Skechers’ Stock Can Keep Running Higher

Benjamin Graham

Investors sometimes confuse a volatile stock for a volatile business. When a stock is up or down by 25% or more after nearly every earnings report, it’s only natural to assume the company’s cash flows are similarly volatile. Sometimes, though, a company’s stock will move dramatically based on sentiment, geopolitical issues, or other factors even if the underlying business is stable.

Skechers has delivered consistent growth over the past five years, but its stock continues to swing wildly based on concerns over its long-term growth and, more recently, the potential impact of tariffs. Despite these swings, the stock has outperformed since we made it a Long Idea (up 20% vs. S&P 500 up 9%). The company’s cash flows continue to grow, its valuation remains reasonable, and the stock remains a good pick for long-term investors. Skechers (SKX) is this week’s Long Idea. 

Steady Profit Growth

Skechers stock has been on a wild ride over the past five years. The stock gained 64% in 2015, fell 19% in 2016, gained 54% in 2017, and fell 40% in 2018. So far in 2019, the stock has rebounded and is back up 53%.

These swings create plenty of value opportunities for opportunistic investors. I first made Skechers a Long Idea on 4/20/2016. The stock quickly fell by 25% after its next earnings report, but it subsequently rebounded, and I closed the position on 3/21/18 for a 40% gain.

Two months after I closed my position, the stock fell by 30% – again on earnings – and I subsequently made the stock a Long Idea again. The position performed poorly in 2018, but the 53% gain so far in 2019 has it comfortably outperforming the market.  

Through all of these swings in the stock price, the fundamentals of the business have remained remarkably consistent. From 2015 to 2018, Skechers grew revenue by 14% compounded annually and after-tax operating profit (NOPAT) by 10% compounded annually. Trailing twelve months (TTM) revenue is up 8% year-over-year and TTM NOPAT is up 17%. Revenue and NOPAT have improved every year since 2012, as shown in Figure 1.

Manufacturing and Distribution Strategies Drive Growth

Since 2012, Skechers has dramatically expanded its international and company-branded retail (both brick-and-mortar and e-commerce) operations to reduce its reliance on the domestic and wholesale markets. The company recently opened its 3,000th store, more than triple its store count from five years ago. Meanwhile, the domestic wholesale segment has declined from 42% of sales in 2012 to 27% in 2018.

The shift to more retail and international sales provides Skechers with a number of key advantages:

It gives the company more control over the marketing and branding of its products because it owns the customer experience and can customize advertising for different geographic markets.

Retail has higher margins than wholesale because there’s not a third-party taking a cut. Gross margin for the retail segment in 2018 was 59% compared to 48% for the wholesale business.

It reduces the company’s reliance on major domestic wholesale distributors, which lowers the risk that issues at a single distributor will impact cash flows and gives the company more leverage in negotiations with distributors.

In addition to taking more control over the customer relationship, Skechers has diversified its supplier base in order to support its retail and international strategy. As Figure 2 shows, the percentage of its products produced by its top 5 suppliers declined from 63% in 2011 to just 42% in 2018. The percentage of sales to its top 5 customers declined from 18% to 11% over the same time, while its gross margin improved from 39% to 48%.

Diversifying its supplier base provides similar advantages to diversifying its customer base. Skechers has greater flexibility to adapt its production to changing trends, it’s not as vulnerable to disruptions to its supply chain if one or two suppliers has issues, and it has more leverage in negotiations.

I highlighted Skechers’ declining customer and supplier concentration as a key bullish point in my original thesis, and it continues to drive improvements that give me confidence it can continue to grow profits in the future.

Targeting an Underserved Demographic Provides Competitive Advantages

In addition to expanding its manufacturing and distribution capabilities, Skechers has fueled its growth in recent years by targeting a demographic often ignored in the athletic shoe industry: women.

Nike (NKE), by far the largest company in the athletic shoe market, earns less than 25% of its revenue from women’s products. Skechers, on the other hand, earns 54% of its revenue from women’s products (compared to 33% from men and 13% from kids).

The company has sponsored a number of prominent female athletes, such as professional golfer Brooke Henderson and Olympic distance runner Kara Goucher, to solidify its position as a go to source for women’s athletic footwear. UK fashion magazine Drapers has named Skechers the Women’s Footwear Brand of the Year in three out of the past five years.

Nike is beginning to make a concerted push into the women’s market, but its established branding may make that push more difficult. “It’s very hard for a company like Nike ... that’s very male, macho ... to make the turn” to focus more on women, Erich Joachimsthaler, CEO of branding agency Vivaldi, told CNBC.

Focused on Price and Quality

Skechers also differentiates itself from Nike by focusing on qualities such as price and comfort rather than trying to design the trendiest shoes.

Jens Jakob Andersen, a statistics teacher at Copenhagen Business School, recently undertook a systematic analysis of price and user rating for 391 different running shoes. His analysis delivered a striking result. Skechers’ shoes were both the cheapest – averaging just over $90/pair – and the highest rated. Figure 3 has details.