Skechers' Toning Footwear A Fraud?

By Matt Cavallaro | October 05, 2011 AAA

On September 28, Reebok International Ltd. settled a lawsuit with the Federal Trade Commission for failure to provide adequate research supporting claims that EasyTone and RunTone shoes, help wearers firm up. It will be Skechers USA, Inc. (NYSE:SKX) that will suffer the most, however, as consumers increasingly question if toning footwear actually works.

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Small Fine, Big Implications
Reebok got off lightly. The imposed $25 million fine nowhere near approaches how much money this billion-dollar industry has generated. To be clear, the settlement is not an admission by Reebok that their toning footwear doesn't offer benefits. The U.S. government says Reebok, which is a subsidiary of German sports apparel company Adidas AG, failed to produce enough legitimate scientific evidence to support their claims that the footwear helps tone legs 11% more and buttocks 28% more, compared with regular sneakers.

It seems obvious that determining the exact muscle toning percentage that any exercise provides is an inexact science; however, that's not what's at stake here. In fact, the fine itself is really a drop in the bucket compared with the size of the toning footwear industry. What investors should take away from the settlement, however, is that marketing practices will have to change. Moreover, existing skepticism as to how much these products really do for users will definitely be enhanced by the ruling. Consumers on the fence now have greater cause not to make that purchase.

Additionally, an even bigger fine could be on the horizon for Skechers, who is the biggest player in the toning footwear arena. The Federal Trade Commission has been in contact with Skechers about making similar unsubstantiated claims. Even before troubles arose with the FTC, The American Council on Exercise raised concerns about claims made by Skechers. More importantly, the damage done to the Shape-up brand will play out significantly in sales. The FTC estimates muscle toning shoe sales grew from $145 million in 2009 to over $1 billion last year. Expect that number to plummet this year, particularly with Skechers now in the government's spotlight. (For related reading, see History Of The U.S. Federal Trade Commission.)

Skechers' Rise and Fall?
NIKE, Inc.
(NYSE:NKE) is, by far, the frontrunner in athletic footwear. Skechers used the Shape-up brand to climb the ladder and become number two in the industry. Skechers Fitness Group President, Leonard Armato, credits a 15-second spot during the Super Bowl, featuring Hall of Fame quarterback Joe Montana, for jumpstarting Skechers meteoric climb. Thanks to a surge in Shape-up sales, the stock surged to an all-time high near $44 per share in June 2010.

Skechers has been in free fall since then. With low cost competitors flooding the market this year, Skechers' margins have been under pressure amid heavy inventory buildup. Skechers was forced to sell excess inventory last quarter at a big discount. As a result, revenues plunged 14% and Skechers suffered a $30 million loss (compared with a profit of $40 million gain last year during the same period). The stock is now trading near the lowest level of the year.

The Bottom Line
Skechers' 13% decline over the past month stands out because footwear has performed relatively well. There looks to be more downside momentum for Skechers and headline risk relating to a possible fine and potentially damaging lawsuit, is enough to recommend avoiding this stock. If the toning footwear industry collapses, Skechers will have to reorient quickly and run uphill back into the very competitive casual footwear arena, where competitors like Crocs, Inc. (Nasdaq:CROX) and Wolverine World Wide, Inc. (NYSE:WWW), have been solidifying their positions. (For more on the S&P 500, see How Is The Value Of The S&P 500 Calculated?)

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