Last week, we covered Lululemon, a brand you all know well, celebrated for its quality and sleek designs.

Today’s company? Let’s just say its designs are far more polarizing. I’m talking about Crocs. But hear me out. If you liked Lululemon’s margin profile and returns on capital, then let me tell you, Crocs is right there.

And instead of paying a P/FCF of 15x for it, you can buy that margin and return profile for just 6x FCF. It sounds absolutely ridiculous, but that’s where we are.

Now, there’s no question about the strength of the Lululemon brand. Crocs, on the other hand, tells a different story. Much of today’s discussion will focus on whether Crocs can stay relevant as a brand and, as a result, keep its impressive financial performance. The latest quarter might already show signs that this is not the case…

Even more than with Lululemon, we need to really understand what makes this business work and why. If we can do that, we can decide whether these numbers are sustainable.

Let’s dig in!

— Daniel

Crocs: Ugly Fad or Successful Fashion?

The Rise and Fall (and Rise) of the Clog

Crocs have come a long way from their humble, and frankly polarizing, beginnings. The company was founded in 2002 by three friends, Scott Seamans, Lyndon Hanson, and George Boedecker Jr., none of whom had any background in shoes or fashion. Perhaps that’s exactly why they had the confidence to bring something so unconventional to market.

It started with a prototype from Canadian company Foam Creations, made of a proprietary resin called Croslite™ — a material that was ultralight, comfortable, and slip-resistant on wet surfaces. On a sailing trip, one of the founders pulled out a pair, pitched them to the others, and argued they could turn this odd-looking foam into a billion-dollar company. Admittedly, I don’t know if that was the actual sales pitch or ambition, but they definitely thought they had something!

They weren’t under any illusions about their beauty contest odds, and this wasn’t a group of desperate entrepreneurs betting everything on one last shot either. Scott and George were more or less retired already after successful careers. Duke Hanson, on the other hand, had recently lost his job selling computers and was crashing on yet another friend’s couch. That friend, Ron Snyder, was not yet involved in the business, but would soon play a pivotal role.

After Crocs sold out their first 200 pairs at the Fort Lauderdale Boat Show, the founders realized they had something special on their hands. The shoes caught on in comfort-driven niches like boating, gardening, healthcare, and hospitality fields, where function trumps form. Nurses became some of the brand’s most loyal customers.

By 2004, Crocs had sold over 600,000 pairs, without big ad campaigns, relying mostly on word of mouth. Snyder, impressed by the early traction, joined as a consultant and was named CEO quickly after. One of his first major moves was to acquire Foam Creations, giving Crocs full control over its core material and manufacturing process, a smart decision that protected margins and reduced copycats.

Momentum exploded. In Snyder’s first year as CEO, annual sales jumped from 600,000 pairs to over six million. The company went public in 2006 in what was then the largest footwear IPO ever. The stock quintupled within a year. But the rise was as dramatic as the fall. By 2008, the combination of the global financial crisis, overexpansion, and a glut of unsold inventory sent Crocs into a tailspin. Losses hit $185 million, hundreds of employees were laid off, and the stock plunged from $67 to just over $1.

For the better part of the next decade, Crocs survived on its utility appeal but faded from cultural relevance. Then, in 2013, private equity firm Blackstone stepped in, buying a 13% stake and installing seasoned footwear executive Andrew Rees as CEO. The turnaround plan was simple but aggressive: slash unprofitable product lines, close underperforming stores, and refocus on the core clog.

The big break came unexpectedly in 2016, when designer Christopher Kane built his entire London Fashion Week collection around Crocs, without the brand paying a dime. This brought a lot of media attention. Suddenly, Crocs weren’t just comfortable, they were fashionable.

Collaborations with celebrities, luxury brands, and viral social media campaigns followed, propelling Crocs into a second life that’s still running strong today. I said it to Shawn in our podcast on Crocs: I can’t help but find it amusing how people have such a strong opinion on clothing or shoes, but as soon as a designer uses them, all of that changes in a second.

Honestly, it’s part of why I generally hesitate to invest in the fashion industry. Almost by definition, brands have to become unpopular at some point. When they are too mainstream, they become boring, and people stop buying. First, people who are early adopters shape the next trend, then the “early majority” follows, until, slowly, the mainstream customer jumps in as well. That can go on for a while, and it’s impossible to know how long, but at some point it comes to an end.

Very few brands manage to escape this cycle. Most are in the luxury space, LVMH or Moncler, but there are some outsiders, like Nike. It’s in a tough spot right now, but it remains one of the rare non-luxury brands that has “survived” its journey into the mainstream — still making it onto kids’ Christmas lists for the shoes their favorite footballers or NBA players wear, onto their parents’ feet for a run, and onto the bodies of fitness enthusiasts heading to the gym. And just last week, we made the bet that Lululemon has become a household name as well.

And that’s the big question for Crocs…can they sustainably be a mainstream product, or are they bound to become irrelevant again? Today’s article will be about answering that question to the best of my abilities. So, let’s dig into the business.

A Business Breakdown of the Clocs Empire

For the longest time, Crocs has been dependent on its signature product. Now, you don’t have to study finance to know that being a one-trick pony comes with a lot of concentration risk. And Crocs did recognize that early on and tried to diversify. Before Blackstone changed the management team in 2013, Snyder tried to expand the product lines by selling rain boots, sandals, and even apparel. It didn’t work out that great, and it was one of the reasons why new management was set in place.

But the idea wasn’t wrong, and everybody knew that. Sooner or later, Crocs needed to diversify. And a couple of years later, after growing the main product and stabilizing the overall company, Crocs did start a second attempt at diversifying. The strategy is built on an “icon and expand” model.

Three-quarters of sales still come from the Classic Clog and its variations. Jibbitz — small, collectible decorations you can clip into the shoe’s ventilation holes — have become a vital part of the business. While that’s not really a new product, I would argue that they added to Crocs’ diversification. The same pair of Crocs can look completely different day by day just by adding these Jibbitz.

You might find them ugly, but they play into several long-term trends in fashion and beyond. The first one is customization. Fashion is the ultimate industry for uniqueness. As explained earlier, if everyone is wearing the same thing, it gets boring, and people want to differentiate themselves. Through Jibbitz, Crocs are more like a canvas.

That’s a big advantage for international expansion as well. North America still accounts for a little more than half of revenue, but the bigger growth story is overseas. China has quickly become Crocs’ second-largest market after the U.S., growing more than 60% last year. Western Europe is another bright spot, with strong gains in countries like France and Germany.

While the main strategy for international success is to expand by focusing on collaborations with regionally popular celebrities, the personalization through Jibbitz also helps. But it’s not just Jibbitz, the variety of Crocs’ product portfolio has also meaningfully increased. And it might just be me, but some of the models look like shoes high-end fashion brands would release. It’s not a coincidence that Yeezys have also dropped slippers.

And if you ask me, and that might be the most controversial take in this newsletter, I think some Crocs shoes look more like a fashion statement than the Yeezy Slippers…

The HEYDUDE Acquisition

Crocs are significantly more diversified than in the early days in terms of product range. However, it was still a one-brand company. That changed in 2022 when Crocs acquired HEYDUDE, a fast-growing slip-on shoe brand known for its ultra-lightweight, casual designs, for $2.5 billion.

The rationale was straightforward. HEYDUDE had gained popularity in the U.S., particularly in middle America, with a product that appealed to a different consumer segment than Crocs’ clogs. By adding it to the portfolio, Crocs aimed to diversify its revenue, reduce reliance on a single product line, and tap into a younger, lifestyle-oriented market.

But $2.5 billion was a huge price tag, and the integration has been far from smooth. Supply chain hiccups and a lack of clear brand identity slowed momentum. While direct-to-consumer sales have grown and average selling prices have risen for seven consecutive quarters, the overall brand has struggled to match the explosive growth Crocs envisioned at the time of the deal.

In fact, revenue has been declining quite dramatically in the last two years. A 13% drop in 2024 and a 10% drop in the first quarter of the year. And while we saw signs of stabilization in the second quarter, it’s undeniable that HEYDUDE has been a big drag on Crocs since the acquisition.

Financials and Capital Allocation

Alright, we discussed a lot of the qualitative factors. Let’s get to the quantitative side of things. And trust me, Crocs’ numbers are nothing less than impressive. I guess that’s why the stock was recommended to us so many times. It just screens incredibly well, considering the low valuation and the great margin and return profile.

Last week, we talked plenty about Lululemon’s superior margin profile. Well, Crocs is right there. Both companies have gross margins close to 60% and operating margins in the mid-20%. Once again, the difference between the two is that Lulu is delivering these results for a much longer time, while Crocs' operating margins were negative ten years ago.

And just for your information, we will still talk about the last quarter. It might have been the most important in a while…

But first, let’s keep focusing on the trend of the last few years. In the graph below, I added Nike and Adidas as comparables. What’s interesting is that Crocs had outstanding ROIC growth until the HEYDUDE acquisition in 2022. Still, mid-20% is very respectable, and if the turnaround of HEYDUDE should play out (and Crocs doesn’t lose momentum), we might see some improvement here.

The biggest outperformance compared to peers is in regard to FCF margins. Crocs delivers almost twice the FCF margin of Lulu and Nike, and even three times Adidas’s margin.

Two other important metrics for retailers like Crocs and Lululemon are the cash-to-sales ratio and the cash conversion cycle. While it wasn’t a dealbreaker for Lulu, there was a trend towards less and less cash on hand relative to its sales.

It’s a similar picture to Crocs. However, in both cases, buybacks play a role. Since 2023, the share count has declined by almost 10% and just in February of this year, Crocs added another billion dollars to its buyback program.

Considering the recent sharp drop, this will have an even larger impact than I initially expected. The currently outstanding $1.3 billion in buybacks represents almost 29%(!) of the company’s market cap.

The other pillar of capital allocation, and reason for the relatively “low” cash on hand, has been the debt paydown. In 2021 and 2022, mostly due to the HEYDUDE acquisition, Crocs issued about $3 billion in debt. However, they were very focused on paying it down as quickly as possible, cutting their debt in half since then.

Management is committed to a net leverage range of 1.0x to 1.5x, and they are right back in that range again. That’s why the buyback program was expanded.

So, the downward trend regarding cash on hand is less due to operational performance and more a matter of capital allocation.

Getting to the cash conversion cycle. This metric is a better descriptor of the operating business. It essentially shows how long it takes Crocs to convert products into cash.

Crocs’s cash conversion has shown some volatility historically, which is not unusual for a retail company, but it generally trends downward, indicating improving efficiency in converting products into cash — a key sign of disciplined working-capital management and tight control of inventories.

If you listened to our podcast, which was recorded a couple of weeks ago, you will hear us discuss a sharp spike in the LTM number (seen on the left chart). A small part of that spike has been due to Crocs building up inventory in anticipation of tariffs. More notably was an increase in accounts receivable. Management said that some wholesale partners took longer to pay, possibly because of liquidity pressures in retail and uncertainty surrounding the consumer.

At the same time, Crocs paid suppliers a bit earlier than usual in Q1. As you can see in the right chart, the trend is already going down again, so, as said, this doesn’t seem to be a long-term problem. One of the most important things when investing in retail is to make sure these trends do not worsen due to poor inventory management.

As we have seen, looking at Crocs and HEYDUDE’s past, and for that matter, pretty much every struggling retail brand, it almost always starts with lower inventory turnover, leading to rising inventories, followed by discounts, a decline in margins, and ultimately also brand equity.

The good news is that Crocs’ management is hyperaware of that, and Crocs’ inventory turnover is once again ahead of the competition. They currently turn inventory about four and a half times a year. Well ahead of Adidas, Lululemon, and Nike.

After all this positivity, though, we have to talk about the last quarter and the cracks it caused in Crocs’ image.

Is this the Beginning of the End?

When Shawn and I recorded the Crocs podcast, things looked pretty good for the company. I think Shawn was even a bit surprised I decided not to add Crocs to our Intrinsic Value Portfolio back then. As he told me, based on the numbers and valuation, I could’ve talked him into opening a position.

But he also knows about my general skepticism with retail. Without seeing multi-year retention data, the kind of data we’ve had for Lulu, I couldn’t get comfortable with Crocs at a $100 stock price.

It’s not uncommon to see fashion brands deliver outstanding sales, margins, and returns on investment at a time when the brand is very popular. If kids or teens want these shoes, their parents will pay $30, but also $50 or $60. Increasing sales, margins, and returns in those times isn’t that difficult. The difficult part is staying popular and delivering sustainable performance.

In its Q2 earnings release, there were the first signs that Crocs might be on the declining end of what has been a pretty good run. Don’t get me wrong, I’m the last person to overreact to a single quarter. However, this is less about the numbers and more about the qualitative aspects of the business.

The Q2 numbers were actually fine. A slight increase in sales, gross margin expansion, and the DTC part of the business outperformed the wholesale part. But as so often in recent weeks, the guidance was the problem.

In Crocs’ last earnings call, the management sounded pretty confident about their ability to manage tariffs. I mentioned that in the podcast as well. The greater was the surprise when the Q3 guidance came out…

Instead of growing or holding ground, Crocs expects a double-digit decline in revenue for the third quarter and a severe margin decline. And the worst is yet to come. The main factor for the decline does not seem to be that management underestimated the direct costs of tariffs. Instead, CEO Andrew Rees admitted that Crocs is also losing shelf space to athletic brands.

Now, we have to make a distinction here between the Crocs and the HEYDUDE brand. While both face headwinds, Crocs is “only” expected to decline in the mid single digits, while HEYDUDE will decline significantly more.

Indirectly, management is still blaming tariffs due to a more cautious consumer and retailers reducing their order books. However, it seems that other brands are not experiencing the same pressure. Birkenstock grew revenue in the double digits, improved margins on all fronts, and reinstated the full-year guidance.

And as Andrew Rees suggested, athletic brands seem to hold on better than expected as well. Nike recovered better than expected, and On’s growth isn’t significantly impacted either. It appears that Crocs has been hit harder than its competitors.

Valuation and Investment Decision

Based on the new guidance and the problems with the brand, I’ve updated my valuation model. Of course, the stock has also decreased 20% since the podcast episode, so, overall, the relationship between price and what the market expects of Crocs going forward is close to where it was a couple of weeks earlier.

I never look at how the fair value estimate changes while adjusting assumptions to prevent unconsciously adjusting until I get closer to the current price.

So it’s interesting that my updated assumptions still landed exactly where the current price is. I revised operating margins by 4% and revenue growth by 1%, due to slower growth in the Crocs, but especially in the HEYDUDE brand.

The question now is whether that is fair. If macroeconomic factors actually caused this Q3 guidance, Crocs will eventually return to its normalized margins from recent years and outperform these updated assumptions. That’s pretty much the bull case.

Should this be the start of a brand decline, Crocs will underperform these assumptions, especially the growth estimates, and end up like in my bear case, which gives a fair value of about $50. That might sound trivial, but it’s important to understand that a brand like Crocs, in its current state, is unlikely to just go sideways. 

Crocs is either growing by becoming more mainstream or declining by losing its mainstream customer base. As value investors, we first have to identify the downside. If you look at my bear case, you’ll see a 40% downside. I believe the actual downside is lower, though, since the reduction in price means that the authorized buyback program of $1.3 billion has an even larger impact (roughly 29% of market cap).

So, honestly, my problem is not so much with the downside but more with the upside. That might sound weird since my bull case shows much room for upside.

However, if you read our Remitly newsletter, you’ll know what type of companies we look for — high-quality compounders. When I look at Crocs, I see a company that could double if it manages to return to its old margin and growth profile, but I ask myself: And then? 

The weakness of HEYDUDE and the fact that, despite many different product lines, Crocs is still a one-product brand suggest that Crocs has problems diversifying the brand. But without a much larger product portfolio, this company is unlikely to become a high-quality, long-term compounder. 

I see Crocs as an attractive short-term play with relatively limited downside, mostly due to the buybacks, which I deem sustainable even with less good operational performance, but I’m not yet sold on the longevity of the brand.

This can change with more customer retention data or similar data points, and if it does, and it fits our Intrinsic Value Portfolio philosophy better, I’m happy to revisit Crocs!

For more on Crocs, you can listen to our podcast here, and check out my valuation model for the company here.

More portfolio updates below 👇

Weekly Update: The Intrinsic Value Portfolio

Notes

• Update on Nubank: Nubank released a very good set of results last week. Nubank continues to grow its customer base in the high teens, and revenue grew almost 30%, driven by a further increase in efficiency and growth in ARPAC (Average Revenue per Active Account).
  

  • The cost to serve per active customer is only $0.8, compared to $12.2 monthly ARPAC, and customers continue to spend more the longer they bank with Nubank.
    

  • Some interesting details: Nubank’s market share for credit card customers in Mexico has been 9%. However, it was responsible for 28% of all newly registered credit cards. The same trend exists for deposits, where Nubank holds a market share of 3%, but was responsible for 14% of all new deposits within the year.
    

  • The balance sheet remains a fortress, too. The capital ratio sits at 32%, three times the required level and about double the average U.S. bank.

Quote of the Day

"The stock market is filled with individuals who know the price of everything, but the value of nothing.”

— Philip Fisher

What Else We’re Into

📺 WATCH: Inside Aswath Damodaran’s Personal Portfolio

🎧 LISTEN: William Green and Robert Hagstrom discuss their learnings from Buffett, Munger, and Bill Miller

📖 READ: The Class Notes of Joel Greenblatt

You can also read our archive of past Intrinsic Value breakdowns, in case you’ve missed any, here — we’ve covered companies ranging from Alphabet to Airbnb, AutoZone, Nintendo, John Deere, Coupang, and more!

See you next time!

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