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.
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.