- Signal from Noise
By Vito J. Racanelli – China tariffs a worry but SKX’s low price and comfort brands have proven value – SKX expanding internationally; shares cheap vs peers, could rise up to 50% – Stock very volatile; quick 20% moves not rare—but playable. Be nimble Volatility in a stock is something many investors try to avoid. We all like to sleep at night. However, there are uncommon volatile stocks of companies with generally predictable businesses. One is Skechers U.S.A. (SKX), a $5.6 billion market cap maker of casual and performance footwear. Its shares appear to be a potential opportunity. Though dwarfed by Nike (NKE), SKX is a global company with more than 3,000 outlets globally and a likely $5 billion in sales this year, with production facilities in China and Viet Nam. China is a rapidly growing part of the empire. You’re guessing the problem already, and I’ll get to that. Now what volatile stock is “predictable”? I’m being facetious, but only a little. SKX has shown some strong trading cyclicality. For example, at various points, the stock was down over 60% in 2016; then up 100% in 2017; down 50% in 2018, and up 85% this year. You get the picture. It’s volatile, but that is potentially tradeable for those who are nimble. Did I mention this is a volatile stock? In April of 2018 it fell 27% in one day. This year, after rising on a strong third quarter earnings report, the stock fell about 25% on trade concerns. SKX isn’t for the faint of heart. If you get the timing right, you can see big gains—but if you don’t but hold on long term you could still see good returns. Intestinal fortitude is necessary. Admittedly, it is still down from an all-time high of $53.43 in 2015. Let’s explore the issues. Lately, it’s been the U.S.-China trade tension. No surprise as SKX has factories there and sold almost 23 million pairs of shoes in China last year. And there’s been some insider selling, though this isn’t a particularly critical signal. Also the stronger dollar has hurt from time to time (as now), and domestically SKX’s growth was a “mere” 3.5% last year. Governance, too, is a minor irritant as two executives hold about two-thirds of the voting power. It’s minor because so far they’ve managed the company pretty well. (It also means SKX is unlikely to be taken over.) I like SKX for a number of reasons. Nike might sell “cooler” performance footwear, but SKX has been building a nice little brand focused on price and comfort, something most folks value highly. In the chart nearby, you can see Skechers’ strong finish in a survey by of over 130,000 online shoe reviews. The website is run by Jens Jakob Andersen, a former competitive runner and teacher in statistics at Copenhagen Business School. Skechers was the top-rated brand and number one in affordability, too. Not everyone wants or can afford Nike’s LeBron 17: $200. SKX shoes run one-fourth of that. It caters to an underserved demographic globally. As noted, SKX had a bang up second quarter, with sales up 11% to $1.3 billion, and net profit up 37% to $111 million, or $0.49 per share vs. $0.29. Same store sales rose 4.9%, 4.2% domestically and 6.7% internationally. Gross margins continue to inch up year after year, now 48%, which is impressive considering SKX has been expanding rapidly overseas. That’s where it will make hay over the next few years, trade tensions or not. International sales are now 56% of the total, up from 34% in 2014. Don’t get me wrong: The China issue is real. SKX sales rose 29% there last year. But SKX has factories in Viet Nam and has said that, while it wouldn’t be immediate, it could shift production if necessary. A complete breakdown of the U.S.-China trade talks—however unlikely—would be damaging, but the issues would be lapped in a year and the international growth would continue. According to New Constructs, an independent equity research outfit, investors “seem to be ignoring the company’s international growth and diversified manufacturing base, which insulates it from most tariff pressure.” New Constructs also points out that SKX is on trend in another way: women’s shoes. SKX earned 54% of revenue from women’s products versus less than 25% for NKE. The valuation is attractive too, with the stock trading at a big discount to rivals and to its own history. See nearby table. At about $35.92 SKX trades at a price/earnings (P/E) ratio of about 14 times analyst estimates of $2.50 next year, much lower than peers and its own median 17 times P/E. It has relatively low long-term debt of about $1 billion, mostly operating leases, and despite that sports a robust 16% return on equity. Additionally, Wall Street has been raising third quarter EPS expectations almost all year. There’s also an interesting seasonality factor apparently at work here. According to , the stock has shown a fairly consistent pattern in the December-February period, with a positive return about 75%-80% of the time over the past ten years and average rise of 6%-11%. The 2019 up phase could continue at least through February. At that point, an investor should revisit the situation as the seasonality deteriorates. Through all the swings, the business has been remarkably consistent, with 14% revenue growth compounded annually from 2015 to 2018. Says New Constructs: If the stock traded at parity to peers, it would be worth $56 a share, over 50% above the current price. I agree. Where could I be wrong: U.S.-China trade talks could fall apart and the tariff war escalate. That could put a crimp in sales growth for the next 12 months. Bottom Line: Footwear is a highly competitive global business, but SKX has proven its mettle and ability to expand profitably in the big markets rivals seem to ignore.