Wednesday, February 20, 2008

What a Croc! Bloated Inventory Causes Stock Slide, Not 2008 Guidance

Despite weak sales in the casual U.S. footwear retail space, Crocs Inc (CROX-$32.08) posted strong fourth-quarter net income of 45 cents a share on an 84% rise in sales of $224.8 million. Nonetheless, shares of the maker of colorful plastic shoes tumbled nearly 13 percent in after-market trading to $28.05 a share after on Tuesday only backing its previous 2008 guidance, slightly below average Wall Street estimates.

Crocs Inc expects to earn about $2.70 per share for the year on $1.16 billion in revenue. Analysts polled by Thomson Financial estimated profit of $2.71 per share on $1.18 billion in revenue, on average.

In our view, the reaction in trading after-hours had nothing to do with the weaker-than expected earnings guidance (of one cent).

Journalism largely consists of saying, "Lord Jones is Dead" to people who never knew that Lord Jones was alive. ~ English writer G.K. Chesterton (1874-1939)

Contrary to the lazy reporting by business journalists, what agitated analysts on the 4Q:07 earnings call was the 27.2% rise in inventory build-up during the third-quarter. Crocs ended 2007 with inventories of $248.4 million, up from $195.3 million the end of the third-quarter, slightly higher than most analysts had modeled going to the end of the year [e.g. Thomas Weisel Partners had forecasted a 15% sequential rise in inventories).

Management said that the Company had historically chased demand since inception and felt the planned inventory buildup was necessary "on a forward-looking turns basis to meet first half forecasted customer demand."

The 10Q Detective questions the ability of management to calculate sufficient inventory levels, as the Company failed to anticipate the higher-than-expected demand for the Mammoth (new fleece-lined Crocs) during the holidays (and had to air freight in a good deal of products, resulting in some gross margin pressure).

On the earnings call, CEO Ronald R. Snyder tried to re-assure investors, saying: "We have very strong indications from our retailers that there is not an overabundance of inventory in retail." He added that the Company had done a good job now of properly positioning the inventory in the right parts of the world to meet appropriate demand (and pre-bookings).

However, footwear products remain subject to seasonal variation, with a majority of Croc’s footwear sales coming in the second and third quarter, for the shoes are more suited for fair weather use. Ergo, the outsized inventory growth might not dip until the spring.

Given the market cap drop of $329.8 million in after-market trading, investors need more convincing that management can execute on tracking inventory versus revenue growth going forward.

On a valuation basis in the footwear space, Crocs now trades for 10.38 times forward P/E; whereas, Steve Madden (SHOO-$18.26)—a shoe company with an absence of any major fashion footwear hits—and operating in a decelerating sales and profit environment, fetches 13.33 forward share-net estimate of $1.37, on average.

However, should Crocs miscalculate demand for its footwear, the carrying costs of bloated inventory levels—warehousing, distribution, work-in-progress, and finished goods—will come back to haunt management, especially if prices start to fall (customer discounts or forced liquidation of excess inventories) for some of its 'fad footwear.'

Editor David J. Phillips is long Crocs call options. The 10Q Detective has a Full Disclosure Policy.


Steve Hoffmann said...

So inventories of $248 million were only "Slightly higher than analysts had modeled"? Let's see ,inventories now stand at 29% of sales versus 25% a year ago and account for over 39% of total assets vs. 28% a year ago.Sounds to me as if write downs are coming.
I was in a hallmark gift card shop over the holidays and was surprised to see a display of Crocs in the store.Now, when I go to hallmarks, the last thing I'm going there for is to buy shoes(Clogs,sandals,whatever).I wonder what the terms of sale were to get these shoes into Hallmarks?

Anonymous said...

If you think the inventory levels are high, you should have seen them after the year end physical inventory, or I mean before they adjusted the numbers of the year end inventory!! The data is there for the auditors, shoes disappeared off the books overnight around the world!!