While investors were enjoying the tech rally last week, the shoe stocks fell sharply after earnings announcement of Under Armour (NYSE:UA) and revenue miss of Skechers USA (NYSE:SKX). Although Skechers delivered strong earnings growth in the latest quarter, the soft sector outlook and thus ability to maintain a high double-digit top-line growth in a very competitive industry is now a major concern. Resultantly, Skechers plunged due to deteriorated investor sentiment and lost 31.50% value in one day.
Skechers share price is on a consistent rise since 2014 driven by strong top as well as bottom-line growth. After the crash, Skechers is still outperformer, up 75% YTD. Skechers results were not that bad, and this dip in price is an ideal opportunity for long-term investor.
The second Largest Player – Ahead of expectations
The global footwear industry value stood at $198.8 billion in 2014 while volumetric sales stood at 9990.7 million units. The industry sales are likely to reach $220.2 billion with 10,974.0 million units by 2020, depicting a value CAGR of 1.72% and volume CAGR of 1.58%. While Nike (NYSE:NKE) is the largest athletic footwear company in the U.S. with a market share of 62%, Skechers holds the second position with 5% market share.
The currency headwind and one-off expenses, which includes increased legal expenses due to a legal settlement and pending litigation and increased deferred rent expenses related to new Fifth Avenue location, negatively impacted the earnings. Thus, excluding that impact of $0.15 per share the diluted earnings per share of Skechers increase to $0.58, a beat of $0.03 per share. This also translates into a massive jump of 76% in adjusted earnings.
Skechers results were not that bad. The company recorded 27% growth in top-line as it generated sales revenue of $856.2 million, but missed the estimate of $876.5 million. The currency headwind and slow acceleration in domestic sales negatively impacted the revenue growth momentum. Skechers is aggressively marketing new innovative products to maintain the growth. The launch of co-branded Star Wars Skechers footwear for Boys and celebrity endorsement, which include Demi Lovato and Ringo Starr, will support the sales in the coming quarters, particular holiday season.
The trend is declining as evident from the fact that first and second quarter 2015 sales increased by 40.5% and 36.4%, respectively. The credit rating agency has changed the outlook for the U.S. apparel and footwear industry from positive to stable. Moody’s expects the U.S. apparel and footwear industry revenue to grow 4% – 6% by 2016. The slowdown in sales growth is attributable to small base effect and penetration level into the certain market category where strong competition from Nike, Adidas (OTCQX:ADDYY) and Under Armour would restrict the top-line growth.
The domestic wholesale business, which accounted for 42% of total sales, delivered just 12% increase during the third quarter as compared to 30% in the previous quarter. This decline suggests that the strategic shift into low-priced sports shoes may not be sustainable over the long run. On the other hand, the strong presence in walking shoe category with Skechers GoWalk should keep adding more sales in the coming quarters.
Expansion To Deliver More Growth
While growth in the domestic market is slow, betting on international markets will help Skechers to achieve its long-term growth target. During the third quarter, international wholesale business accounted for 30.2% of total sales, up from previous year contribution of 25.7%. The increasing contribution from international markets is in-line with the company strategy to earn roughly half of total sales from outside the domestic market by 2020. So far, this strategy is working well for Skechers and international wholesale business delivered 53% increase in sales, which included strong double-digit gains in Europe and triple-digit growth in China and the Middle East. China and the Middle East will should the primary target markets outside the U.S. as pricing and brand appeals of Skechers fit in those markets.
In the meanwhile, the operating strategy of Skechers is very convincing. The joint ventures, franchisees, and distributors’ network helped Skechers to expand successfully in the domestic as well as international markets. Thus, increasing the store base to over 1,280 by the end of the year will add quick numbers to the top-line. Moreover, the focus on launching new innovative products across all the categories while improving distribution channels should boost sales and profitability. In addition to that, Skechers must overcome its weakness in direct-to-consumer sales to improve the profit margins.
Nike Is Eyeing $50 Billion In Sales – Skechers To Double The Business
Nike dominates the athletic footwear industry and it is very hard for a company like Skechers to compete with Nike. The unmatchable innovative, a strong brand name across the globe and top-class athlete name attached to Nike makes the company hard to beat. Nike is growing at a very decent and consistent pace. Nike is eyeing $50 billion in annual sales revenue by 2020, up from current $30.6 billion. This means Nike is targeting a CAGR of 13% over the next five years, which is pretty achievable as Nike witnessed 10% growth in the fiscal year 2015. Nike’s main bet is women category, the business Nike intends to double over the next five years.
On the other hand, Skechers also expects to double its business over the next five years. Nike is premium athletic brand whereas Skechers is a low-priced brand. Both companies are successful in their strategy, and I think Skechers will continue to focus certain class of customers rather than aggressively competing with Nike. Moreover, the increasing buying of athletic-styled clothes and shoes for everyday wear will benefit both companies.
Skechers is primarily focused on comfort and style to target women, young girls and kids. Skechers is targeting younger girls with pop singers Demi Lovato and Meghan Trainor as endorsers. Moreover, with the development of new innovative products, brand awareness in the international markets, and aggressive expansion will have a positive impact on growth momentum across three main business channels in the future. Although there is a risk of a slowdown in top-line growth, the international markets and marketing arrangement will continue to support a high double-digit sales growth for a longer run.
As the earnings outlook is intact, the valuation of the company is looking more attractive and the dip is an ideal opportunity to buy Skechers for long-term investment. The stock is trading at forward PE of 14.79x, very low multiple for a growth stock which is delivering robust sales as well as earnings growth. Thus despite a slight bounce back, Skechers offers a hefty upside potential of roughly 42% at an average target price of $47.08.