Skechers U.S.A., Inc. $SKX
My Investment Checklist
1. Is the company undervalued?
EV/EBIT: 11.44
EV/Sales: 1.13
Price/Book: 1.86
Skechers trades at a large discount to the market, while offering investors double digit growth potential. Furthermore the company has solid profitability metrics and recently implemented a new share repurchase program. Notwithstanding there are some near term concerns including; supply chain issues, increased labor costs, and Covid lockdowns hampering international expansion. Even still, $SKX appears on the surface to be trading well below intrinsic value.
2. Can I easily explain what the company does?
Yes, they are an international omni-channel retailer who sell footwear. They distribute primarily thru wholesale, but are expanding their direct-to-consumer business.
3. Does the cash flow statement line up with income statement?
Net income does not line up with their cashflow statement:
This is always cause for concern, however $SKX just booked a $346M tax benefit last quarter which more than explains the discrepancy.
Regarding capital allocation Skechers spent most of their cash on debt repayment, a build up on inventories, and capital expenditures. The increase in inventories of $454M (~45% YOY) is bothersome, although $325M of which was in transit at quarter end. The rest can be explained by sales growth, which was up 24.4% YOY compared to 2020. This is something to keep an eye on moving forward, as it could signal slowing demand.
4. Is the Balance Sheet Healthy?
Total Cash: $894M
Total Debt: $1.66B
Current Ratio: 2.33
Skechers holds very little debt relative to their market cap and pay next to nothing in interest expenses. Moreover over $1B of the outstanding debt comes from long term lease obligations, which IMO shouldn’t be counted as long term debt. For this reason, $SKX is effectively sitting on a net cash position. Put simply, Skechers has an excellent balance sheet.
5. How profitable is the business?
Gross Margins: 49.31%
Operating Margins: 9.52%
Net Margins: 11.8% (This is overstated)
It’s clear to see that $SKX is a highly profitable business, which reflects a strong brand and pricing power. Skechers’ net margins are inflated due to the tax benefit they received, but these numbers are more or less in line with their historical averages. Nevertheless, margins are expected to contract next year due to increased input costs. However the decrease in margin isn’t expected to be material, and management thinks they can hit 10-12% operating margins long term. All in all, I believe $SKX is an above average business.
6. What is the company’s growth potential?
9-yr Revenue CAGR: 14.58%
9-yr Operating Profit CAGR: 22.82%
9-yr FCF CAGR: 20.69%
These numbers are outstanding, especially when you consider only $124M was spent on acquisitions during the last 9 years. Although future growth expectations should be tempered. Management thinks they can hit $10B in sales by 2026, which works out to just shy of a 10% CAGR. In fairness the C-suite is likely giving a bull case here, but not an unreasonable one. $SKX still has plenty of room to grow internationally and direct-to-consumer only makes up ~29% of sales currently. If this trend persists, $SKX could grow their bottom line faster than their top line.
7. Is management rewarding shareholders?
Skechers does not offer a dividend, however they just implemented a 3 year $500M share repurchase program. On the other hand Skechers does issue a decent amount of stock based compensation, $60M in total for 2021.
With operating income expected to come in around $650M and $275M in capital expenditures next year, $SKX could start getting aggressive with buybacks. I don’t think it would be irrational to assume $200M returned to shareholders annually (net of SBC). This works out to a 3.3% total shareholder yield, which is excellent for a company growing at an above market rate.
8. How does the company stack up against their peers?
The closest competitor to Skechers is Under Armour, Inc. $UAA
$UAA EV/Sales: 1.28
EV/EBIT: 13.77
Operating Margins: 9.27
Under Armour is slightly more expensive than $SKX and has grown at roughly the same rate. Interestingly they implemented a $500M share repurchase program shortly after $SKX announced theirs. Although being a bigger market cap, shareholders are getting less bang for their buck. Additionally there has been extreme variability in Under Armour’s operating margins. Ranging from 11.5% in 2014, to 3% in 2018, and back to 9.27% last year. Which is why $SKX is the better risk adjusted bet.
9. What’s the counter argument?
The counter argument is that margins will come down near turn due to supply chain and labor costs. Furthermore demand may have been pulled forward in 2021 and future growth will be lackluster as a result.
I don’t dismiss any of these arguments, however I believe there’s a fair amount of pessimism already reflected in the share price. For example, $SKX has typically traded north of 15X EV/EBIT historically. Moreover all of these concerns appear to be temporary in nature and Skechers is a strong brand, which should be able to pass on costs to their customers.
Regarding demand, $SKX is listed as a consumer discretionary stock, but I would consider them more akin to a consumer staple. I mean honestly, you’re pretty much a psychopath if you don’t buy a new pair of sneakers every year. Finally, Skechers’ president just dropped a cool $3.8M on the open market to buy more shares:
10. Is there something I think the market may be missing?
Skechers is focused primarily on growing their international and direct-to-consumer segments, which I think is a savvy move. Both of the aforementioned categories are significantly more profitably than their domestic wholesale division:
Additionally $SKX is in a nice niche where they’re cheaper than Nike or Adidas, but still high enough quality where consumers are willing to pay a premium. This is why I believe $SKX will be able to achieve an improved margin profile moving forward.
Final Thoughts:
My base case would be EBIT growth of 9% annually, a 3% total shareholder yield, and a 16X EV/EBIT exit multiple in 5 years. This works out to a ~19% expected return, which is way higher than I thought it would be going into this writeup. Unfortunately the expected return isn’t high enough to qualify as one of my 10 best ideas, although it’s not far off. $SKX is expected to report earnings next week and if the stock tanks, I might seriously entertain taking a position (so long as the thesis remains unchanged).
***Disclosure: I have no position in the security mentioned above, nor do I have any plans to purchase within the next 72 hours. This article is intended for educational purposes only and in no way should be interpreted as investment advice