Bought SKX at 21.80

Skechers - 01/04/11


Summary



- Skechers designs and markets Skechers-branded contemporary footwear for men, women and children under several unique lines. Skechers operate 235 retail stores and 40 international stores. Core consumers are style-conscious 12 to 24 year-old men and women attracted to our youthful brand image and fashion- forward designs. Skechers best-selling and core styles are also developed for children with colors and materials that reflect a playful image appropriate for this demographic. Brand recognition is an important element for success in the footwear business. Skechers basically designs shoes and outsource all their manufacturing to china using third party vendors

Latest Story Line:

Recently the stock price tanked from $44 to $20.57 as of yesterday in the last six months. Its market cap is 1.0B and Enterprise value of $731MM. It recently fell pretty hard due to its inventory problems and market believes that its recent “Shape UP” line could be fad. There are even couple of lawsuits that their advertising is false. Recently Nike did not even design shape ups thinking it is fad.

The most important question whether this is a short term problem or fundamentally much deep rooted problem. Before we answer this question, let’s look at the DNA of this company.

Skechers was started in 1992 by Robert Greenberg. Let’s look at the career of Robert Greenberg (Career: Talk of the Town, 1962–1969, owner; Wig Bazaar, 1965–1968, owner; Wigs 'n Things, 1968–1970, owner; Europa Group, 1970, owner; Europa Hair, 1971–1974, owner; Wild Oats, 1974, importer; Removatron, 1977, investor; Roller Skates of America, 1979–1983, owner; L.A. Gear, 1983–1992, CEO; Skechers USA, 1992–, CEO).

Obviously plenty of experience in Hair Products and Shoes. Both of them have a touch of fashion and fickle minded customers. To provide some ammo to the shorts, the earlier business he started was L.A.Gear (which capitalized on the aerobics craze of the 1980’s.). By 1990, L.A.Gear had $820million in sales and no.3 retailer behind Nike and Reebok. It took a loan amount of $360MM from a consortium led by Bank of America and one of the covenants stated that if L.A.Gear lost money in any quarter they would pull the line. Obviously they lost money in one quarter and the rest is history and it filed for BK in 1998. In a way this is good as he obviously learned his lesson as Walter Schloss said in Rule no.16 - “Be Careful of leverage as it can go against you”. The good part is that he has plenty of experience in Shoe business and he has learned his lesson related to leverage. No wonder, SKX has $249 MM in cash without any debt.

If you look at Shoe industry, it is very sensitive to fickle mindedness of the customers. As a value investor why would you bet on this kind of business unless it sells very cheap. Obviously the recent hot product “Shape Ups” could be real disaster but if you ignore this product, it was still selling close to $1.5B in revenues in the last two years. I think the core earnings are in line and even if you assume they do not make a penny on shape up’s, they have strong operating leverage going forward.

It recently started going into two most populous countries in the world (China and India) and also in Brazil. International whole sale business is up by 26% for Q3 and 36% for the first 9 months. Most of the subsidiaries had double digit growths for the first 9 months. They currently have 43 stores in Asian Region and point of sales to 375. Let’s look at last quarter numbers. Sales were $554MM. Domestic whole sale is 56%, International whole sale is 22% and Retail is 20%. The domestic retail grew by 14% and international retail grew by 52% Even if you assume that 25% ($500MM) from toning sale is zero value add, still the stock looks cheap. You also get a free option for BRIC/toning play/retail improvement in 2011/12. They just opened 4 Skechers stores in Mexico.

Obviously we cannot compare these three businesses but let’s look at a few numbers for SKX, Nike and Crocs.

Skechers

P/B – 1.12

P/S – 0.52

P/E (TTM) – 6.25

Forward P/E – 8.75



Nike

P/B – 4.41

P/S – 2.2

P/E (TTM) – 21.75

Forward P/E – 17.18



Crocs

P/B – 4.16

P/S – 2.04

P/E (TTM) – 29.93

Forward P/E – 18.46



I think even though they messed up these designs and the inventory is bloated, if you have long term horizon this should do fine. It has lot of other designs. I think they could easily get to $2.0B in sales in next three years and have a margin of 5% - 7% and this could earn up to $100MM - $140MM. . I think this would mainly come from growing internationally. Currently 22% of sales are coming from international sales and this could go easily up to 40% sales. With a $249MM in Cash and this could easily grow to $300MM by Q2’10. Then the enterprise value will be close to $700MM and a potential earnings yield of 14% - 17% on Enterprise value in next 2-3 yrs.



Obviously lots of assumptions go into this estimate but here are few things that can throw a curve ball into these estimates.



Design failures

Unable to pass the increased cost of goods due to inflation

Most of the manufacturing is in China and with strong renminbi, this could be an issue

Currency Translation


If you look beyond four quarters, I think this should do well unless they really mess up their process but without any debt and potential strong international expansion, I think it will be a decent business with intrinsic value between $32 - $36.

But for next two quarters, you will see plenty of bad news when they start writing off their inventory.

You should have a strong stomach to hold this business. But with longer time lines and you can make decent money on the wall-street short sightedness.