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Could Crocs Bite the Dust?


The shoe company faces possible extinction.

Did investors learn anything in 2008?

After the implosion of major financial institutions, I was under the impression that investors were aware of the outcome of rapidly rising asset prices -- particularly when those assets aren't worth anything at all. Apparently I was wrong.

Since the beginning of the year, Crocs (CROX) has skyrocketed 216%. That's a ridiculous return for even the hottest tech companies, let alone for a fading retail brand during a major recession.

This isn't the first time we've witnessed this kind of action at the shoe company. In 2007, the stock rose 240% to over $74 per share from January through October as investors created one of the largest fad investment plays of the year out of the company. Crocs was wildly overvalued but at least the company was churning out massive revenue growth. Today, sales are falling, the bottom line is inked in red and the Crocs brand has been, for the most part, ruined.

While the company was able to produce extraordinary growth in the beginning, the growth was severely mismanaged by an inexperienced management team that fell into the typical start-up growth firm trap: overexpansion.

The product was available everywhere and distribution control was abysmal. Management got caught up in the rush of sales and built inventory with a mindset that demand would continue at exponential rates. Even in 2008, inventory growth was outpacing sales by far. It seemed as if management tuned out the economic environment.

And apparently they did. CEO John Duerden recently admitted the company's miscalculation of demand by writing in an email that "the industry was taken by the severity of the downturn. It affected us more than most because the brand had been gearing up for a continuation of the extraordinary growth in the prior year."

The company is now priding itself in quarterly results for working through the excess inventory, but it's taking drastic steps to do so. In 2006, Crocs' gross margin was 56%. By the end of 2008, it fell to 32%. In the most recent quarter, the gross margin stood at 36%.

In other words, consumers are picking up Crocs far cheaper today than they were several years ago. The markdowns have been devastating to the bottom half of Crocs' income statement, but the good news is that the bargain prices have given loyal consumers a last chance to scoop up their favorite models before the company folds.

I've come to realize that die-hard Crocs fans will fight till the end to defend this stock. However, I honestly don't think Crocs stands a chance to survive. While the $3.92 price tag for a share of stock seems cheap in comparison to Crocs' historical prices, it's expensive for a company that may be worth nothing in the next few months.

Not only is this one-trick-pony company attempting to restructure and rebuild a brand in the worst recession in decades, it may be soon out of a credit line. Crocs managed to extend its credit facility with Union Bank of California a few months ago and it has until September 30 to repay its debt. The company's balance sheet had enough cash last quarter to fulfill the obligation, but this would severely hurt the firm. If the company continues burning through cash like it has in the past, its life without credit will be short-lived.

Browsing through the financials of Timberland (TBL), Sketchers (SKX), and Steve Madden (SHOO), it's quite evident the shoe industry doesn't look too enticing these days. (Though I do like Deckers (DECK) for its impressive track record of managing its brand portfolio.) But the problems at these companies pale in comparison to the issues Crocs faces right now.

The company reports second-quarter results this week. And while just about anything close to good news will get investors giddy about the stock, any gains are like to be temporary.

Investors buying into the euphoria might just wind up looking like... well, looking like they're wearing Crocs.
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No positions in stocks mentioned.
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