Tuesday wasn't a great day for Crocs (NASDAQ: CROX ) shares, which dropped
39% on lower guidance. The obvious question many investors will ask themselves
after the dip is whether the stock is a bargain at $16 and change. It's not.
While Crocs' business mode has dramatically improved from its heyday in 2007,
it still has a lot of work ahead of it. Don't be tempted to take the deal.
Instead, replace it with Deckers Outdoor (NASDAQ: DECK ). Here's why. Awful
Timing Crocs dropped third-quarter guidance from 40 cents per share to between
31 and 33 cents. At the low end, it's a 29% downward revision. It's still
making good money, so the drop itself is not really a concern. What's more
troubling is the fact that the company released this information one week before
its Q3 announcement. Either it felt compelled to spill the beans now in an
effort to limit the downside or it's completely unaware of what's really
going on in its business. Obviously, shareholders hope it's the former and not
the latter. On the surface, it seems clear that this move was nothing more than
damage control because in the previous four quarters, the company has had
positive earnings surprises of 17%, 150%, 20% and 39%, in that order. A 30% miss
without any warning would be devastating to any stock in this type of trading
environment, but especially so for one with a checkered past. A 39% decline
today probably translates into a 50% drop or more on the day of its
announcement. Management averted a firestorm by talking down its stock. That's
classic Investor Relations 101 stuff. Is it enough? What's Really Happening?
The above assumption hinges on the notion that management knew far in advance
that its business wasn't going to hit its margins in the third quarter and
most likely the fourth as well. According to Robert Samuels of WJB Capital,
Crocs' goal to hit a 15% operating margin for the year is now likely
unattainable . Making a quick calculation, working backward from its third
quarter EPS estimate of $0.31 a share, I come up with an operating margin of
11.4%, 130 basis points lower than in the third quarter of 2010. What exactly
does this mean? For starters, the company is growing revenues at the expense of
profits. Even with the revision, third-quarter revenues will increase by 26%
year over year, which is higher than the 21% growth it experienced in the third
quarter of 2010. If this margin compression continues into the fourth quarter,
year-end earnings won't be nearly as impressive. Samuels cut his 2011 estimate
by 25 cents, and the consensus before the guidance was $1.38 a share. Therefore,
let's assume it does $1.13 per share in 2011. For the first half of the year,
its earnings per share were 85 cents. Add 31 cents for the third quarter and you
have a 3-cent loss in the final quarter. This compares to a profit of 5 cents in
the fourth quarter last year. Sales are moving ahead while profits are falling
behind. Until Crocs can demonstrate it has its expenses under control, its stock
is not a bargain.
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