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Tickers in this Article: CROX, SKX, TBL
Back in July, I wrote on Crocs (CROX), which is the seller of the wildly popular resin-based footwear. The focus of that piece, which can be viewed here, was on whether this product was a fad or a sustainable venture. I concluded that this is likely a fad but that the company and its shares would likely see strong growth in the short-term as it was still in the early stages of its popularity growth.

Since I last touched on the company, its shares have risen nearly 50% as investors have bought into the Crocs story. And it has been a great story so far, with revenues and earnings increasing in the first half or 2006 by 255% and 320% respectively, when compared to the same period in 2005.

And with the company just wrapping up its third quarter, which has been the strongest yet, it is likely to show similar if not better growth rates in Q3.

But for those concerned with Crocs being nothing more than a fad (a group which includes me), realize that Crocs is on the case. Earlier this month, the company signed a licensing deal with Disney, which will allow Crocs to use Disney characters on its products, which will be called Disney by Crocs.

These are expected to be out before the holiday season and could help drive Q4 sales, which have historically been the weakest. This is the second major licensing deal following the company's deal with 80 major colleges to sell college-branded Crocs.

And if you think this is just a one trick pony, think again, Crocs has expanded to over 20 models, including the popular flip-flops. Another attractive thing about Crocs is its distribution network, which gives the company the ability to move their merchandise through 14,000 locales in 60 countries.

But it is the valuation of the company that cautions me the most, as Crocs, in my estimation, appears to be setting up a clear growth trap. Currently, Crocs has a valuation of $1.4 billion, which puts it between Skechers USA (SKX) and Timberland (TBL), in terms of market capitalization. Crocs, with its current valuation, is trading at 4.7x 2006 sales estimates. Skechers is trading at 0.98x 2006 sales estimates while Timberland trades at 1.17x.

The concern here is that one would expect that the price to sales figure will come back into line with the industry. For this to happen, Crocs will have to grow its revenue to around $1-1.5 billion per year. This would be a ton of Crocs, as their products sell between $20 and $50 (down from $20 to $60 in 2005). Assuming that all products are sold at $50, the company would need to sell 20 million Crocs per year to generate $1 billion in sales. But to be fair, there are other products coming online, which could help limit their reliance on footwear.

Consensus estimates put revenue for this year at just over $300 million and peg 2007 revenue at $390 million, even though the 2006 revenue amount represents a 200% increase over 2005 revenue. This is an indication that 2006 was a clear break-out year for the company's products, but a similar trend should not be assumed looking forward. The consensus 2007 estimate places revenue growth at 30% and if we assume this as the long-term growth rate, it won't be until 2011 that Crocs breaks $1 billion in sales.


So it is clear that investors are paying a lot right now for the company's future growth. Looking at some other valuation metrics, Crocs is trading at 23x 2007 EPS estimates and sports a peg ratio of 1.22, both of which aren't as scary as its P/S figure. The company also has healthy margins – 26% operating and 16% profit – which may justify a higher P/S figure.

Looking forward, I still expect Crocs to have a strong third quarter, producing large year-over-year gains, but it is the future that worries me. The question that all Crocs investors should ask themselves is whether or not they believe that the company will be able to generate $1 billion in revenue each year, which its valuation suggests it should. To do this the company will need to transform from a simple footwear company to an apparel brand, all while protecting its easily copied main product, which many feel is just a fad.

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