Did Crocs croak?


Normally, when a company reports a quarter with numbers as impressive as Crocs (NASDAQ: CROX) did, you expect the share price to rise. On September 30, Crocs reported third quarter earnings per share of $0.66 versus expectations of $0.63 and revenue of $256.3 million, in-line with expectations. The death knell was the dreaded words "in-line."

The company had been on a run of exceeding Street expectations by quite a bit. The shares were hit very hard on Thursday coming down from $74 to $47, exacerbated by a 360-point decline in the Dow.

The numbers that Crocs reported were actually quite impressive as revenue were up 130% over last year's 3rd quarter and earnings were up 144% for the same period. The gross margins expanded from 58% to 60.4%, while the ever-important operating margin actually hit above 30%. Young growth companies are not supposed to hit operating margins of 30%. It is virtually unheard of.

The other important piece of news was the company raising its 2008 guidance for earnings in the $2.65-2.70 range. With 2007 looking to be at $1.96, the growth for 2008 would be 35-40%. The stock market reaction was a tremendous overreaction, and the shares are now selling at quite a discount to its growth rate and operating margin level.

Typically, the market is comfortable assigning one P/E point to one point of growth or one point of operating margin. With the growth rate and the operating margins north of 30%, Crocs could support a 30 PE of its 2008 earnings expectations or $81 per share. Assigning a premium over the 30 PE would lift the shares even higher.

Crocs has executed superbly thus far in developing its brand and its massive distribution system globally. Fifty-one percent of revenue came from international sales. Again, for a young growth company, that is another impressive statistic. Crocs is also learning to manage product flow versus expectations of delivery. Being late to the party with inventory in Europe cost it about $20 million in sales, thus eliminating the revenue upside for the September quarter. That is a lesson that has been learned and will likely be avoided in the future.

The new product flow is impressive and substantial. The early read on both the men's and children's apparel line has been very strong. With the shares trading at a low P/E of 17 times 2008 earnings and a PEG ratio of .5 times 2008, the stock is a strong buy.

The shareholder base is changing as the fast money hedge funds that got killed earlier in the year have now extracted a bit of revenge. Traditional institutional investors are doing the work as the shares are too cheap and look extremely attractive. I spoke to three such institutions this past Thursday and Friday and all three are buying shares.

Young growth companies have their moments of experiencing growth pains in the development. Google (NASDAQ: GOOG) went through this back in the June quarter of this year, now Crocs is. Google had the audacity to report "just an in-line quarter" and the shares were knocked out of a bed. They have now recovered and have gone to record highs. The Crocs concept is playing in a massive and global market and the shares will rebound. With a $47-48 current price, the shares have still more than doubled this year. There is still a lot more to come.

Georges Yared is the CIO of Yared Investment Research.

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Last updated: February 12, 2012: 09:13 AM

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