Wednesday, July 04, 2007

The crux with the Crox valuation

Can someone please help me justify why any investor would be buying Crox, Inc. (CROX) at these price levels?

Some financial facts:
- Price to Sales multiples of 9.4x on 2006 sales and 4.7x on 2007 sales
- Price to Earnings multiples of 51.6x on 2006 income and 25.8x on 2007 income
- Cumulative Net Income from 2003-2006 equal to $78.3 million; resulting in a cumulative Free Cash Flow from 2003 to 2006 to $(2.6) million..putting a significant amount of faith in the management with the re-investment.

After completing my initial analysis on this stock, I am hesitant to issue a "Sell" rating because of the following
#1. Significant amount of shorts that may cause a short squeeze
#2. A Consistent "Buy" recommendation from Jim Cramer and his following
#3. A recent stock split (historically stock splits have provided favorable returns to equity owners one year post split)....

Therefore, I am putting this as a "Hold" waiting for the first sign to short sell, specifically missing the Q2 sales estimate...

With a market cap of $3.3 Billion, CROX has experienced a recent decline in their share price since the stock split on June 15th.

Figure 1. Stock Performance

Don't get me wrong, CROX deserves some credit with the growth rates that the company has achieved to date. I just don't think there is enough gas in the tank to meet future analyst growth targets. Here is a chart showing Sales and Income growth rates by quarter.

Figure 2. Sales and Income Growth Rates.

With the above initial valuation metrics that I have provided, I also completed a discounted cash flow model on the stock to see what it would take to justify today's $3.32 Billion price tag.

Summary or Assumptions to justify valuation:
- Forecast Time Period: 2007 - 2013 (7 years)
- Using the Analyst sales forecast to 2008, then growing sales at the following rates: 2009 @ 25% declining to 5% in 2013
- Net Income Margin of 18%, consistent with analysts
- Free Cash Flow % to Net Income of 25% in 2007 growing to 110% in 2013
- WACC of 12% and a Terminal Rate of 5%

Significant Risks:
- Annual sales growth profile from 2007-2013 in the face of competition and keeping the brand fresh
- Risk of CROX net income margin erosion due to new licensing agreements for Warner Bros. and Looney Tunes characters
- 5% Terminal Rate staring in 2014

Figure 3. CROX DCF model

Disclosure: Author does not own or is short CROX at the time of publication.
Yahoo Finance
SEC Filings
Company website


Rabbi Bruce said...

In late May, my family tried to buy Crox but couldn't get them in the right sizes or color.
Everywhere I look (including Whole Foods and Wal-Mart), there are now racks of Crox. I worry that they are channel pushing and will be stuck with inventory at the end of the summer.

Steve Rubis said...


I wanted to say that your write up of Crox is amazing. You provide readers with a short and concise arguement for why CROX should be sold short. Please continue writing articles like this one.

Furthermore, I really enjoy the charts you provide in your analysis.


Jason said...

How did you come up with $6,229 FCF in Terminal value? i.e. it seems you gave 2013 FCF a 15x multiple to get there, but that does not support your 5% terminal rate assumption. Rather, it would be 6.667%. Please clarify. Thanks


I find that the best indication of how undervalued a stock is is the price to sales ratio or what is commonly referred to as market cap. It works beautiful well.

Simply stated. If a company does 1 billion in annual sales but it has a market cap of 100 million dollars than the price to sales ratio is ten to one. In other words the market is valuing a company that does 1 billion dollars in annual sales at just 100 million dollars. But what does this mean. It means everything if you are a classic value investor.

Here is a perfect example of why the price to sales ratio is so very important if you are a value investor in stocks. If our 1 billion dollar company is breaking even that is they are not making a profit nor losing money. Lets say the company has 250 millon dollars in long term debt and 80 million dollars in cash. We will say they are in the food business they make a wide aray of food products. Maybe the company did a buyout of another company a few years ago that did not work out as well as expected. So thats why the company is having trouble making a profit but things now seem to be moving in the right direction. If I purchase shares in the company for say 10 dollars. And over a five year period the company improves their earnings performance to the point where their now earning say 60 million dollars on sales of one billion two hundred million dollars. Thats a profit margain of 5%. If the stock were to now trade at twenty times earnings that would now mean that the price of the stock would be at 120 dollars a share or another way to put it the marketcap is now one billion two hundred million instead of 100 million.

The problem for me is not that this investment method is not effective it works great. I purchased seaboard stock back in 2000. I think it was for 190 dollars a share around that. I following the exact method I describe above. I sold my shares about five years later for 2500 dollars yes thats correct 2500 dollars or more than twelve times what I paid for the shares. Seaboard was profitable when I bought it and profitable when I sold it. The stock was just a great undervalued stock that was overlooked by investors.

Like I was saying before the problem is not with this investment method. Its that stocks like seaboard are very rare indeed theirs just not a whole lot of quality companies out their selling a very low price to sales ratios. Another issue that I have been having is when a company of decent quality trades at a very low price to sales ratio its not long before a private equity firm or the family of a family owned company takes notice and usually makes a low bid for the shares and takes the company private preventing me from realizing the enormous gains that mght have been possible had I not been forced to sell my shares out to a party that was making a very unfairly low offer for the shares of the company.

Another thing to keep in mind when it comes to value stocks that have a low price to sales ratio that could give the buyer a tremendous advantage is this.

I mentioned earlier that are food company had 80 million dollars of cash on their balance sheet now if the company choose to they could buy back a large chunk of their stock maybe 30 million dollars worth of the shares outstanding it would only cost them 30 million dollars they still would have 50 million dollars of cash left on their balance sheet. This means that under the positive earnings outlook for the company the stock price could even be much higher than 120 dollars a share. If the company were to retire a large percentage of their exsisting shares in a stock buyback.