VALUE: After Hours (S07 E31): Crocs: Ugly Shoes, Beautiful Numbers

During their recent episode, Taylor, Carlisle, and Stephen Farrington discussed Crocs: Ugly Shoes, Beautiful Numbers. Here’s an excerpt from the episode:

When somebody is asking themselves, “Should I go with a knockoff or should I go with the name brand?” Well, if your name brand isn’t pursuing those aggressive margins, if your name brand is going for a reasonable price, there’s no reason to go for the knockoff. Chinese people love to go for the Chinese competitor. There’s this huge stickiness culturally in China. It’s like an old Buy American campaign, but it’s not even necessarily pushed so hard by the government.

There’s an old sociology political science paper that tracked after how many generations does an immigrant become indistinguishable from the native population? And for most immigrant groups, it was one generation. For most immigrant groups, if your kids grow up here and go to college, then they’re indistinguishable. The way they vote, the way they behave, you can’t tell the difference. For Chinese immigrants, it’s more than three generations. So, unless your great grandparents were building railroads in California, the cultural stickiness of the Chinese is just so powerful and so strong. So, every American company that goes to China has such enormous difficulty penetrating that market.

There’s Crocs with 30% year over year growth. Last quarter, they just flipped to 52% international, 48% US. There’s an enormous international growth story. They’re crushing it in Korea and they’re crushing it in Japan. It’s a combination of, they’re really good at social media marketing. They get the right influencers to wear their shoes and they don’t push the price. It’s 45 bucks for a pair of clogs. Why would you want the knockoff if the name brand is reasonable?

Jake: What is it about the Chinese culture that has a more stickiness?

Stephen: Oh, it’s central to it. French is a little bit similar, but the Chinese take it to a whole other level. The whole concept of the symbol for China, is that the line with a little circle in the middle, it stands for the Middle Kingdom. That’s the way of saying the center of the Earth. It’s just inherent within, this is the center of the universe, the sun revolves around China. It is, we are the best. If we are the best, why would you want to change anything about yourself if you’re already the best? So, it’s really foundational to the whole Chinese identity to be part of the Middle Kingdom, to be the best people on Earth.

My first 10 years of my career, I was a chef, and a car accident sent me back to college. It was a fantastic car accident, because I had a lot more to offer the world than a bearnaise sauce. I found myself working for a French chef in Honolulu. He would, [chuckles] at least twice a day, he would go through the kitchen and tell everybody, get everybody’s attention and say, “This is the best mustard. Do you know why this is the best mustard? Because it is French,” and then he would just leave the room. He would do that at least twice a day with a different ingredient. It was just that the ethnocentrism of it all. I always found it hilarious. But I think the Chinese–

Jake: Wasn’t French’s mustard American brand?

Stephen: No, no. He was talking about it was a whole grain stone ground Dijon. Yeah, anyway, but he would do that with a different ingredient at least three or four times a week. But Chinese take it to a whole different level. Just the Middle Kingdom, center of the Earth, it’s just so foundational to their identity and who they are that American brands, yeah, it’s very hard to penetrate there. But if you don’t push the price too hard and do the right social media marketing, there’s Crocs with 30% year over year growth in China.

Tobias: Can you work walk us through the Crocs opportunity?

Stephen: Yeah. So, let me take a step back and share a picture, because something amazing happened in the market last quarter. So, this graph is the spread between the realized move and the implied move. The normal outcome which has happened since the beginning of options trading is what happened to Nvidia last quarter. Last quarter, Nvidia’s implied volatility. So, if you are buying the options, you’re buying expensive options based on implied volatility, but the market expected Nvidia to move 9% on earnings. And then, when the earnings call came out, Nvidia only moved 4%. So, the realized was much less than the implied. That’s the normal state of affairs since options were invented for all of the history of options is how it’s been.

And last quarter for the first time ever that flipped. The average option, the realized volatility ended up being so much more than the implied. So, for example Crocs coming into last earnings. The implied volatility was 8% or 9% and the stock sold off from $101 to $75. So, the realized volatility was over 25%. And so, for the first time in the history of options, the people who buy options are on average making more money than the people who sell options. And that’s never happened before.

Maybe this is just a one off, maybe this will go back to mean reversion or maybe this is a new structural part of our market that these dips become so extreme when these sell offs become just absolutely crazy. That’s one aspect. And then, when I pull up the Crocs price chart– You can see that here. So, this last earnings call– Again, it was $101 and then just crashes down to $75. This was their highest revenue quarter ever. They absolutely crushed it. But there was enough in there for the algorithms not to like. So, there was a non-cash write down. There was a goodwill write down from their Hey Dude acquisition.

Three years ago, Crocs did a bad acquisition, and they overpaid and they spent $2.5 billion for a shoe brand called Hey Dude which is a Jimmy Buffett oriented– It’s a traditional shoe. It’s got several different kinds of fabric. Whereas Crocs, these resin injected molded shoes, they’ve got 60% gross margin on those things. When you switch to having four different kinds of materials that have to be stitched together, the margins go way down. And also, they are experts at social media marketing, but their social media marketing, I think they thought too highly of their expertise, because half of it I think is that Crocs fit the modern world much better than Hey Dude.

The Pajamafication of Society

I think I wrote about it in my Substack write up that there is a pajamafication of society that everybody’s walking around in their yoga pants and their clogs now. So, yes, Crocs are masters of social media marketing, but I think they accidentally had the right product for the time. And with the Hey Dude acquisition, they’re trying their social media marketing and it’s not getting the right traction.

But that bad acquisition was three years ago. And right now, the whole company together is being aggressively punished. And part of it those non-cash write downs. So, when you write down goodwill and generally accepted accounting principles, it shows up as negative income. And if you actually think that’s real income, even though no cash changed hands, you’d say that right now Crocs has a price to earnings of 8, even this is showing 20. But if you actually look at the operating cash flow, it’s trading at a price to earnings of four and a half. I mean this is just an incredibly cheap company that’s growing aggressively.

They also guided for a week next six months in the US, but everybody guided for a week next six months in the US, because the consumer is squeezed and there’s tariff uncertainty and there’s interest rate uncertainty. So, every consumer brand across the whole country is guiding for a week six months in the US, but then better after that. So, yeah, I think the selloff was overdone, and then on top of that these new world where the realized volatility is so extreme. I think the only strategy to overcome that is to know what you own, have a lot of small positions.

When a 40% dip or a 25% dip comes on earnings, and you know it’s a good company and you know what you own, then you can move quickly and grab on with both hands. That’s why my theme for the write up was the one that got away. Because I first found Crocs a couple years ago because of the insider behavior and I didn’t understand these stupid ugly clogs. I just didn’t get it. I was at my pediatric dentist taking the kids to the dentist for a cleaning, and there was an elementary school kid next to me for their family for the dental cleaning and they were wearing Crocs and they were all covered with the charms. They call them Jibbitz. I was like, “What’s the deal with Crocs?”

I said everybody in elementary school is wearing them, absolutely everybody. So, 25% of Crocs revenue is elementary school kids. What’s amazing about that is their feet grow. They need to have new replacements every couple years.

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VALUE: After Hours (S07 E31): Crocs: Ugly Shoes, Beautiful Numbers

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