortable, easy to put on / easy to take off, and easy to clean clog is also great for kids of all ages.  Recent brand partnerships with companies like KFC are fun promotions that draw attention to the brand and move a little special addition product.

Crocs benefits from larger trends in casualization and personalization.  On the personalization front, Crocs has a growing Jibbitz business where one can buy letters, numbers, characters or images that attach to your pair of Crocs.  Jibbitz typically sell for $3.99 and are easy to put on and take off, enabling one to have a fresh new look every day if you so choose.  The Jibbitz concept sounded a little silly, but ever since I’ve been walking around with “G-I-R-L” on my right Croc and “D-A-D” and six goats in homage to our lost quarterback on my left Croc, I totally get it and would encourage everyone to give these high margin products a chance.  The current selection of Jibbitz is fairly basic, but recent partnerships with the likes of ‘Star Wars’ helps show the possibilities and how much white space there is to grow this business line.

Years of investment in e-commerce and branding paid off in 2019, with Crocs selling a record 67.1 million pairs of shoes, up 12% from its previous record.  It was a challenging year for the retail industry working around USA-China tensions, and continued tariff headlines.  Crocs ended the year with less than 10% of its production in China, and was seemingly set to ride strong brand momentum into an even stronger 2020.

Crocs came into the year with an elevated inventory position in anticipation of another record year, but was forced to course correct, as COVID-19 spread from China to the U.S.  Global retail store closures and fears of another great recession or worse headlined the news creating a laundry list of issues for global retailers.  Crocs’ C-Suite went into inventory crisis management mode, and cancelled shipments to many international distributors with weaker balance sheets, with a focus on ending the year in a clean inventory position.

On its earnings report last week, Crocs posted strong results in the quarter given the state of the world, but guided to flat second half sales year/year given the need to restock inventory with the higher than expected sales levels in the second quarter.  The ecommerce business was showing 100%+ gains for much of the quarter, and Google search trends were the best in company history.  As with many retailers that recently re-opened stores – Crocs confirmed the trend of less foot traffic combined with higher conversion and average transaction value.  Overall, we were encouraged by the results that showed strong ecommerce gains and brand strength, and can live with demand outstripping supply for a few months given what transpired globally in the first half of the year.

Management likes to talk about playing offense and defense this year, but they have definitely been more ’85 Bears than ’07 Patriots.  With perfect hindsight we can now look back and say it was obvious there would be record fiscal and monetary stimulus, consumer spending would hang in and the market would be back near all-time highs.  I have daily liquidity and there are many trades / missed trades I wish I could have back from the March time period.  I can’t imagine the difficulty in running a growing, global retail company in the face of global lockdowns and a most uncertain future, and am not going to second guess management’s decision to focus on ending 2020 in a good inventory position.  Given that for the most part Crocs’ inventory is not seasonal, we can nitpick the degree to which management cut back on inventory, but overall we think they are getting through the crisis in a strong position.  Management took pay cuts in March, at the same time the inventory decisions were made, so management was consistent in all actions when planning decisions for the remainder of the year.

Crocs pushed back a number of collaborations into the second half of 2020 and early 2021, setting up a strong 2021, while also scoring some great marketing by donating 860,000 pairs of Crocs to healthcare workers in the midst of the pandemic.  The Crocs brand has been re-invigorated by the current management team, but still only has a 22% aided brand awareness.  Positive press during the ten-week Crocs healthcare giveaway, coupled with getting the product on nearly a million potential customers are all positives.

Coming out on the other side of COVID-19, whenever that is, we think Crocs will be better positioned than the completion due to enhanced ecommerce capabilities and partners wanting to work with fewer, higher-quality brands.

On the ecommerce side, not surprisingly the most recent quarter showed huge acceleration with North American traffic up 100%.  Crocs was the third most searched for footwear brand in the quarter behind Nike and Adidas, which is impressive given Crocs limited aided brand awareness.  The company is in the midst of adding ecommerce distribution capacity adjacent to its existing Ohio facility, and is well prepared for continued growth.  If we were connoisseurs of the compounder, we might wax on about the flywheel created by consumers shopping directly on the website, cross-selling opportunities with the Jibbitz product line, and ability to collect more consumer data, but we don’t plan on valuing this with a Price / Sales multiple.  We do think the Crocs was well-prepared for the COVID surge after years of investment in ecommerce, and will emerge in a stronger competitive position.

We’re also encouraged by the recent addition of Beth Kaplan to the Board of Directors.  Mrs. Kaplan is a managing member of Axcel Partners and previously held the positions of President and COO of Rent the Runway.  She currently serves on the boards of Rent the Runway and Framebridge – and brings significant retail and importantly ecommerce experience to the board.

Crocs has provided investors with more granularity on its end markets in recent quarters and well positioned with etailers like Zappos.com, while having minimal (5%) exposure to the perpetually struggling/terminal department store sector.

International growth, particularly in Asia, is the next pillar of growth.  For multiple years management has touted 2021 as the year when Crocs Asia business begins to accelerate.  The company has been building out distribution, and following a similar playbook as they did in North America by partnering and collaborating with celebrities.  The company recently rolled out a collaboration with actress / singer Yang Mi in China, and early search results on Tmall are encouraging.  International markets are forecast to have a higher footwear growth CAGR than North America in the coming decade, but consumers are less familiar with the classic clog style so Crocs will need educate consumers on the product and continue to push marketing collaborations.

One interesting nugget that showed up in the proxy is that a small portion of management compensation is tied to the “successful execution of the first phase of our China Long-Term Growth Plan.”  This doesn’t imply next quarter’s China sales will beat the street by X%, but it is a positive that the board and in turn management are focused on the tremendous opportunity in China.  Off the top of my head, I can think of at least one Phase 1 China deal that hasn’t progressed to a Phase 2, so it will be interesting to see how management comp progresses.  The Crocs Phase 1 China plan is at the discretion of the board and not laid out in detail, so it will be interesting to see if they add anything numerical or break out a Phase 2 in greater detail next year’s Proxy.

We think highly of the management team and are impressed with the improvement in the financials, the brand and the capital allocation in recent years.  The CFO recently rejoined the company after a stint as the CFO of Zappos.com, and will be a resource in building out ecommerce capabilities.  Capital allocation has been solid, with the company buying back a slug of shares from strategic investor Blackstone, while spending Capex on ecommerce and building out distribution centers globally.  The company halted buybacks this year, but we anticipate they will be turned back on next year while the company continues to invest in international growth and ecommerce.  Crocs increased financial disclosures earlier this year at investor’s request, and we find the team to be shareholder friendly and like the compensation plans.  There appear to be numerous signposts that the company is properly focused on the large ecommerce and Asian markets and we think the next few years these signposts will show up in the already improving financials.

Valuation

We think CROX should trade in the high-$40 range based on an 18-20x multiple of $2.50 in 2022.  We originally had the company earning that in 2021 but given the pandemic have pushed out a year.  Asian growth, and in particular China, can skew numbers to the upside depending on how successful collaborations and product launches are.  We’ll be looking at compensation plans for clues on how the business is progressing.  There is also the opportunity for more shelf-space in the sandal category if vendors use fewer brands in the coming years.  Crocs has a 1%ish share in sandals, so small gains can be material.

Overall, Crocs has a strong product portfolio and brand that is driving record ecommerce volumes with significant opportunity in Asia ramping next year.  We see Crocs as a long-term retail winner run by a creative a management team executing through challenging conditions.

Catalysts:

Continued business momentum

Restocking of inventory earlier in 3Q

Improved ecommerce abilities following distribution center expansion

Asian expansion in 2021 and beyond

Risks:

Second COVID wave causes rolling or national shutdowns

Federal stimulus abruptly ends

Recession hurts consumer spending

                All of the above are hedgeable

Limited product line leaves the company subject to potential fashion trends.  Sales trends have been strong and brand momentum continues.  Could be solved by integration with a larger footwear player.

Catalyst

Continued business momentum

Restocking of inventory earlier in 3Q

Improved ecommerce abilities following distribution center expansion

Asian expansion in 2021 and beyond