Shares of athletic apparel brand Skechers (NYSE:SKX) popped in mid-July after the company reported record second-quarter results which came in well ahead of expectations. Management also delivered an above-consensus third quarter guide, and said all the right things on the conference call. SKX stock jumped 14% in response to a new 52-week high.That post-earnings rally is a continuation of what has been a much bigger and longer rally in Skechers stock throughout 2019. Year-to-date, SKX stock is now up more than 68%.
I’ve been bullish on SKX stock the entire way up, pounding on the table over and over again that this is a really strong company with robust, long-term growth prospects and a persistently undervalued stock. But, on the heels of a 68%-plus year-to-date rally, my bullishness on SKX stock is waning some.
Why? Valuation. At $40, SKX stock is now fully valued considering its realistic long-term growth prospects, according to my numbers. The stock still has some momentum upside left over the next few months as it appears that third quarter back-to-school numbers will be good. But, with the valuation now maxed out, further upside in SKX stock from here seems limited.
As such, while I’m still a fan of the Skechers long-term story, I think the best of the 2019 rally in SKX stock has already played out.
Skechers Is on Fire
Second-quarter numbers affirmed that Skechers is on fire right now.
The company reported 13.7% constant currency revenue growth in Q2 — up from 5.2% in the previous quarter — including a 25.2% gain in the international business, a 1.5% gain in domestic sales, and a 4.9% rise in comparable sales. Those are some of the best numbers this company has reported in recent memory.
Further, things are only getting better. Management said on the conference call that growth trends within the second quarter improved each month, and have continued to tick up in July. That’s why they are guiding for another of 10%-plus revenue growth next quarter.
Under the hood, Skechers is leveraging product collaborations and a shift to direct-to-consumer sales to be both more interesting and relevant to consumers around the globe. These two initiatives are working. They are also far from over. Skechers plans to launch more collaborations over the next several months, while the company continues to add several new direct-to-consumer stores.
As such, Skechers has a ton of momentum heading into the important back-to-school season. That should translate into strong sales for the brand, which means that third quarter numbers could look even better than second quarter numbers. With this big catalyst on the horizon, analysts will likely upgrade SKX stock, and investors will buy in.
Thus, it does appear likely that SKX stock has at least some upside firepower left for the foreseeable future.
Skechers Stock Reflects This Recent Strength
The problem with SKX stock is that favorable back-to-school sales trends are already priced into the stock, and the underlying valuation here is starting to look maxed out.
I’ve always seen Skechers as a solid footwear brand in the secular growth athletic apparel market. The secular appeal of Skechers is two-fold. First, the shoes are cheaper than Nike (NYSE:NKE) and Adidas (OTCMKT:ADDYY) shoes, yet are of similar quality and have similar styles. Second, Skechers shoes are all about comfort over style, whereas other brands can often get caught up in the style wars.
This low price positioning and comfort-first approach means that Skechers will continue to attract the price-sensitive and comfort-oriented customers around the globe. Second-quarter numbers speak to the magnitude of this trend. As do the numbers over the past several years.
From this perspective, I think Skechers should be able to grow revenues at a 6%-plus compounded annual growth rate into 2025, just slightly above the 4% projected growth rate for the global textile market. During that stretch, gross margins should expand gradually as consistent and strong demand allows for product price hikes. At the same time, the opex rate should fall with scale as Skechers pulls back on what was accelerated marketing spend over the past few years.
Broadly, I think Skechers can do about $7 billion in sales by 2025 (versus $4.6 billion last year) on operating margins of 12.5% (versus 9.4% last year). That combination ultimately leads me to believe that Skechers will produce roughly $4 in EPS by fiscal 2025. Based on a market average of about 16-times forward multiple and a 10% discount rate, that yields a fundamentally supported 2019 price target for SKX stock of $40.
Bottom Line on SKX Stock
The reality is that Skechers is a great company, and SKX stock is up more than 68% year-to-date because the market is finally starting to appreciate this reality. But, the valuation is now starting to look maxed out, meaning that the best of the 2019 rally in SKX stock may have already come and gone.
That’s why I used this post-earnings rally as an opportunity to take profits off the table. I’m fairly certain that given the inherent volatility of SKX stock, I’ll be able to buy back into this stock at lower prices in the not-too-distant future.
As of this writing, Luke Lango was long NKE.