Business model

Crocs Inc (Crocs) is engaged in the design, development, marketing and distribution of casual footwear. Crocs sells their product to consumers through retailers. The end customer base is diversified and worldwide. Footwear is a discretionary item and usually is a minor expense for the consumer. Sales are one-off and will only recur when the shoe wears out.

Market and competition

The global flip flops market is expected to be worth around $32.30 billion by 2032 growing from $20.4 billion in 2022. This market is forecast to grow at a compound annual growth rate of 4.7% between 2023 and 2032.

The global market for athletic footwear is expected to be worth around $203.84 billion by 2032 growing from $115.5 billion in 2022. This market is forecast to grow at a compound annual growth rate of 5.3% between 2023 and 2032.

While Crocs’ clogs shoe fits into the flip flop market, it also has a range of other casual footwear that can partially compete in the athletic footwear market, since many people wear sneakers and athletic shoes casually (like I am doing right now).

In the USA, Crocs’ main competitors are Nike, Deckers Outdoor, Skechers, Steven Madden, Wolverine World Wide and VF Corporation. If we look at the market share split between the US competitors, we can see that Crocs is a fairly small player in the US footwear industry with market share of around 4.8%. The dominant competitor in the market is Nike with 62% market share.

Looking at revenue growth of 11.5%, we can see that amongst the USA competitors, Crocs is one of the fastest growing footwear companies. This is also evident from their steadily increasing market share (above).

Both the flip flop and athletic footwear markets are growing steadily, which gives Crocs room to grow in future. We also see that Crocs is steadily growing its share of the market, which is a positive indicator for its ability to successfully compete.

Profit margins

Gross profit (GP) margin shows us the percentage of profit left over after subtracting the cost of sales from revenue. Crocs has a GP margin of 55.8%, which is the highest margin amongst all their US footwear competitors. This is a healthy GP margin and slightly above the average of 52% for the companies in the S&P 500 index.

Operating profit (or EBIT) margin shows us the percentage of profit left over after subtracting the cost of sales and all the expenses to run the business. Again, Crocs leads the pack with an EBIT margin of 26.4%.

Crocs runs a tight shop and is more profitable than most of its US footwear competitors.

Free cash flow

The free cash flow margin is the amount of cash that is generated for each dollar of sales. Unsurprisingly, Crocs leads the pack with a 19% free cash flow margin. Almost double that of its nearest competitor. Very impressive.

Crocs’ growth in free cash flow is also industry leading. While free cash flow growth can be volatile, Crocs’ has been the most consistent amongst its competitors.

Crocs generates more free cash flow per dollar of sales than its competitors and it is able to grow those cash flows over time. This is a positive indicator for the company’s future value.

Stock based compensation and dilution

US companies are fond of paying staff with shares, particularly in the tech industry. The problem with paying in shares is threefold:

• Firstly, it elevates profit levels because no salary expense is incurred. In other words, profit looks higher than it should.

• Secondly, it causes dilution in the ownership of the company. This is bad for the shareholders because the company is being given away slowly.

• Thirdly, companies often try to cover this up by engaging in share buybacks, even when their shares are overvalued. That is a value destructive use of shareholder funds.

Over time, the stock-based compensation issued by Crocs has been dropping. That is a good sign and at 3.6% of free cash flow, the amount paid is reasonable when compared to the S&P 500 where it is over 9% of free cash flow.

The equity dilution has been negative at Crocs, which means that they are buying back shares.

Capital allocation

Capital allocation is a fancy way of saying “what the heck are they doing with my money”. You can think of it like that because the free cash flow remaining after debt is repaid belongs to the shareholders, and it is management’s job to use that money wisely to grow the business.

 Crocs has three major uses for the cash flow generated:

• Their largest use is repayment of debt, which is a perfectly reasonable use of free cash flow.

• Their next largest use is for buybacks. Share buybacks are a very hard thing to judge regarding whether they are a good use of capital or not. In this case, it does not appear to have been a poor use of capital because Crocs is not an overvalued company.

• The third largest use is for capital expenditure (capex). Crocs is growing the business by purchasing plant, property and equipment. This is always a good use of funds and it is needed if they intend to grow with the market, while also taking market share from competitors. Crocs is reinvesting about 12% of operating cash flow in capex. This varies over time, but is in the middle of the range compared with competitors.

Return on capital employed

As I have mentioned in previous newsletters, you can think of return on capital employed (ROCE) as analogous to the interest earned on your savings account. The higher the interest rate the better. Crocs has a healthy ROCE of 26.5% (usually above 15% is good), which is the second highest amongst their competitors.

Crocs has a good business that is being well run by management.

Debt

Equity-to-assets tells us how much of the assets are financed with equity. Crocs has 31.3% of assets financed with equity. This is similar to Nike and about middle of the pack amongst the competitors. That means 68.7% of the business is financed with debt. This is higher than the 60% average used by an S&P 500 company. It doesn’t mean there is a problem. The reason for the increase in debt is related to the acquisition of a footwear brand called HEYDUDE in 2022.

Crocs’ total debt to free cash flow ratio is 4.1. That is around the middle of the pack and nothing to be concerned about.

Valuation

Here are compound annual growth rates for Crocs over different time periods:

• 1-year: 34.7%

• 3-year: -2.40%

• 5-year: 39.5%

• 10-year: 23.9%

As the price graphs shows, the past few years have been volatile for Crocs’ shareholders. However, in the long-term Crocs has delivered extraordinary returns. Crocs’ 10-year return of 23.9% per annum is more than double that of the MSCI World Index return of 9.3% per annum.

• Crocs has a price to earnings (P/E) ratio of 9.8. That is slightly below the mean of 10.1.

• Crocs has a price to cash flow (P/FCF) ratio of 8.8, which is significantly below the mean of 12.6.

This indicates that Crocs is trading cheaper than it has been in the recent past. Yet, the numbers show us that Crocs has been gaining market share, generates healthy free cash flow and earns good returns on capital. So it is getting cheaper while getting better.

Margin of safety

Crocs is selling at $129 per share which is below our moderate valuation, which comes out at $187 per share. That gives it a margin of safety of 31%.

Conclusion

Crocs definitely has the makings of an Extraordinary Company. Its valuation is much more attractive than the highly valued tech companies. For now, we will be adding it to the ROA Watchlist and it may be a candidate for the Extraordinary Companies portfolio in future.

(Note: The averages in the tables are long-term averages)