Choice Equities' Mitchell Scott making the case that $CROX is not a fad (podcast #189)
Mitchell Scott, Founder and Portfolio Manager at Choice Equities Capital Management, joined the podcast to make the case that Crocs, Inc. (NASDAQ: CROX) is not a fad.
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Transcript begins below
Andrew Walker: Hi, Hello and welcome to the Yet Another Value Podcast. I'm your host, Andrew Walker. If you like this podcast, it would mean a lot if you could follow rate, subscribe, review it wherever you're watching or listening to it. With me today, I'm happy to have on for the first time Mitchell Scott. Mitchell is the founder and portfolio manager at Choice Equities. Mitchell, how's it going man?
Mitchell: It's going great, Andrew. Big fan of the show, so thanks so much for having me. Great to be here with you today.
Andrew: Hey, thanks for coming on. I'm excited to have you on because I've been bugging you to come on since we met in person almost a year ago now, and we finally got you on, and it's a really interesting one, but before we start talking about that, quick disclaimers to remind everyone that nothing on this podcast is financial advice, please do your own research, consult a financial advisor, all that jazz. Mitchell stock we're going to talk about today is Crox. The ticker is C-R-O-X.
I'm sure everyone is familiar with this. This is a really interesting one because everyone's got a view on it. We'll talk about the bear case later. Tons of insider buying recently, it's cheap, but yeah, I'm kind of starting to ramble to get ahead of myself, so I'll just toss it over to you. What is Crox and why are they so interesting right now?
Mitchell: Yeah, sure, so great to have the opportunity to talk about it. We try to buy quality companies cheaply and I think that's what we've got right here, so long story short, Crox is basically the most profitable shoe wear brand in North America, if not the globe of scale, and along with that, it actually trades at the cheapest valuation of its peers in the space, so there's a lot that goes in there. I've described it as the shoe people love to hate and I guess you can describe the stock as the stock people, investors love to hate on occasion, but I think a lot of people tend to think it's a fad.
I'm sure we'll go into that at some length, or at least I think we should, but we've come to a different view and I think that explains the valuation, but also explains the opportunity.
Andrew: Great, so let's just start real quickly. I guess the 3 things that are probably attractive about Crox are 1, the insider buying. The stock has sold off after earnings and you've got literally millions of dollars of insider buying, and you and I were actually responding on an email thread on an insider buy, and it would be like, one would be you and I replying, and then the next would be a new insider buy. It was kind of crazy, so but the other 2 things are growth and cheapness, so why don't we just start quickly with the growth story, so kind of how quickly is Crox growing, where are the growing, all that type of stuff.
Mitchell: Yeah, sure, so I think that's probably an underappreciated element of the story, and if this turns out to be a fantastic investment, it'll be because they really port ported their playbook that they've been very successful here with in North America abroad, and so where they are today, the sort of traditional North American clog is really a little bit less than 40% of total sales, so they bought Hey Dude, and we'll definitely have to spend a good bit of time talking about that, but that's about 24% of sales.
Independent of that, they've got a handful of other drivers that are very important to the story, so I think maybe 60% of the sales are US when you count, Hey Dude, but less than that, when you don't count Hey Dude, so you've got Amelia, Europe, middle East, Latin America, that's 15, 16% of the revenues, and you've got Asia Pacific, and that is about 15 to 16% as well, and so both of those regions are currently growing, 20s, 30s, and have been growing fairly steadily each year for each of the last 6 years.
Layer in that, a couple of other sort of product vectors, so they've got sandals, they've been really focused on for the last several years, but really are only just now starting to push that and really get traction with that, and then finally jibbitz and jibbitz are a real big piece of the profitability puzzle that I think some people tend to overlook.
Andrew: Can you just describe what a jibbit is because before I, I would've known it if I seen it, but for people who haven't seen it or don't know, can you describe what a jibbit is real quickly?
Mitchell: Yeah, sure, so it's this little charm, so all the Crox that you buy, they've got little holes on them, and then this is a little charm that you stick in a hole and so one of the really interesting ones they did was a KFC fried chicken, like a drumstick, and it actually just like a scratch and sniff, it actually smelled like chicken, so that one was a really good one for them, but Star Wars themes, movie themes, serial themes, sporting team themes, all kinds of just random little things that you find in pop culture, show up as jibbitz and people buy them and they put them on their shoe and they're actually very profitable.
It's sort of like fasten all selling a screw, it doesn't cost much, but it's pretty important and it's got a high gross margin on it.
Andrew: Two questions about jibbitz that are just popping into my mind, so again, these are the things, if you've got a cross, you think if they're classic clog, they've got the little holes in them, and they released one with Barbie, so they were Barbie thing Gibbs that went in the shoes. 2 questions on them. Is Crox the only one who can make Jibbitz? Or I'm guessing there have to be like a thousand people making knockoff jibbitz that go into these Crox shoes.
Mitchell: They're out there, they've done a fairly good job of policing this,
Andrew: They have it pa... I guess not patented, but trademarked where they can go on Amazon or wherever somebody would sell a knockoff jibbtz and be like, "Hey, you can't sell that thing."
Mitchell: Yes. Yeah.
Andrew: How do they have that patented? Because I could understand how you could not use Crox when you're marketing it, but if you were just like, look at this little big pin or something.
Mitchell: I think the enforcement of it, it can be difficult, but on the bright side it is, probably somebody selling just something for $5, so it's not a huge, huge market, but it is a good market for Crox. This sort of goes back to when they bought it, they actually bought it, I think in 2007. It was kind of an afterthought for a really long time. They spent $10 million on it and ultimately started paying a lot more attention to it in the last kind of 4 or 5 years, but yeah, counterfeiting there is a risk. It's something that they're pretty attentive to.
Andrew: It's also something I could see being really popular, so Crox is making a big direct to consumer push and I could see it being really popular, and really like kind of enforcing a moat where, hey, you get somebody on the Crox app or whatever, and then you're pushing new jibbitz to them all the time. You learn about their personality. Hey, this is a person who likes Star Wars. Asoka comes out this week, let's push some Star Wars branded jibbitz. Hey, this person bro bought Barbie. What's the next smash hit, I guess Barbie, everybody watched.
I haven't seen it yet, but I guess everybody watched Barbie, but you could see how you could push it and it could be a draw to get people into the app buying directly from them, which is going to be higher risk margin, forming that relationship forming like kind of a sticky thing. Almost razor razor bladers. Second question on jibbitz. I don't have kids yet, but do people, when they wear them, are they changing them in and out every day? Like, "I'm going to the Barbie movie today, let me put a Barbie in." "Tomorrow, I'm going to Star Wars, let me put some Star Wars in."
Or do they kind of wear the same one for a month, 2, 3, 4 at a time?
Mitchell: It's kind of personal preference and it's all over the map, so some kids change them out more often than others and others don't, so it really just kind of personal preference.
Andrew: I'm so lazy. I feel like I'd say to myself, "I'm going to do it every day." And then I'd never change at all. All right, so we talked about...
Mitchell: Well, but then you kind of go to school and you want to show off your new gymnast, so there's your sort of counter to that.
Andrew: Most of the people who are buying Crox, actually let's save that for the bear case, so we've talked growth. You've got the Crox brand the Hey Dude brand growing nicely, domestically growing 20% plus internationally, so that's your growth. Let's talk valuation, and then I want to spend most of the time actually talking the bear thesis because that's really where the crux of the stock is, but we are talking today, mid-August, the stock is trading just under a hundred dollars per share. Can you talk to me about the bear thesis or sorry, the valuation for the stock?
Mitchell: Yeah, sure.
Andrew: My wife just walked in, so I got a little distracted.
Mitchell: Yeah, no, that's okay. Well, it was trading very cheaply, so the bear seemed to be in control at least of the stock at the moment, so I was trading at 8 times earnings, and what is it? 7 or 8 times IBITDA, 10% free cash-flow yield, so things that have runways for growth that are profitable companies tend to not trade at those kind of valuations, so there's obviously an argument here, so I can sort of kind of talk about a little bit more, what we see happening or we can jump into the bear case, but that's kind of where it's trading right now.
Andrew: Just on valuation, I would just throw in and you're welcome to add here, this will become growthy, retail and consumer goods brands generate a lot of cash-flow. Eventually this will become a capital allocation story. We'll talk the Hey Dude acquisition later that'll play into capital allocation, but I would just mention it's a 6 billion-ish market cap, and in July in their earnings release, they said, "Hey, we bought 50 million of stock in July."
You run rate that for a full year. That would be, we're buying 5% plus of the company every year. I'd throw that in.
Mitchell: Yeah, no, that's right, so and they've got a billion dollar authorization on the repo, so that's 15, 16% of the float outstanding, and they've bought aggressively 2 other times in history under basically the same board, so it's kind of in their DNA, they like to buy shares, especially when they think they represent value, and it goes back to me, probably the bear case, you kind of got to go all the way back and maybe we'll talk about, maybe we won't if you want to delve into it, but you got to go back to sort of the Blackstone investment, and when Andrew Reese came in as president and then ultimately became CEO.
One of the first things they did is they did the PIPE, the private investment public equity and then they used that and they bought a lot of the shares back, and shrank the float dramatically, so that was the first iteration of them with the big buyback, and then they've done that a couple of times since.
Andrew: Again, we'll talk Hey Dude in a second, but I do think it seems quite astute on capital allocation. You mentioned the prior buybacks. If you look at a chart of their share repurchases, I think you were probably the person who shared it with me, but when the stock's a 150, you see all the insiders selling, and then when the stock's a 100, you see all the insiders buying and you can see different variations of that trade over the past few years. Which it's really interesting when you've got a board that's owned some financial sophistication with their insider buys and sells.
They're buying back stock now. They're doing insider buys now, but I'm giving the bull case for you. Let's turn to the bear case because I think that's really the most interesting thing. Everybody can agree this is a nicely growing brand that's trading cheaply. I think the bears would push back on a lot of pieces of what we talked about. We can go any place, but I think the number 1 place to start would probably be a bear would say, Hey, this is a clear COVID beneficiary during COVID, everyone wanted to be comfortable. Are they in a better spot now than they were before COVID?
Sure, they've got a lot of more people who were exposed. It's a little more socially acceptable to where your Crox to school or whatever, but I think a bear would just come to you and say, hey, 2019, this was a 50% gross margin business today it's a 60% gross margin business. 2019, 2018 this is an 8 to 12% IBIT margin business this year. They're guiding to approaching 30% IBIT margins, and the bear would say, look, you fast forward this a year or 2, everybody who wants a crocs probably already has a pair of Croxs, this was a huge COVID beneficiary.
As those trends kind of unwind, you're looking at a business that is way over earning, their sales have exploded. I think this is coming back and you guys are talking 8 times this year's earnings. I'm looking out 2 years from now, and I think 2 years from now looks closer to 2019 than 2022, 2023, so how would you respond to that?
Mitchell: Sure, and I hate to sort of piggyback on the thing I said for the last question, but to me they are somewhat similar answers in that the company over the last 7 years has really become a much, much better company, and so a lot of this goes back to sort of the first things they did in kind of 2014, '16, they've got some good slides to it, but they took out 80 million of fixed costs. They shrunk the skew count by half, they shrunk the store count by third, and they had digital sales were like 10% of the mix, and so now they're 40,45 and and probably going to 50, 55.
Those are more profitable sales. To your point about the margins, so those major sort of elements in terms of the restructuring, making the company more efficient, more profitable, those things had all been done kind of like '14, '15, '16, but they didn't really have the sales falling down, and showing up on the income statement at high incremental margins the way that they wanted.
They were growing, but they were really only growing sales 7, 8, 9%, so there was a huge benefit particularly in '21, at the top line from pandemic goods spending, but good for them, they were put themselves in a position to capitalize on it and they did, but even independent of that, the whole body of work I think paints a picture of a management team that's become very adept at meeting their customer marketing and creative and clever ways, building sort of recurring demands of I think half the shoe purchases at some point, if you're not counting sort of new growth markets are probably some form of repair replace, so replenishment.
There's that element, and then we talked about jibbitz just a little bit, but jibbitz were basically an afterthought, and I think they're adding somewhere between five hundred basis points to the gross margin line that falls fairly neatly down to the IBIT line, so if you compare it to a company like Decker's, what you see is Decker's margins, the 2 companies margins tend to be on a similar profile, but then there's a separation there in 2020 with Crox and I think jibbitz to some degree, really drive that separation.
Andrew: Let me ask maybe a stupid question for somebody who follows the company, and maybe this is the equivalent saying, hey, Nike makes shoes and sells Air Jordans for $200, why can't I buy the Chinese knockoff Air... what would a Chinese knockoff of Air Jordan be? Air Judeans or something? I don't know. Replacing the O with the U, but why can't you just buy the cheaper knockoff brand or something? Because I do remember it when the first 2008, 2009, the big spike happened and they had a lot of trouble with they were selling Crox in grocery stores and stuff, but you could find Crox knockoffs everywhere and replace them.
Why aren't there more like Crox knockoffs? Because it's not a our product to make or copy or anything.
Mitchell: Yeah, that's a great question. There certainly are some that are out there, but they do have some forms of protection and they're certainly going after people, where they're seeing these things pop up in size and scale, so I think about natives. For little kids, they look a lot like Crox, but that's part of the deal. You see that time and time again, so it's up to the company to be vigilant about that. Do the very best they can to minimize those sales, to go after people and enforce that where they can, so they've got the the resources to do that and they're doing that, so that's up to them and it's something you always think about, but it's not something that's not on their radar.
Andrew: Air Jordans, I was replacing the O with a U, but I think maybe it would be Jardans[?], but neither here nor there, so a lot of people would say COVID beneficiary, and I do wonder Peloton was huge COVID beneficiary. Everyone was buying a bike in 2020 and early 2020, that fell off. Is there something to hey Crox, yes, they grew like crazy in 2020, 2021, but as you said, a lot of the repurchases are replacements. 2022, they still grew, 2023, they're still growing. Is there something to, hey, they're growing through it, they've kind of proven out that they weren't just only a COVID beneficiary.
Or would the wall be like 6 months away, or something if they were going to run into a wall?
Mitchell: That's a great question, and I talk about this with other investors as well. You would've thought they would have run into the wall by now, so 2020, 2021, 2022, 2023, so 3 comps in a row, they've continued to grow here in North America on kind of the core products, so even just doing some channel checks recently, the feedback was the same, which is they continued to grow the core product, which is pretty astounding, so there is some repair, replace, there are some kids, they get older shoes wear out, but they've done a really good job maintaining relevance and interest with their customer.
Then in addition to that, they've got new kind of silhouettes. They've got sandals, just kind of all these little collaborations, the way they sort of market the stuff, so Barbie's a decent example, it was a limited run. It was really only available for 2 days and that was intentional. They wanted limited distribution to capture sort of the imagination and the mind share of their customers, and not everybody could get them, and that was intentional, so they kind of do that to perpetuate the brand and the sales.
Andrew: There was a really interesting quote in their last earnings call where somebody was saying, "Hey, you guys basically discount once a quarter, you let your retailers discount once a quarter. Aren't you training your customers to wait for a discount and then buy the shoe?" And they said, "We don't see that in the numbers." And I think that's kind of silly because Apple discounts only on Black Friday or whatever. A lot of people do wait for Apple, but Apple's doing just fine with people waiting for Apple Black Friday, but Crox said, "Hey, we don't see it in the numbers, and even more than that we train our customers."
As you said, when we do a Barbie drop 2 days and then it's gone. When we do a seasonal drop, when we do some colors drop, you need to buy it then or else it's not going to be there, so you can't wait for a sale. I just thought that was really interesting, and a lot of times that is the sign of real brand power. Customers don't wait for the discount because it speaks to them and they really want it. I'll let you comment there and then I've got plenty more questions.
Mitchell: Yeah, no, that's exactly right, and look, it's the number one thing I think about too. That's the brand and so it's very difficult to build a brand. Some of these things are sometimes almost historical accidents, but this brand like if you and me and ten other people sat in a lab back in 2004 and we wanted to create the most and comfortable shoe and profitable shoe, I don't think in a million years we would've come up with this exact little iteration, but they did 20 years ago, and then it sort of found its way into the culture.
People got really comfortable with it because it is comfortable shoe, but now there's 20 years of people. They've sold a billion pairs of these things. That's a lot.
Andrew: Have you heard the idiocracy story?
Mitchell: No.
Andrew: Oh, what sort of Crox investor are you, if you haven't heard the idiocracy story? So idiocracy is this comedy, which is quite funny. It's about what happens if some average joke gets frozen, he for like 5,000 years and he wakes up and the country's just the dumbest country in history. Like everyone has got an IQ of thirty, so he's the smartest man on the planet anyway, so that's what everyone is and at the time that idiocracy guy was filming, they had a very small budget and he said, "I need shoes that are really stupid." And he went looking and he found this startup brand and he was like, "These are the ugliest, stupidest shoes I've ever seen."
He had all the actors wear Crox all the time when he filmed them, and between filming and releasing, Crox blew up and it was the first wave of Crox, so it is like, nobody's going to get the joke that these are the stupidest issues on earth, or people are going to think I intentionally chose these, but I was just trying to get something really ugly, so I thought that was so funny.
Mitchell: That is so funny.
Andrew: Switching, so I think the typical customer these days is quite young. Like teenager is my imagination. How much of sales are going to teenagers for the core Crox brand?
Mitchell: Probably in the neighborhood of thirty to fifty, so I think that's where they started out. Over the years what you've seen is it's become a little bit more widespread, and then there's a bolus of people that bought, 10, 12 years ago that are continuing to buy, so so the sort of distribution of the customer set has, has broadened.
Andrew: Here's my worry, it's popular with teenagers today, but teenagers are fickle. Like Abercrombie and Fitch is popular in the nineties for 3 or 4 years, but then your teenagers become young 20s and the teenagers behind them say, "Oh, I don't want the Abercrombie and Fitch because that's my older brother, or that's for the olds. I get something new." And I worry this wave is not so much COVID beneficiary as it is like this wave of teens, and the next wave of teens aren't coming, so I guess the question I'm asking is how much of this is fashion risk or age out risk?
Mitchell: Very much. I mean, it is definitely the bear case, and it is front of mind for everybody, so a couple of things I'll say about that. A, I think we're all looking at this. I think management's also very attuned to this. B, they've been working to broaden their portfolio because of this for a long time, so so they've done that, so now let's say 30% or whatever, so within sort of the Crox mix, some of these are used as garden shoes, some of them are used as house shoes, and then some of them certainly are worn more stylistically, and so what I would say is of that sort of 30 to 50% of the mix.
Maybe half of that is the fashion risk, so now you're down to 15% and then that 15% is really what? 40% of the whole company sales, so you're getting into sort of 10% of the top line that's sort of at risk, and and that sort of framework, so it's a risk, but again, they're thinking about it, they're doing what they can to continue to stay relevant.
Andrew: Yeah, and I guess one of the bets you're making is, I can just think of in the past few years, there was the healy shoes. I guess those might've been a little younger than teenagers, but the healy shoes were selling off the charts for two years and then those went away. Sketchers had the Kim Kardashian shape up Skechers and you can see these in the stock charts too. Like the Sketchers go up like this or they have the shape ups and then they've got the really comfortable shoes for I think a little bit older people that Joe Montana was pitching, and they go like this, and I guess the bet bears might think, hey this is... some people think it's COVID or some people think, "Hey, it's just like Kim Kardashian Skechers over again."
The bet you're making is this is a real brand, and so far it is sustaining does see it. Let's see, let's go to the other, so late 2021 Crox on fire. The business is growing like crazy. They've got the international growth story, they're pitching off tons of cash. They've got the jibbtz, all this sort of stuff, and then they buy Hey Dude, for a business that I don't think many people had heard of, I certainly hadn't heard of it. I remember at the time I had some friends who were bearish Crox. They look at this as you said it, I think your letter, they just went Crox buying Hey Dudes is going from fad to fad squared in a lot of people's eyes.
They pay a big multiple for it. It's a really growthy brand, and I think a lot of people looked at that skeptically, and this year, Hey Dude seems to, not that it's struggling because it is going to grow, but they cut out a lot of what they say are low margin sales. They're having some ERP integration issues, some inventory that, so I think a lot of people look at the Hey Dude and say, "Hey, is management skeptical of the Crox story by buying Hey Dude." And also "Hey, does this reflect strangely on Crox's capital allocation acumen?" So I guess I'll just pause there and toss it over to you on the Hey Dude front.
Mitchell: Yeah, so we'll definitely have to dive into Hey Dude, what's I guess most interesting about this is, and we didn't really get involved in the stock until sort of spring, summertime last year, so sort of post the Hey Dude massacre in the stock, and and there was a number of things just kind of pattern recognition you see in the market from time to time. Like sort of the top of the deal, top of the market, you add leverage, you do it in December. I think they've been out basically telling people they were probably unlikely to do any major deals a week or 2 before, and all sort of the recipes there to create a pretty meaningful decline in the stock.
Layer into that, the notion that there's a large set of investors out there that are looking at that, and very plainly seeing that as justification that management thinks the Crox brands best days are over, so all these things sort of dovetail together, and now sort of fast forward to today, to some degree what's happened is the bear case has kind of flip flop, so over the last 2, 3, 4 quarters, the Crox brands continued to outperform expectations here domestically, but also internationally, and Hey Dude, have very high expectations, they went from 200 to 500 to 900 to 1.1 billion in sales this year basically, but then all of a sudden now based on sort of some channel dynamics, which we can talk about.
Now it looks like they're down 3% in the coming quarter, so basically it appears if you're not willing to really dig in, and try to suss through the channel dynamics, it appears as though the brand was streaming hot and has come to a scorching halt, and so now the bear case is being driven by Hey Dude, and then to your point is calling into question, management acumen around capital allocation and their ability to do deals smartly, so we can dive into the finer points of each of those. I'll let you pick.
Andrew: No, that's great. I guess I just wonder like how do you think about the how... yeah, I'll just let you dive into like how do you think about the Hey Dude acquisition and Hey Dude, go forward, what the management's doing?
Mitchell: Sure, so it's another billion dollar shoe brand and there's really not that many of them, depends on sort of how you cut it, but there's ten or twelve in North America or something like that, and so now they own 2 of them, and nobody had heard of them. It's got a pretty interesting background. It's founded in Italy making shoes in China, selling them in America, and so then management paid 2 and a quarter billion dollars or fifteen times IBITDA, and so it's very easy to understand how in the very short IBITDA people wouldn't feel very good about that, so but what are they doing now?
There's certainly been some moving parts and maybe everything hasn't gone incredibly smoothly, and relative to forward expectations with the integration of the company, but they're putting sort of the, the Crox playbook into, into work here, and it's a pretty good playbook. It really revolves around being efficient, controlling distribution, managing the inventory in the channel, and then very savvy digital marketing. All their marketing's been is 100% digital and it's celebrities hyper-local influencers and these collaborations, and they've spent some money, they're moving Hey Dude into a distribution center in Las Vegas.
They've got some other things going on. There's some channel dynamics we should probably talk about that are... I don't want to say small picture, but they're the worry of the moment that, arguably in 6 or twelve or eighteen months, everybody will look at it and say, "Oh, well that was maybe not that big of a worry." And maybe create a pretty nice buy-in opportunity, but look bigger picture, it's 1.1 billion in sales that does a high twenties op margin that is similarly profitable to Croxs. The average owner of Hey Dudes owns 4 pairs, so they've got a...
Andrew: Who is the average owner of Hey Dudes,
Mitchell: basically everybody that's on the Dude Perfect channel, and we'll talk about that too, but probably starts in between 12 and 15 and skews it up and 40, 45, but I would say and primarily male, but within that I would say, the real sort of, meat of that curve is kind of the eighteen to 35 year old male.
Andrew: I texted you, I bought a pair of Hey Dudes this morning for due diligence. I got them on Amazon. Unfortunately they didn't come in time for me to hold them up in the screen, but I think the bear case is my wife got an email saying, "Hey, we you got something on Amazon." She just sent me a screenshot of the Hey Dudes, and she said, "Ew." And I said, "It's for podcast research and I need something to walk our dog in." And she just responded again. "Ew." That there is the bear case though. I've always thought there is something like Crox and Hey Dude, it is something that your typical wall Streeter would not wear, probably wouldn't be caught dead end.
I have always thought there's something to buying stuff that a typical wall Streeter doesn't understand, wouldn't buy that type of stuff and Crox and Hey Dude certainly fall into that category
Mitchell: Very much so there's a bit of a Peter Lynch leggings element at play here.
Andrew: Hey Dude, this just might be because I haven't seen it as much. I don't know why. I bought some on Amazon and we can talk about the Amazon gray market problems they had as well, but I bought my pair on Amazon for I think it was $35 on sale, and it looks like a fine shoe, it kind of looks like a knockoff boat shoe or something, but I do wonder with Hey Dude, even more than Crox, because Crox at least it's very visible, it had that big spike. Everybody can recognize a Crox. When I say Hey Dude, again, it might be because I just don't know it, but why don't they have a knockoff problem?
I could find a I think Hoka is very popular. They've got some shoes that look like this. Why don't they have a knockoff problem?
Mitchell: Yeah, so generally it kind of comes down to the brand. Is the brand powerful? And does it matter to people if they wear the knockoff or not? So certainly with Hey Dude, there are competitor shoes out there that look like them, and so that's a problem for everybody that competes in the shoe wear business. Nobody's got a stronghold on the whole entire shoe market, so there are competitors out there for sure.
Andrew: I could see some Chinese knockoffs that are Hey Dude, but Dude is Doode. I could see those getting real popular.
Mitchell: Hey Schmo. Yeah, no, it's certainly something to monitor, but there is a brand there, the average owner of Hey Dudes has 4 pairs of Hey Dudes.
Andrew: What do you need 4 pairs of hey Dudes for? Because they, they are kind of rubber and quick drying, aren't they? Is it just because you're going out into like muddy field so frequently you need them, or I guess style you need blue, black, gray.
Mitchell: It's more the style element. It's also the price point which allows that, so you got your shoes 40% off, but if they're 60 or 65, which is sort of the average ASP of the retail you can get 2 or 3 or 4. People are accessorizing their shoes these days, so sneaker heads, what have you, that sort of phenomenon is probably applying here, and is why people own more than more than one pair.
Andrew: Let's see, what else should we talk about? Yeah, I think we've hit a lot of the questions. I guess just when you look at this, like how do you think... again, it's tough to disprove a, hey, this is Skecher, sorry, this is Crox. They already had one hypergrowth cycle in kind of '07 to '09 that ended in tears when as we said, they were selling them out of gas stations and everyone had them and they were basically like, buy a pair for $5 and took a long time to remove from that. How do you think bearers ultimately kind of... I hate to use the term get defeated, but how do you ever climb that wall of worry that this is always one quarter away from a huge rollover inventory starting to pile up, huge discounting, turns out to be a fad.
Mitchell: Yeah, that's part of what's in the valuation here today for sure, but it's just time and execution really, and if they buy back 15% of the float and continue to post double digit top line growth, that's a tough thing to short.
Andrew: Look, I don't do a lot of shorting. I'm with you though. I hear the concerns over cyclicality inventory, all that sort of stuff, but it's also like, hey, it's 8 times price to earnings. It's growing and they're buying back shares. Like I can't we go short. What was the read that had all their income was coming from related parties. Like that seems probably better than an eight times, instant brand name recognition company that as we've mentioned, people are still buying them despite it seems like it should be easy knockoff material. People are still buying them, they haven't had that issue.
Mitchell: Yeah, that's what I would say, so don't want to move off of Hey Dude just yet, so a couple of things to think about, so the brand is young, most of all these sales, they've sold about a hundred pairs of shoes so far, but if you look back to the beginning 2022, they had basically nil presence in California, which California's a pretty big state and it's on the coast. Roughly the GDP of France, so they have no sales in California in a market that arguably would be a good fit for them.
Even now to this day, the 5 people I talk to in California regularly, none of them still heard of Hey Dude, so there's an opportunity there. Another element is some of the marketing that they're doing, they're just now kind of putting into place kind of some of the Crox marketing muscle, so they've got some SEC football stuff coming, my understanding is maybe there's some name image and likeness deals with some athletes.
Andrew: Great market for a brand that kind of looks like a boating shoe and his everyday lifestyle brand. Absolutely. You went to Clemson, if I remember correctly.
Mitchell: Yeah, I did. Hopefully we can get them linked up with the folks at Clemson too. That would be great.
Andrew: That's what you need. Like Davo Sweeney wearing a pair of Hey Dudes on the sidelines, that's what you can need.
Mitchell: Yeah, so it's a marketing agent. It's a marketing company, so if they have marketing muscle, and a good product they can continue to drive. Nike calls it demand creation expense for a reason, so just last week they announced this partnership with Dude Perfect, and so that to me seems like something that people are not talking about that might actually be a real needle mover for the Hey Dude brand, and so I spent kind of the weekend reading about Dude Perfect and they're awesome. I watch them with my kid, and they're super entertaining and not offensive, and generally fun loving people.
Good brand ambassadors, but I had no idea how big their reach was, so they have a hundred million subscribers across all of sort of digital social media channels, 60 million on YouTube, and even more surprising to me than that was half of that 60 million on YouTube is international, so ever since Hey Dude showed up under the Crox umbrella, I've been wondering kind of asking around, people have been thinking like what sort of international legs does this have for Hey Dude, and that's actually a pretty decent lens in a way to look at the market.
There's arguably thirty million people. I'm not saying it's one for one, but even if you just get half of them, that's fifty million people that are not thinking about buying Hey Dudes that the sale side not thinking Hey Dudes.
Andrew: I do hear you, but who is it? Nas X did a collaboration with Crox, and I'm sure Nas X has like a hundred million Twitter followers or people who listen to it, and while I do hear you, I also wouldn't be like, "Oh, fifty million of them are international, so twenty five million of them." I hear you on the brand but it is tough to create like Dude Perfect YouTube followers to how much, but I certainly hear where you're going. Let me actually switch to something different, so all acquisitions.
There needs to be a reason for you to be the best acquirer, and I think one of the reasons people saw Crox buying Hey Dude for a high multiple is they hadn't seen it before. It was a pretty eye popping multiple for a very growthy brand, but I think people also saw, hey Crox, like you've got this growth business, you're that you can execute yourself. People were worried, hey, are you just trying to diversify out of a fad, but I think the other is why is Croc the best buyer and owner of Hey Dude.
It sounds to me like you think Crox almost has a mini process where probably not just with Hey Dude, they could go buy 2 or three more growth brands than a probably the Crox playbook, so more DTC, more marketing, getting direct apps, getting these partnerships going. Sounds like you think this could be almost a mini shoe brand conglomerate, if I'm saying that correctly.
Mitchell: Yeah, I'm not necessarily advocating for them to go buy another Hey Dude today, let's digest this one, but look, all the sort of critical pieces are there and yeah, I think that's what they were thinking when they bought it. My understanding is it was a PE auction of primarily financial sponsors and Crox was the only one they sort of weezled their way into the auction and they were the only strategic that that saw it, which is somewhat interesting, so you just think about the distribution channels, the marketing muscle, the know-how, and the brands do have some overlap.
I don't want to get too carried away with that, but there is some overlap there, and and there's some low price point. There's some commonalities where you can see that, hey, maybe this does make a little sense for them to be together rather than just any old shoe brand, but you got the distribution synergies, you've got the marketing synergies, and it looked like they paid fifteen times. Now it looks like they paid 8 times and leverage was 3 and a quarter and now it's 1.7, so they do levered very quickly because they've been able to generate a lot of cash.
Andrew: If I remember correctly, what they were saying at the time of the acquisition was, "Hey, I know it's a huge number on this year's earnings, but this is a brand that's growing 25, 30, 40% even before we put the CRX playbook and get any synergies off that you run this forward one year, you get some operating leverage, this multiple's going to look reasonable really quickly." What do you think the end game for Crox is, so 3, 5, 7, 10 years out, is this a public standalone company that maybe has gone and bought 1 or 2 more brands and they're just growing and everybody thinks of Crox in kind of the same way they think of a Deckers or something?
Or do you think a sale candidate to a bigger kind of consumer brand conglomerate? How do you think this ultimately plays out?
Mitchell: Yeah, and I've heard both, I've heard rumors around certainly enough imminent. I don't mean to suggest that, but like down the road, maybe it makes sense for them to get acquired. Maybe some of the sort of...
Andrew: Who do you think would be an acquirer? I don't think a Nike would be an acquirer or an Adidas like it's a strange fit to imagine.
Mitchell: Yeah, I don't know. You could see Nike. They're doing a similar thing with the Jordan brand. The sort of sneaker-heads and how many sneakers does the average sort of sneaker-head type buyer probably.
Andrew: I'm not a sneaker head, but my understanding, you see the people with closets full of sneakers.
Mitchell: Yeah, I know plenty of them and it's not like 7, it's like seventeen or twenty seven, so maybe there's some similarities there. Yeah, maybe Decker, I don't know, but if they continue to grow and reach a certain scale, at some point the buyer pool will start to window down, so I don't know, I'm thinking about it mostly from the perspective of this kind of 3 to 5 year window, and if they can do what they've set out to do and accomplish sort of the expectations they've set for themselves, that always worries me a little bit, like treat the management plan as the upside plan, but they've done a good job of hitting hitting their targets, and so those targets been passing pretty impressive earnings and cash flows.
Andrew: Yeah, I just wonder because I guess there is Skecher and Deckers which do have like Deckers they kind of incubated. I think they bought it for a song, but they kind of really grew the Hoka brand. Sketchers I don't think has anything other than Skechers at this point, but it is rare to have like a 1, it would be 2, but kind of like 1 overarching brand footwear brand thing. Actually, speaking of that, Nike is not just footwear, a lot of it is apparel and stuff. Is there a Crox apparel business down the road or something like that?
Mitchell: I don't know. I like the footwear business. I like the businesses they have, and footwear to me is a better business than apparel for a number of reasons. The margins and then kind of the replacement, it's a little bit less competitive and recently at least in these 2 cases, I think they've got pretty good brands there, just shirts are pretty tough.
Andrew: I'm imagining a Crox shirt with just holes all the way down it or something.
Mitchell: I can see that with some fried chicken jibbitz on it.
Andrew: I like that. I like that. Yeah. The KFC fried chicken, it's so genius because it happened 5 years ago and when I was researching it was the first thing that popped in into my mind, and I think they go for hundreds of dollars if you want to buy one of these.
Mitchell: Yeah, that's my understanding too. You got to buy one eBay for ridiculous prices.
Andrew: Yeah. Look on an acquisition, again, it's this one shoe brand and that is kind of an odd duck. Not that there aren't any out there. It is a little bit of an odd duck in the markets, but at the same time, if they keep growing like this, they're going to generate a lot of cash and all you need is a lot of cash and you can do really well for your shareholders, and on the acquisition front, I don't know if Tapestry or whatever it is, buying coach, I'm not sure I would've thought of that a few months ago, but there's always buyers for good brands that are growing and throwing off cash flow.
If you're someone else who sells through Crox's distribution channels, there are going to be a lot of synergies, and whether it's you buying Crox or them buying you, there are going to be synergies, reasons to combine that type of stuff.
Mitchell: Yeah, very much so. I think you're right. What you're seeing is sort of in responsibility, Baton, all these guys are trying to put more good brands under one umbrella so that they can continue to compete, and so that and sort of the digitization of these channels, I think makes the brands more valuable on a sort of a secular basis.
Andrew: Anything else we should be thinking about with Crox?
Mitchell: There's a lot to think about, we didn't really talk too much about the gray market for the Hey Dude stuff. I think that's somewhat of a...
Andrew: Let's talk, because look I got the Amazon piece prices pretty cheaply. I think I bought directly from Hey Dude, but I'm not sure. Let's talk about it because it was kind of critical to the strategy and why the business is kind of slowing down a lot this year. Let's just quickly address the Hey Dudes, how they shifted the wholesale channel and what the gray market is.
Mitchell: Yeah, that's right, so basically when they bought Hey Dude, I think hey Dude was using only one distributor. Those people that had access to Hey Dude were really excited to have access to hate, and then Crox bought them, and then Crox kind of came in and sort of puts the Crox playbook on that, and that is different than the Croxc playbook, so they de-emphasized some vendors and merchants, and sort of emphasized some other vendors and merchants. What that created was a dynamic.
There was a very large sort of sell them last year, and the kind of the wholesale channel, so that created a kind of a tough comp for them this year, which they're laughing and so a handful of extra pairs of shoes out there, but mostly what it did is the people that got sort of kicked out of the network, some of them are no longer allowed to sell online, etcetera. They were happy to have the Haiti relationship and then they're kind of ticked off that they don't have the Haiti relationship.
Basically they're dumping them all on Amazon for whatever they think they can get for them, so Crox said that they've been putting a stop to that basically over the course of the last 2, 3, 4 months, so my sense is that we're starting to see the end of that. There's still maybe a handful of sort of extra shoes out there at some retail channels, but in the context of a business that, online is continuing to grow mid 30s very healthily, so there's plenty here to suggest that this is kind of a small sort of channel lapping issue, and less endemic of a brand that's not as sought after as maybe they thought.
Andrew: The nice thing is if your brand's growing 10, 20, 30% online, you eat up all that extra excess inventory real quickly.
Mitchell: Yourself. Yeah, exactly, and so part of the multi-channel offering too is you can adjust and position it, where it can be best suited, so and again, very underpenetrated in California and some of the other coastal states, and internationally as well, so nobody's even really thinking about international sales, so that's kind of the gray market issue.
Andrew: Last one, and then I'll let you go, and look, I know you're not basing this on one quarter of an investment. I never base anything on one quarter, but it does just kind of strike me as interesting. Dick's Sporting Goods reported earnings this morning and their stock was down 25%. They had inventory buildup. I remember this was CVS a few years ago. They mentioned, "Hey, we're having a lot of trouble with theft." And the reason I really mentioned Dick's, I think they sell some Hey Dudes and Crox.
The reason I mentioned them is because last year Academy, I remember, because I've been watching Crox for a while, academy rolled out Hey Dude, and I specifically remember they said the hey Dude roll-out is the best roll-out that we've ever had. I think that was in the Q-2, 2022 earnings call if I remember correctly. That's from memory, so I could be wrong, but they said that, and I just wonder, when you see Dick's, Macy's, Warren this morning, it does seem like retailers are still kind of figuring out their inventory slowdown, all that sort of stuff.
Look, they reported earnings 2 weeks ago, so I hate to say are you worried about this year's earnings, but are you worried about this year's earnings, and kind of a inventory buildup or anything?
Mitchell: Yeah, sure. No, great point about academy sports, and then that was kind of the same feedback for most of the folks on the channel we spoke with. It's like this thing's hot and we really want it and can't get ahold of it. Yes, that is a pattern that we're seeing across retail, they tend to at least in recent years, all order exuberant together and then all order cautiously together, in unison, and so I think we're seeing a little bit of that here for the back half, paradoxically or in juxtaposition of that.
I think what we're seeing at least from the consumer is that people are spending a little bit more freely in the second half and back to school than they were for the first half, so that's probably a thing that can sort of sort itself out. As far as Hey Dude goes, I don't believe they're in Dick's actually right now. They did just sign an agreement for Footlocker for four hundred of their stores, so still sort of early days there, and again, yeah, I mean there's obviously concerns about the consumer, but I think there's enough sort of growth factors in here that management has embedded, that they can continue to drive sales.
Andrew: Perfect. I think we'll wrap it up there then. Look, this has been a super fascinating one. It's so funny because on one hand you can say, as we said at the start, insider buying 8 times earnings, buying back shares, growing quickly, and then on the other hand you can say this is a fad. We've already seen it once before 15 years ago where they're riding a growth wave and then it crashes and yeah, it's just a super fast one, but Mitchell Scott, Choice Equities tag the Twitter account.
Everybody can find him. Q-2 letter was excellent, sold out a Celsius a little too early though, but some of us missed the whole run, so but Q-2 letter was excellent. I really enjoyed it and I really enjoyed having you on for the first time and looking forward to the next one.
Mitchell: Awesome, Andrew, thanks so much for having me. A pleasure.
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