[1]How long have you held the stock?
We just initiated the position, so less than a month.
What do you like about it?
Crocs is a rehabilitated former high-flier, which we identified through Morphic’s proprietary screening process. Crocs’ hugely successful brightly coloured clogs made it a household name in the mid-noughties. Investors piled into the growth story but found out the hard way that ubiquitous fads do eventually face a backlash (as Apple seems to be facing today). After five years of extraordinary sales growth, Crocs stumbled in 2008.
The share price tumbled and many investors walked away, vowing never to return. Since then, Crocs has been quietly executing an astonishing transformation. Sales have almost doubled since they bottomed out post-bubble in 2009 and are now close to one-third higher than their previous peak. Today, traditional clogs account for less than 50% of sales as the company has successfully diversified into other casual footwear products.
Crocs generates almost as much revenue from Asia as it does from its domestic American market. Given that it has been close to five years since Crocs fell from grace, we believe it is time for investors to start paying more attention to the turnaround story.
How is it better than its competitors?
Crocs outclasses its competition in three respects. First, its brand awareness is phenomenal, comparable to brands such as Nike and Converse, which have much larger marketing budgets. Second, the company earns a class-leading return on equity of over 23% on the back of its brand, pricing power and margins.
[2]Third, Crocs is extremely cheap compared to its peers. Crocs trades at a forward price earnings multiple of about 10 times – a discount of 50% to its peers. This gap should close over time as Crocs continues to execute its transformation.
What do you like about its management?
Management has made all the right strategic moves, capitalising on its strong brand by expanding into adjacent product and geographical markets. Furthermore, executives seem to have learned a lesson from boom times and are now much more conservative in their guidance, providing more scope for upside surprises. Finally, as you would expect of an undervalued but highly cash generative company, management has also been fairly aggressive in buying back shares.
What is your target price?
Our target price is US$21.00 per share, or approximately 14 times expected earnings for 2013.
At what point would you sell it?
At Morphic, we look at both fundamental and momentum factors in deciding when to close positions, so it is tricky to provide one single sell price. As long as earnings and price momentum were moving in our favour, we would expect to stay in the position until we felt that the price had run significantly ahead of fair value.
How much has it added to your overall portfolio over the last 12 months?
Having just entered the position, we are up modestly.
Is it a liquid stock?
Yes, on average more than $US20 million worth of Crocs shares changes hands each day.
Where do you see the value?
The value in Crocs lies in investors recognising that it has closed the door on its former woes. Management is doing a great job in executing its strategy and, in our view, it is only a matter of time before the tide of new (and returning) investors pulls Crocs out of its valuation trough. At the same time, given the frothy market for leveraged buyouts in the United States, we also see a takeover as a long odds catalyst.
By Jack Lowenstein.
Jack Lowenstein is joint CIO and managing director of Morphic Asset Management. He left Hunter Hall , where he was deputy CIO and responsible for risk management and portfolio construction, after 13 years to start up Morphic in 2011. He has a BA and MA from Oxford University.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
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