3 Reasons Why Skullcandy Won’t Rebound

by Alyssa Oursler | March 11, 2013 1:30 pm

Shares of headphone-maker Skullcandy (NASDAQ:SKUL[1]) got downright trounced this past Friday — to the tune of 22% — thanks to a not-so-hot quarterly outlook.

Even with a slight 3% rebound so far Monday morning, year-to-date losses are sitting north of 30%, while all-time losses since its mid-2011 IPO total a staggering 73%.

Here’s a quick look at why the stock crumbled … and why it probably won’t climb back.

Too Much Red

While Skullcandy posted a decent fourth quarter, including solid 29% year-over-year sales growth, its earnings still missed expectations.

The bigger problem, though, was the fact that the company’s sales are expected to drop 30% YOY in the current quarter for an estimated total of $37 million vs. an original estimate of $59.7 million. The two main culprits: the loss of HMV as a customer and lineup changes. That slide will translate to a Q1 loss between 25 and 35 cents per share vs. original expectations of a 5-cent profit.

Plus, full-year earnings now are expected to come in below not just 2012 levels, but 2009 levels — reversing what had been an improving trend. (The company lost money in 2010 despite growing revenue, but pulled into the black for 2011.)

On top of that, those numbers are merely a reflection of some fundamental problems with the business — problems that aren’t going anywhere and will thus keep dragging profits and the stock down.

Too Crowded

Skullcandy’s business is simple: develop and distributes headphones and other audio accessories, both online and through a variety of retailers — Best Buy (NYSE:BBY[2]), Zumiez (NASDAQ:ZUMZ[3]), AT&T (NYSE:T[4]), and so on.

The problem? Everyone makes headphones. Apple already provides (NASDAQ:AAPL[5]) earbuds — excuse me, EarPods[6] — with iPods and iPhones, while higher-quality products can be found from Beats by Dre, Bose and Sony (NYSE:SNE[7]), among several others.

The headphone game isn’t an easy one to be in, either. Sure, headphones are a popular product (if not a necessity nowadays), but there are really two main types of customers — and neither is very appealing.

The first: cheap earbud buyers, like me, who lose or break their pairs so often there’s no point in buying nice ones. These people are hardly loyal to the brand they choose — Skullcandy or otherwise — and the products they buy have very low margins. Unfortunately for Skullcandy, this is its bread and butter.

Other customers invest in a quality headset, which Skullcandy also provides at much better margins. But these shoppers spend the money so their product will last. If it does indeed work for a while, you have a one-time (or few-time) customer on your hands. If it doesn’t last, your customer sure isn’t going to to buy the same non-lasting brand the second time around.

This tough reality is probably part of the reason Skullcandy’s margins slid last year — a trend that seems likely to continue even if the company can get people to choose its product despite a plethora of alternatives.

Too Trendy

Because the headphone business is crowded, having a niche seems like an obvious solution. In fact, Skullcandy’s niche — its unique collision of music, fashion and action sports to create a bright lifestyle brand — is the defining part of the company. The seeming result is its edgy, skull-shaped logo; brand “ambassadors” from Wale to NBA stars; bright colors and eye-catching patterns; and custom designs.

The real result, though, is a product with “fad” written all over it.

Fashion is fickle, and while Skullcandy can try to adapt, any shift in fashions will mean a complete redefinition of the brand. Plus, relying on celebrities to sell your brand sounds fun, but most people don’t base their headphone choices on Hollywood’s hottest. And the trendy aesthetics seem to overshadow quality in some cases. Many users complain about the sound quality for Skullcandy’s high-end products — not good considering that’s where the money’s to be made.

While having a niche is nice, Skullcandy’s emphasis is too specialized … and too trendy.

Bottom Line

In the end, Skullcandy’s stock has been sliding for a reason. And unless the action-sports-themed headphones fad suddenly becomes hot again — which seems highly unlikely — or its higher-end products become much more well-received, there’s little chance the company will be able to reverse that trend.

Tune out any noise you hear about valuation, too. While SKUL is trading for a mere 5 times trailing 12-month earnings, it’s also trading at 13 times its fiscal 2014 earnings — earnings expected to grow an unimpressive 8%.

In the end, while you might be OK buying one of Skullcandy’s cheaper pairs of earbuds, you’re better off staying away from its struggling stock.

As of this writing, Alyssa Oursler did not hold a position in any of the aforementioned securities.

  1. SKUL: http://studio-5.financialcontent.com/investplace/quote?Symbol=SKUL
  2. BBY: http://studio-5.financialcontent.com/investplace/quote?Symbol=BBY
  3. ZUMZ: http://studio-5.financialcontent.com/investplace/quote?Symbol=ZUMZ
  4. T: http://studio-5.financialcontent.com/investplace/quote?Symbol=T
  5. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL
  6. EarPods: http://store.apple.com/us/product/MD827LL/A/apple-earpods-with-remote-and-mic
  7. SNE: http://studio-5.financialcontent.com/investplace/quote?Symbol=SNE

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