Skechers (SKX): Opportunity or Trap?

Last Thursday, I woke up to a flurry of messages. Almost all of them are from students asking me about Skechers (NYSE: SKX). Many of them are either holding on to stocks or an option strategy on Skechers.

Honestly, I don’t follow stocks on a day to day basis so when I saw the news I was also taken a back.

“Skechers fell 25% after-hours due to mis-earnings”

Many people are panicking to say the least. Indeed, a single day drop of 25% is really hard to swallow if you are holding on to the stock. For those who did options, maybe the pain is lesser but still painful nonetheless. While I am not vested in SKX at this point. Each time I see a news like this, I will think of the possibilities.

Is this an opportunity or a trap?

And to find out, you just need to examine the stock briefly. Firstly, you need to ignore the price drop, because it will tend to cloud your judgement. Go into your analysis with a calm mind as much as possible (drink some tea or whisky if it helps, I prefer whisky).

What is Their Business?

In official terms, they are in the sports retail business. In my terms, they are shoe maker.  This means they are in the same industry as Under Armour, Nike, Adidas, Puma, ASICS etc. Knowing the competitors is useful, as we will compare them later on.

Are They Profitable?

Looking at their past earnings, I would say yes. The net income has been rising and their cashflow is healthy too. To me, these are good signs.

Are They Enjoying High Margin?

I prefer to invest in business with high margins. High margins tells me that the business has some pricing power or customers are not so sensitive to prices (I did a quick survey in the office and one of my colleagues told me that she just bought a pair of sport shoes for $200). In addition, high margins also provide the business with more buffer in running the business. If your margin is very thin (e.g. 5%), when your raw materials goes up by a little, you will be left with nothing. However with a high margin like 40%, you are still able to run the business with healthy profits even if the raw material prices go up.

Looking at SKX’s gross margin, I am happy for them! In fact, other indicators such as sales and operating income are also on the rise.

Source: SKX Annual Presentation Slides

Are They Carrying A Lot of Debt?

Sometimes companies may do very well on the surface, but they achieve at a cost – HIGH DEBT. I like companies which can run their business without too much debt.

Source: SKX Various Reports

From their past reports, it seems like SKX has very little debt (the debt level is less than 10%). That’s another good sign.

Are They Growing?

Of course, to invest in retail business, I want to know if they have been growing fast. Retail is a competitive space, and the consumers’ taste changes very quickly. So “land-grabbing” is very important and I want to see the high growth rate in their business.

Their revenue has been growing at an average of 20-25%while their profits are much more erratic, fluctuating between 10 -45%  for the last 5 years. So in my view, the growth is not bad but not fantastic either.

Are They Cheap?

Now after understanding the business, it is time to evaluate their value.

There are many ways to value a business but in this case, I will use two estimation. One is called Peer Comparison while the other is Discounted Cashflow (DCF).

Look at Others – Peer Comparison

So who are the competitors? Like I said earlier, Under Armour, Nike, Adidas, Puma, ASICS. I selected these companies because they are also listed on the stock market so I am able to make a comparsion. The ratio I will use is called EV/EBIT, it is very similar to the famous PE ratio but it includes a bit more information. Similar to PE ratio, the lower the EV/EBIT, the better.

Sources: Compiled from Yahoo Finance

Looking at the other sports-retail companies, it seems to indicated that Skechers is cheapest among all. However, sometimes a company may be priced cheaply because they are losing to their competitors. Looking at the gross margin, it shows that Skechers is able to price their product equally and enjoy the high margins too. They are keeping with the competition.

Look at Yourself –  DCF

Now knowing that Skechers is cheap compared to others may be good news, but we also need to know that Skechers is cheap intrinsically too. One simple way is to estimate the future cashflow and find out what Skechers may be worth now. To keep the post short, I won’t be explaining how to do DCF, you can go to this website to find out.

My preferred way to do DCF is to look at it at both the optimistic and pessimistic scenario.

Based on their growth rate, I think an optimistic scenario might be SKX cashflow growing at 20% for the next 5 years, while pessimistic scenario might be SKX cashflow growing at 4%  for the next 5 years (just meeting inflation).

For 20% growth, I will arrive at ~$35.80, whereas at 4% growth, I will arrive at ~$19.10

What is the Offering Price Now?

Time to look at the carnage this morning, after hours, SKX fell 25% to $24.13. This means in the optimistic scenario, this price giving a discount of over 30% while in the pessimistic scenario, the current price is too high.

My Opinion

In my view, Skechers does not look like a trap. It has a strong business and comparing to other sport-retailers, it is pretty cheap. 30% discount seems quite attractive at this point. But I will wait a little while to see if the market will continue to over-react to the bad news because SKX has the history of huge falls and rises in the past.

Source: Google Finance

If the market continues to over-react, it may present a better price to buy into SKX! For now, I will be a bit cautious, perhaps just use some options strategy to gain good premium as such huge swings usually brings huge premium on the options market!

Oh the US market just opened! Ka-Ching!

Disclosure: I do not own any SKX shares now, but may initiate a position in the next 24 hours.

<<Updated on 23 Jul>>

Since my first post on Facebook, I had more time to do a bit more digging so I just want to share my findings here.

Trade War

During one of the earnings call, it was asked to the COO, David Weinberg, how would the trade war affect them? He replied that it is uncertain however, with increasing overseas sales for SKX, he is not very concerned. I think that’s partially true. Indeed, more than 50% of SKX sales come from outside of US hence it would be affected by the trade war. However, an impact on the remaining 40% is still a sizeable amount.

Rising Cost to Sell Overseas

One thing I noted is their rising cost. Looking at their past Selling, General and Admin (SGA) expenses. You will notice that it has gone up from less than US$750m to almost US$1,750m

That is a staggering number! However, if this rise in cost has brought about more sales (revenue) then it will be justifiable. To understand that, we take a look at the SGA as a % of the revenue. You can see that the SGA % has crept up from 34% to around 38%. This means the growth in cost is rising faster than the growth in sales. This will be a big area to watch as they continue to expand more businesses overseas. Ideally, you want to see this SGA% level becomes stable and stop rising.

Family-Run Business

I also noticed that Skechers is a family-run business! Looking at their directors and executives, you can see there are many Greenbergs and Weinbergs. There is nothing wrong with family-run business but I would generally prefer professionally-run business. In addition, they hold about 15% of shares in total.

See you soon!

Investing Always,

Pete

Please refer to the disclaimer here