Crocs Stock: 3 Reasons Why I Am Buying The Dip (NASDAQ:CROX)

Introduction & Investment Thesis

I last covered Crocs (NASDAQ:NASDAQ:CROX) in May, where I reiterated my “buy” rating on the stock. My thesis was predicated on my belief that the headwinds from its HEYDUDE are likely priced in and that the company should benefit from higher ASPs and volumes sold for its Crocs brand as it expands internationally and drives robust product innovation along with memorable marketing moments to engage its customers.

Although the stock initially rose 14% to a high of $165 after my second “buy” rating, it has since declined over 5% from my price at publication, underperforming the S&P 500. However, I believe that the recent underperformance has created a great buying opportunity in the company, and in this post, I have discussed the three reasons why I am buying the dip and kept my “buy” rating with a price target of $192.

Reason 1: Higher volume and ASPs, coupled with strong international expansion for Crocs brand

Crocs reported its Q2 FY24 earnings, where revenue grew 4.8% YoY (on a constant currency basis) to $1.12B, beating estimates. Out of the $1.12B in revenue, Crocs brand contributed 82% to Total Revenue (compared to 79% in the previous quarter), growing 11.2% YoY to $914M. The remaining 18% of the revenue was driven by HEYDUDE, which continued to struggle with revenues declining 17.5% YoY to $198M.

Starting with the Crocs brand, the revenue growth was driven by a mix of both volume, which grew 6% YoY to 35M pairs of shoes sold, and higher Average Selling Price, which grew 4% YoY to $25.96. Meanwhile, its International markets continued to outperform, where revenue grew 22% YoY to $425M, contributing 46% to Total Revenue with China leading the way, growing over 70% YoY, while Australia also saw exceptional growth and European markets grew by double digits.

During the quarter, the company continued to evolve their partnership model to drive engagement and build brand affinity, where they created SpongeBob and Patrick Clog to celebrate SpongeBob’s 25th anniversary, along with partnerships with Pringles, Naruto, Treasure and Minions while innovating their product lines and franchises to expand into new usage occasions at the same time. In my previous post, I discussed that the management is optimistic about its Sandals and Jibbitz product segments in the Crocs brand, where it expects to gain market share by launching new products. During the Q2 earnings call, the management reiterated that their Sandals segment continues to strengthen with strong performance across its new and established franchises, while the Jibbitz segment benefited from strong double-digit growth in Asia, where customers are purchasing with higher frequency and average order value.

Reason 2: HEYDUDE revenues continue to decline from falling units; however, gross margins and ASP show signs of improvement.

Unfortunately, the HEYDUDE brand continues to struggle, where both DTC and wholesale revenues decreased by 7.6% and 23.5%, respectively, weighing down on the overall revenue growth of the company. Although the company sold 23% fewer shoes compared to the previous year, the management discussed that they have made progress in improving the health of the business, which is reflected by pricing up digital, with ASP’s up 7% YoY and gross margins improving by 200 basis points YoY to 49.1%.

Meanwhile, under the leadership of Terrence Reilly, the company is taking a more focused approach to the product with key sneaker and boot styles as they look to optimize their SKU count. At the same time, the management also discussed that they intend to accelerate their marketing investment for HEYDUDE in the second half of the year to drive more brand heat, especially as they have already opened 19 HEYDUDE outlet locations, with 11 more planned for the remainder of the year. However, what I find a little concerning is that the management has kept their revenue guidance for HEYDUDE unchanged, where they expect a year-over-year decline of 8–10% in revenue, despite the planned increase in marketing spend. Simultaneously, if we see a macroeconomic slowdown resulting in declining customer demand, the higher marketing spend may not translate to higher purchase volumes and ASPs, leading to margin pressures down the line. While keeping the revenue guidance unchanged for its HEYDUDE segment may be a strategy for the management to better manage investor expectations, we need to be paying attention to overall trends in customer demand for HEYDUDE as well as for the Crocs brand to see if the company risks falling under margin pressure from higher marketing spend.

Reason 3: Strong profitability with management raising guidance

Shifting gears to profitability, Crocs saw its non-GAAP gross profit grow 9.5% to $682M with margins expanding 330 basis points to 61.4%. While Crocs brand grew 210 basis points higher to 64.1% from higher ASPs, favorable product, and freight costs, HEYDUDE also saw a 200 basis point margin expansion to 49.1% for similar reasons as mentioned above. At the same time, the company generated an Adjusted Operating Income of $326M, which grew just 0.4% YoY with a margin contraction of 100 basis points to 29.3% as SG&A spend increased 19%, faster than revenue growth from continued investment in hiring talent, driving engaging marketing moments to drive engagement, and building their DTC channel to position for long-term market share gains.

Revisiting my valuation: Reiterating my “buy” rating

Looking forward, Crocs management has kept their revenue guidance unchanged, where they expect Crocs Brand to grow 3-5% YoY, while HEYDUDE to decline 8–10% YoY, thus growing overall revenue by 3-5% YoY for the full year FY24. Assuming Crocs can continue to expand its presence internationally as it scales its DTC and wholesale channels along with strong product innovation and marketing moments, it should be able to continue to drive higher volume and ASPs for the brand, especially as it sees greater market penetration for its Sandals and Jibbitz product segments. Simultaneously, assuming that it can turn around its HEYDUDE segment with the help of a more focused product strategy, it should see its overall revenue grow in the mid- to high single digits over the next 2 years, resulting in a total revenue of approximately $4.7B.

From a profitability standpoint, the management raised their FY24 guidance from “approximately” 25% to “over” 25%. This is a positive sign in my opinion, especially as the management expects to continue spending on its SG&A initiatives across both its brands, indicating that it will continue to optimize its inventory levels and SKUs while focusing on driving higher ASPs to unlock operating leverage. Assuming that the company grows its margins by 100 basis points every year for the following two years, it should generate approximately $1.267B in Adjusted Operating Income, which will be equivalent to a present value of $1.05B, when discounted at 10%.

Taking the S&P 500 as a proxy, where its companies grow their earnings on average by 8% over a 10-year period, with a price-to-earnings ratio of 15–18, it should trade approximately at par with the index. But taking a cautious approach, I will take my original PE ratio of 11 in the event of a macroeconomic slowdown, margin pressures, and unexpected headwinds from HEYDUDE brand. This translates to a price target of $192, which represents an upside of 41% from its current levels.\

My final verdict and conclusions

Although the stock had climbed over 14% to $165 since my second buy rating on the stock (when it was trading at $144), it has since fallen over 5%, underperforming the index. However, I believe that the recent selloff has created a great buying opportunity into the company that is continuing to build innovative products and driving strong customer engagement.

Its Crocs brand continues to benefit from robust international expansion, with steady market share gains across its product segments as the company continues to create memorable marketing moments, resulting in strong volume sold and ASPs. Although it may see some normalization in its international growth rates, especially with China, as it faces tougher comps moving forward, I believe that its brand affinity and product innovation should continue to attract new and existing customers both in North America and internationally.

Meanwhile, its HEYDUDE brand is showing early signs of hope, with rising ASPs and gross margins. While volume sold continues to decline, I believe in the management’s strategy to take a focused product approach while building brand heat with strategic marketing investments.

Finally, the management continues to demonstrate financial discipline through strong gross and operating margins, while investing in talent, marketing, and other strategic initiatives at the same time. Even though the management is expected to increase their marketing investments for HEYDUDE, they have raised their Adjusted operating profit margins to over 25%.

Therefore, assessing both the “good” and the “bad”, I will maintain my “buy” rating on the stock with a price target of $192, which represents an upside of 41% from its current levels.