Should You Get Some Skechers?

GuruFocus.com

- By Mark Yu

Skechers USA (SKX) fell an incredible 22% on July 22 after it announced its earnings. According to GuruFocus data, Skechers now trades at its lowest price-to-earnings multiple for the past three years. Still, Skechers USA trades 2.5 times its book value of $9.83 per share.

Since its IPO price of $11 a share in June 1999, Skechers USA has provided an annual average total return of 11.79%, while the Standard & Poor's 500 delivered 4.83%.


Business overview

Skechers was first incorporated in California in 1992 and reincorporated in Delaware in 1999. According to its annual filing, the company designs and markets Skechers-branded lifestyle footwear for men, women and children.

Skechers USA has several brands.

  • Lifestyle Brands (Skechers USA, BOBS from Skechers, Mark Nason, Skechers Active, Skechers Sport Active and Skechers Sport).

  • Performance Brands (Skechers GOrun among others).

  • Skechers Kids.

  • Skechers Work.



Skechers brands are sold through department and specialty stores, athletic and independent retailers, boutiques and Internet retailers. In addition to wholesale distribution, Skechers footwear is available at its ecommerce websites and its own retail stores.

Skechers USA has several stores worldwide that are either wholly owned, operated through a joint venture or run by distributors and licensees. Altogether, the company had 1,548 retail stores worldwide. In its recent earnings announcement, the company's chairman of the board, CEO Robert Greenberg, stated he expects to have the total count reach 1,600 by year end.

Stores

In its annual report filed Feb. 15, Skechers grew its stores by 17% to 649 retail stores in 2015 from a year earlier. The company had 391 domestic stores and 128 international retail stores. Skechers owned and operated 80% of these stores while the remaining 20% or 130 stores were operated as a joint venture in Southeast Asia (China, Hong Kong and India). Further, Skechers plans to open 55 to 65 new stores in fiscal year 2016.

Distributors and licensees (D&L) stores

According to Skechers, these are businesses that are responsible for their own stores' operations, have ownership of their respective stores' assets and select the broad collection of our products to sell to consumers in their regions. D&L stores grew 39.8% to 663 stores in 2015 from 2014.

Skechers recognizes earnings from the D&L stores under royalty income. Royalty income, as a result, does not incur any operational charges and is directly added to Skechers' gross profit. Royalty income had contributed less to Skechers' overall sales in the past three years to 0.82% in 2015 from 0.94% in 2013. In contrast, the segment actually grew 18.5% in the same time frame. This just shows that Skechers demonstrated stronger growth in its wholly owned and joint venture stores than its licensees.

Sales, profits and growth

In its recent second quarter earnings announcement, Skechers delivered 9.66% sales growth to $877.8 million compared to the second quarter of 2015. The company had profits of $100.4 million, down 10.60% from the same quarter a year ago. This gave the company a profit margin of 11.4% in the quarter.

Further, the company provided an earnings per share (EPS) of 0.48 cents from 0.52 cents in the same time frame. This negative 7.69% EPS change led to the heavy punishment Skechers share price received on Friday.

Skechers provided three reasons that led to the negative growth figures in its earnings:

  • Foreign exchange loss. The company derived 41.9% of its sales from overseas. Skechers claimed it had about $8.3 million or 0.05 cents reduction in its diluted EPS.

  • Additional value-added taxes in Brazil for $2.7 million.

  • A $900,000 charge secondary to a fire in Skechers' Malaysia warehouse.



Nonetheless, the company exhibited consistent year-on-year sales growth. Observably, Skechers has been gaining more growth in its overall sales overseas. In 2015, the company recognized 40% of its sales were from abroad. According to its chief operating officer and chief financial officer, David Weinberg, international wholesale and retail business comprised 45.0% of the company's total sales for the first six months of 2016.

Skechers also has better gross margins in its overseas and retail sales. Retail sales, according to the company's filing, include its ecommerce sales. In 2015, the company had margins of 60% and 42% in retail and international wholesales. This compared to 39% found in domestic wholesales.

In the past three years (2013 to 2015), Skechers delivered a sales growth of 26%, and profit growth of 189%.

2011 performance review

Interestingly, nobody in the U.S. seemed to bother purchasing much of Skechers' products in 2011. Skechers experienced a 30% drop in sales domestically while recording some 16% growth overseas.

According to the company's 2011 fiscal year report, it experienced a drop of 20% in total sales to $1.6 billion from $2 billion in 2010.

In addition to the weak sales, Skechers also had to perform several activities that further reduced its earnings. The company performed inventory write-downs ($10 million), padded up a reserve ($45 million) for costs and potential exposure relating to existing litigation and regulatory matters, made writeoffs ($4.6 million) in foreign bad debt and acknowledge asset impairments ($3.1 million).

The company then reported a profit loss of $67.5 million with negative 150% year-on-year growth.

Dividends and share repurchases

For the dividend investors out there, the company would automatically be crossed out. The company had never issued dividends and has this following statement regarding its dividend policy:


"Earnings have been and will be retained for the foreseeable future in the operations of our business. We have not declared or paid any cash dividends on our Class A Common Stock and do not anticipate paying any cash dividends in the foreseeable future. Our current policy is to retain all of our earnings to finance the growth and development of our business." - 2015 annual report



As for share repurchasing activities, the company also had not performed any. Skechers performed share issuance instead. The company had grown its outstanding shares by 6% to 154.2 million in 2015.

With these characteristics (absent dividends and share dilution), Skechers may not be an immediate candidate in most value investors.

Cash, debt and book value

As of July 21, Skechers had $628.8 million in cash and cash equivalents. The company also had $71.3 million in total debt thereby representing a debt-to-equity ratio of 0.04. The company also had not noted any goodwill nor intangible assets. Skechers had a book value of $1.59 million.

Cash flow

In fiscal year 2015, Skechers grew its cash flow from operations by 41.7% to $232.2 million. One contributor to this growth was observed in its profits - 67%. Further, provision for bad debts and returns grew negative 46.9%.

In contrast, payables and accrued expenses grew 128% while capital expenditures grew 107.6%. Still, Skechers had a free cash flow of $114 million. Further, the company reduced its debt by $34.4 million.

Valuation

Skechers currently trades at a discount (14 times) compared to the S&P 500 (25 times) compared to earnings. Also, the company is slightly cheaper in terms of book value. According to GuruFocus data, Skechers has a price-to-book value of 2.54 times while the S&P 500 has 2.89 times. Also, Skechers currently has the lower price-to-earnings ratio compared to its three-year average of 26.6 times and 10-year average of 27 times.

Conclusion

Skechers USA definitely experienced an unjustifiable selling on Friday. Looking at the company's business operations, there is no doubt that the company would survive even the toughest times. The company has been run by an exemplary management, too. Greenberg, for example, has been with the company since 1993. Discounting the nonexistence of dividends and share buybacks with focus on growing its business makes this company a growth company rather than a traditional value company.

Disclosure: I may initiate a position in Skechers USA in the next 24 hours. I have no business relationship with any company whose stock is mentioned in this article.

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This article first appeared on GuruFocus.