Crocs, Inc. (CROX) designs, develops, manufactures, and sells casual footwear, apparel, and accessories for men, women, and children.
It operates through the following segments: Americas, Asia Pacific, and Europe, Middle East & Africa (EMEA).
Crocs is a fundamentally strong business that has been caught up in the recent market sell-off. As a result, we believe the company is now undervalued and deserving of a bullish rating.
Measuring CROX’s Efficiency
As a retailer, Crocs needs to hold onto a lot of inventory to keep the business running. Therefore, the speed at which a company can move inventory and convert it into cash is very important in predicting its success. To measure its efficiency, we will use the cash conversion cycle, which shows how many days it takes to convert inventory into cash. It is calculated as follows:
CCC = Days Inventory Outstanding + Days Sales Outstanding – Days Payables Outstanding
Crocs’ cash conversion cycle in Fiscal Year 2021 was 49 days, meaning it took the company 49 days for it to convert its inventory into cash. If looking at the last 12 months, the cash conversion cycle is currently 90.
However, this appears to be a seasonal spike because the CCC metric tends to be higher when looking back 12 months from every first quarter. The important thing is that whether we look at fiscal years or trailing 12 months, the trend is decreasing in both scenarios.
For example, its cash conversion cycle was much higher in Fiscal 2015, at 104 days. Its CCC has been trending down ever since, indicating that the company’s efficiency has improved, as a lower figure is better when it comes to this metric.
As a result of this improving efficiency, Crocs has developed a measurable competitive advantage.
Crocs: Its Competitive Advantage
There are a couple of ways to quantify a company’s competitive advantage using only its income statement. The first method involves calculating a company’s earnings power value (EPV).
Earnings power value is measured as adjusted EBIT after tax, divided by the weighted average cost of capital, and reproduction value (the cost to reproduce the business) can be measured using total asset value. If the earnings power value is higher than the reproduction value, then a company is considered to have a competitive advantage.
For CROX, the calculation is as follows:
EPV = EPV adjusted earnings / WACC
$4.6 billion = $414 million / 0.09
Since Crocs has a total asset value of $4.47 billion, we can say that it does have a competitive advantage. In other words, assuming no growth for Crocs, it would require $4.47 billion of assets to generate $4.6 billion in value over time.
The second method to figure out if a company has a competitive advantage is by looking at its gross margin because it represents the premium that consumers are willing to pay over the cost of a product or service. An expanding gross margin indicates that a company likely has a sustainable competitive advantage.
If a company has no advantage, new entrants would gradually take away market share, leading to a decreasing gross margin over time.
In CROX’s case, its gross margin expanded steadily in the past several years, going from 46.8% in 2015 to 60.5% in the past 12 months. As a result, its gross margin trend indicates that a competitive advantage is present in this regard as well.
These competitive advantages have allowed the company’s investments to create value for both the business and shareholders.
Crocs: Creating Value for Shareholders
We can measure CROX’s ability to create value by looking at a metric known as the economic spread, which is defined as follows:
Economic Spread = Return on Invested Capital – Weighted Average Cost of Capital
The idea is straightforward; if a company’s return on invested capital is greater than the cost of that same capital, then the company is creating value for its shareholders through well-thought-out projects. Otherwise, the company is destroying value and would be better off simply investing money into risk-free bonds.
For Crocs, the economic spread is calculated as follows:
Economic Spread = 22.7% – 9%
Economic Spread = 13.7%
As a result, the company is creating value for its shareholders, implying that management is efficiently allocating capital.
It’s interesting to note that Crocs’ share price only started to meaningfully take off around the same time that the economic spread turned positive, which was in 2018. The return on invested capital had jumped from 3.8% in 2017 to 15.6% in 2018.
Since then, the return on invested capital has continued to grow along with the share price up until the peak that marked the beginning of the recent sell-off. Nevertheless, this disconnect between price action and fundamentals presents an interesting opportunity for investors who can stomach the volatility.
Wall Street’s Take
Turning to Wall Street, Crocs has a Moderate Buy consensus rating, based on five Buys, three Holds, and zero Sells assigned in the past three months. The average Crocs price target of $108.13 implies 99.5% upside potential.
However, it’s worth mentioning that the range between various price targets is very wide. The lowest price target is $59, while the highest price target is $200.
This range perfectly illustrates the varying degree of uncertainty in the market at the moment, which has been causing the volatility in price action. Still, even the lowest price target is above the current price. This suggests that Crocs may have overshot to the downside.
Indeed, the company is trading at a price-to-earnings ratio of 4.8x. Now, you might be thinking that the reason why it’s trading so low is that earnings are likely to fall going forward, and you’d be right.
Analysts do expect earnings to decrease in 2022. However, the forward P/E ratio is still only 5.2x, with the company expected to return to double-digit earnings growth in 2023.
Some may be turned off by the company’s $2.88 billion in debt compared to just $172 million in cash. However, this debt was used for its HEYDUDE acquisition, and management plans on using its cash flow to get its debt ratios down, going forward. Free cash flow is expected to be $455 million for 2022 and $668.5 million for 2023, which seems pretty good for a company with a market cap of $3.7 billion and an enterprise value of $6.4 billion.
Crocs is a growing and profitable company that is trading at a ridiculously low valuation due to the indiscriminate selling in the market. Once the fear reverses, we believe Crocs will reward patient investors.
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