Description

Skechers U.S.A., Inc. is a growing company that is priced like a value, no growth company despite achieving topline growth of 15%+ the last two years and a 5 year revenue CAGR of 8%+ (using street estimates for Q4 sales, which seem achievable).

Skechers designs and markets footwear for adults and children primarily under the Skechers brand name.  The company currently has very good business momentum and strong growth prospects.  Sales have increased at least 19% for each of the last four quarters versus the prior year.  Skechers sells goods as both a wholesaler and through its own stores.    The company is roughly 60% domestic wholesale sales, 20% owned retail sales, and 20% international sales (done through either wholly owned subsidiaries or distribution partners, depending on the country).  The company primarily sells the Skechers brand, but about 15% of sales are in various “street” brands, the most significant of which is Marc Ecko.  The company’s wholesale business in the US is fairly mature, although this business has recently been growing in the low to mid teens, primarily because they have been hitting the fashion right and are, at least for the moment, offering product that is both “in” and affordable.  Retail sales have been growing around 20%, mostly through square footage growth but also aided by same store sales that have been up a healthy mid to high single digits.  International growth has been extremely strong with growth in the 40-60% range, with some key countries as high as 80-100%.  Years of investment in international distribution has finally paid off, as getting product distributed widely abroad where retailing is less consolidated has been a challenge for most American apparel and footwear companies – this simply can not happen overnight and Skechers has reached a key inflection point for growing their international business. 

Another growth driver is the new line CaliGear, which was introduced in the second half of 2007 and is essentially a Crocs knock-off with a wider breadth of styles than Crocs.  The success of Crocs has essentially created a whole new category in shoes which is called molded footwear.  It has been the single biggest mass trend in shoes of the last couple of years, and regardless of what one thinks of Crocs in terms of appearance (which many deem hideous) or stock price (which many deem absurd), this is a trend that is here to stay.  For some unspecified reason, most likely capacity/production shortages, Crocs has resisted going into certain mass retailers such as Kohl’s and JC Penney.  These retailers wanted to participate in the molded footwear trend, and thus been very open to allocating floor space to the CaliGear line.  CaliGear does not however generally take away square footage from the core, legacy Skechers lines, since the CaliGear product is sold on upright racks at the end of shoe aisles or near the cash register, as opposed to in the shoe aisle itself.  The physical positioning of the product therefore limits its cannibalization of the core Skechers product.  This launch is significant for Skechers, as they have expressed confidence in at least meeting first year expectations of around $200 million.  This represents 17% of 2006 sales levels.

Even if US wholesale growth grinds to a halt next year (excluding sales of CaliGear), SKX is still capable of putting up mid to high teen revenue growth in 2008 on the back of international growth, retail growth, and CaliGear.  In fact, my above consensus model for 2008 predicts earnings of $2.03 (versus consensus $1.97) assuming decelerating growth for retail (15% versus 20%) and international (35% versus 50%), no growth for domestic wholesale, and $100 million in incremental CaliGear sales.  Gross margins are held steady, and there is slight improvement in the expense level based on the discontinuation of a couple of small street footwear brands and the closure of a sourcing office in Taiwan (both already announced).

Skechers’ stock is simply cheap.  Investors get a rare chance to pay a value price for a stock with healthy growth.  This is not only Growth at a Reasonable Price; I would say it is growth at a cheap or value price.  Both the valuation and balance sheet provide a margin of safety, which is essential given the current consumer and broader market environment. 

Skechers’ valuation is compelling on both an absolute and a relative basis.  The stock trades at approximately 11x 2007 estimated earnings and 10x estimated 2008 earnings.  If you back out the $4.30 (23% of the stock price) of net cash on the balance sheet, the 2007 P/E drops to 9 and the 2008 P/E drops to 7.5.  Skechers trades at 5.3x trailing twelve month EBITDA and 4.3x estimated 2008 EBITDA.  All of these metrics are compelling on an intrinsic level and fall at the low end of historical trading ranges.  The balance sheet is obviously rock solid given the net cash position.  Valuation and a cash rich balance sheet should protect the downside from here. 

I became interested in Skechers after the stock declined over 30% in July on an overreaction to a disappointing Q2 earnings report.  In the current stock market, obviously even the slightest disappointment in earnings is perceived as a disaster.  At that point it was clear that management had set the bar very low, likely too low, for Q3, which proved to be the case when the company reported earnings of 53c for Q3 versus consensus estimates of 44c.  On the back of that strong earnings beat, SKX moved up around 15% in a few days and peaked around $25, which also marked a 37% recovery from the post miss low of $18.30.  Sellside estimates, which had been too low for 2008, came up about 10% and got closer to what I think the company will actually earn next year.  Since that report on October 24, there has been no company specific news, yet the stock has pulled back 22%.  This is not unusual within the retail/apparel/footwear universe as investors are beyond jittery about the prospects for the economy and the holiday season.  Skechers should be doing better than the average retail stock however as it will still post earnings this year that are up around 8% and was not an expensive stock to start with.  In a tough retail environment, it is still growing domestically and posting healthy comps at its owned stores.  It is executing well, and is often called out by its retail partners (such as Shoe Carnival) as one of the only brands in the store selling well and meeting plan.  The company admittedly hit some road bumps in Q2, but they were related to expense control as opposed to topline growth.  There are admittedly a lot of retail, apparel and footwear companies trading at or below 5x EBITDA right now.  I would argue however you would rather take your chances in an uncertain economy with a company that has healthy sales and non-peak margins (therefore room to push on the expense lever) than a company that is operating at peak efficiency but has an underlying sales or demand problem.

The catalysts for this company are a little limited.  There had been a great catalyst going into Q3 with the beat, but given extremely tough comparisons in Q4 (sales were up 36% in Q4 2006), another beat is highly unlikely for Q4 and Q4 will likely show much lower revenue growth than prior quarters (probably low single digits).  They could modestly beat Q1 assuming retail spending doesn’t take another dive.  The real catalyst for this company will be just making their numbers next year.  If this company really grows the topline 17% and the bottom-line 20-25% next year as analysts predict, then it will likely not be trading at 4x EBITDA next year after making numbers.  The current stock price clearly reflects a near universal disbelief that they can make their numbers and a distaste for consumer names generally.

The biggest knock against this company is the management, which has been notoriously disinterested in pleasing shareholders in the past.  The chairman, Robert Greenberg, owns over 20% of the company and controls the vote, and is widely disparaged for, among other things, not controlling expenses as well as he could (true), not managing the street well (true) and being responsible for the high profile bankruptcy of 80s footwear brand LA Gear (not true).  In the past, management has showed little interest in catering to the street…they frequently widely miss or beat guidance, and don’t preannounce when they do, which makes the stock highly volatile and displeases investors, but doesn’t necessarily change what the intrinsic value of the business is.  Perhaps the most valid knock against management would be their reluctance to do a stock buyback, which they clearly have the means to do and at these levels should do.

While management clearly deserves some criticism regarding their polish and investor relations efforts, they are undoubtedly good managers of a shoe business.   Since going public in 1999, sales have grown at a 16% CAGR, going from $425 million in 1999 to an estimated $1.4 billion this year.  The success has derived from a combination of cultivating the right retail relationships, designing the right product, and being astute marketers.  It should be noted the company is a heavy user of advertising, particularly celebrity endorsements.  This management team has shown a consistent ability to identify celebrities, usually from the music world, at the moment they are breaking out when they are still affordable, but then getting the opportunity to capitalize on them when their value soars in the months and years that follow (they most famously did this with Britney Spears at the time of her first album, but have repeated that formula more recently by signing Carrie Underwood and Ashlee Simpson right before they became tabloid staples).  So while you can certainly knock management for a lack of Wall Street acumen, they possess high Main Street acumen when running their business.

The biggest risk here is the consumer and the economy.  If the world completely falls apart, it is possible they do not make their numbers.  But given their business momentum and their balance sheet, in virtually any scenario they should fare better on a relative basis than the vast majority of their footwear, apparel, and retail peers.  By paying a rock bottom multiple for a company with a solid balance sheet that is currently taking market share and has been for awhile, I think you get a very good risk/reward.  This stock could easily see the mid $30s if it were to get a 14-15 p/e ex-cash on its $2+ of earnings, and at a 9 p/e excluding cash on the current year, the downside seems quite limited.

Catalyst