Skechers: Is it an overlooked company?

Skechers is a company that first caught my interest when I attended the Phil Town workshop years ago. It has been on my watchlist ever since. I believe this company is often overlooked because they have consistently delivered higher gross profit margins compared to a company like Nike. I decided that now was the time to take a fresh look at Skechers.

This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.

For full disclosure, I should mention that at the time of this writing, I do not own any shares in Skechers. If you want to see the shares I own or want to copy my portfolio, you can find instructions on how to do so here. While I don't own any shares in Skechers, I do own several pairs of Skechers shoes because I find them to be very comfortable. I also really like their values as they make significant efforts to reduce their use of plastic. Additionally, their "Bobs for dogs" campaign has saved the lives of more than 588.000 animals. Nonetheless, even though I like the company, the analysis will always be unbiased. If you want to purchase shares or fractional shares in Skechers, you can do so through eToro. eToro is a highly user-friendly platform that allows you to start your investment journey with as little as $50.

Skechers is a company that was founded in California, United States, in 1992. Skechers designs, develops, markets, and distributes footwear for men, women, and children worldwide. It is the third-largest athletic shoe brand globally. The company operates through wholesale and direct-to-consumer segments. The wholesale segment includes sales to a network of partners, such as Skechers-branded stores operated by third-party franchisees and licensees, family shoe stores, specialty athletic and sporting goods retailers, department stores, big box club stores, and distributors in select international markets. The wholesale segment contributed 56% of sales in 2023. The Direct-to-Consumer segment comprises sales by Skechers directly to consumers through a combination of channels, including company-owned Skechers-branded stores, company-owned e-commerce sites, and leading third-party marketplaces and digital platforms. The direct-to-consumer segment contributed 44% of sales in 2023. Skechers makes 38% of its revenue in the United States, while the remaining 62% is generated internationally. By the end of 2023, Skechers had 5.168 stores worldwide, with the majority being wholesale (approximately 3.500). Skechers are known for combining comfort and performance in their shoes, particularly renowned for their memory foam technology originally developed by NASA, which is what gives Skechers its brand moat.

The CEO of the company is Robert Greenberg, who also happens to be the founder of Skechers. He had previously founded L.A. Gear in 1978 and served as its CEO until he stepped down to establish Skechers. With over 40 years of experience in the industry, he also received the Lifetime Achievement Award from Footwear News in 2015. Under his leadership, Skechers was named Company of the Year twice in 2022 by both Footwear News and Footwear Plus. He has achieved remarkable results during his time at Skechers, transforming it from a small company in 1992 to an $8 billion global enterprise in 2024, selling its products worldwide. He believes in a very aggressive marketing philosophy called "Unseen, Untold, Unsold." This philosophy emphasizes the use of marketing strategies to drive traffic, build brand recognition, and effectively position diverse product lines within the marketplace. According to Comparably, he has an employee rating of 75/100, which places him in the top 15% of companies of similar size. He certainly has the credentials and experience to drive Skechers forward. However, another aspect that I really appreciate is that he is the founder of the company. In general, founders are usually more interested in growing the company than in filling their wallets.

I believe that Skechers has a strong brand moat. I really like the management as well. Now, let us examine the numbers to determine if Skechers meets our criteria for having a strong moat. In case you want an explanation about what the numbers represent, you can refer to "MY STRATEGY" on the website.

The first number we will investigate is the return on invested capital, also known as ROIC. We require a 10-year history where all figures exceed 10% each year. Skechers has managed to deliver a Return on Invested Capital (ROIC) above 10% in seven out of ten years. However, in two of the three years, the Return on Invested Capital (ROIC) was nearly 10%, while the only underwhelming year, 2020, was affected by the pandemic. Thus, I'm not concerned with the numbers, despite only exceeding 10% in seven out of ten years. ROIC increased in 2023, but it hasn't reached previous heights yet. Hopefully, we will see a higher Return on Invested Capital (ROIC) moving forward.

The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. While the ROIC was somewhat inconsistent, these numbers are a textbook example of what you would like to see. Skechers has consistently increased its equity year over year for the past 10 years. It is also worth noting that the equity has increased by more than 10% in eight out of ten years. Hence, I am very encouraged by these numbers.

Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. The free cash flow has been somewhat inconsistent over the past 10 years. One notable trend is that Skechers reported a negative free cash flow in both 2021 and 2022. Luckily, there is an explanation for that. Operating cash flow was lower in 2021 than usual due to an increase in inventory and merchandise in transit. At the same time, capital expenditures were much higher in 2021 than usual because funds were allocated for a distribution center and new corporate offices. In 2022, Skechers made significant investments in their global distribution capabilities, leading to another year of negative free cash flow. Hence, although I am not fond of observing a negative free cash flow, there is a justification for it in both 2021 and 2022. Skechers typically generates a positive free cash flow, which is why I am still willing to invest in the company despite occasional years of low or negative free cash flow. It is worth noting that Skechers not only achieved a positive free cash flow in 2023 but also reached a record high. Levered free cash flow margin has historically been underwhelming, but reached a record high 11,3% in 2023, which is an encouraging sign. Free cash flow yield is also at record high levels, which could indicate that Skechers shares are trading at a reasonable valuation. However, we will revisit this later in the analysis.

Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a period of 3 years. We do this by dividing the total long-term debt by earnings. Once I have done the calculations on Skechers, they can pay off their debt in 0,45 years, which is well below the three-year requirement. Therefore, debt is not a concern when investing in Skechers.

As with all other investments, there are risks associated with investing in Skechers. One of the risks is competition. The global footwear industry is highly competitive. Thus, Skechers faces intense competition from other established companies in the footwear industry in terms of product offerings, pricing, production costs, and advertising and marketing expenditures. Consumer demand for Skechers products may decline significantly if the company does not adequately and timely anticipate and respond to its competitors. Some of their competitors have significantly greater financial, technological, engineering, manufacturing, marketing, and distribution resources than Skechers does. Their superior capabilities in these areas may empower them to withstand periodic downturns in the footwear industry, compete more effectively on price and production, keep up with rapid changes in footwear technology, and swiftly develop new products. New companies may also enter the markets in which Skechers competes, further increasing competition. Relying on manufacturers. Skechers' footwear products are currently manufactured by independent contract manufacturers. The top five manufacturers of Skechers products produced approximately 45,7% of their total purchases, while the largest manufacturer accounted for 21,4% of total purchases in 2023. Skechers competes with other footwear companies for production facilities, and they do not have long-term contracts with any of their contract manufacturers. Under our current arrangements, these manufacturers can terminate their relationship with Skechers at any time. If any of the larger manufacturers terminate the contract, Skechers will have to find new manufacturers. These manufacturers may offer higher prices, less favorable payment terms, and lower manufacturing capacity. Macroeconomics. The uncertain state of global economic and political conditions, including the impact of inflation and the challenging consumer retail market, may negatively affect Skechers' business. The company relies on the general economic environment and consumers' levels of discretionary spending. If the economic situation weakens, Skechers may not be able to maintain or increase their sales to existing customers, make sales to new customers, open and operate new retail stores, maintain sales levels at their existing stores, maintain or increase their international operations on a profitable basis, or maintain or improve their earnings from operations as a percentage of sales.

There is also plenty of potential for Skechers. One is direct-to-consumer sales. Skechers is increasing its direct-to-consumer sales. It can be done through their company-owned stores, digital commerce, or hosted direct-to-consumer sales via marketplaces like Alibaba's Tmall. In 2023, Skechers continued to see strength in their direct-to-consumer segment, which increased by 20% and exceeded 50% of Skechers' total sales for the first time ever in the fourth quarter of 2023. It is driven by an increase of 27% internationally and 12% in the United States, with both their physical and digital stores achieving double-digit growth. Management expects that direct-to-consumer sales will continue to perform well and anticipates double-digit growth in 2024 as well. It is significant because direct-to-consumer sales have higher margins than wholesale, which will boost Skechers' profitability. New categories. Skechers is expanding its performance division by introducing two new categories: Soccer and Basketball, which will be added to the current categories of Running, Walking, Golf, and Pickleball. Skechers Soccer is now available in the United States and Europe and will soon be introduced to markets worldwide. The Basketball collection has been launched in the world's largest basketball markets: North America, China, and the Philippines, and will expand to new markets in 2024. Management believes that these new categories represent significant growth opportunities worldwide. Management has mentioned that they believe that as we progress through the year, transitioning from 2024 to 2025, the opportunities for Skechers on a global scale, both in footwear and apparel, as well as in player endorsements and expanding into additional sports, will be significantly substantial. Growing in China. Skechers is growing in China, as sales grew by 15% in 2023, driven by double-digit growth across all channels. Management has mentioned that they continue to be encouraged by the progress they see in China, but that it is still a market in recovery. However, it seems like the recovery is on the right track as Skechers experienced a 22% growth in sales in China in the fourth quarter of 2023, which is significantly higher than the 15% growth year over year. Management has mentioned that China continues to perform better than they originally expected, and the Chinese market continues to show every sign of recovery that management could hope for.

Now it is time to calculate the share price of Skechers. I perform three different calculations that I learned at a Phil Town seminar. The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 3,49, which is from the year 2023. I have selected a projected future EPS growth rate of 12%. Finbox expects EPS to grow by 12,7% in the next five years. Additionally, I have selected a projected future P/E ratio of 24, which is double the growth rate. This decision is based on Skechers' historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $64,30. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Skechers at a price of $32,15 (or lower, obviously) if we use the Margin of Safety price.

The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 1.231, and capital expenditures were 324. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 227 in our calculations. The tax provision was 151. We have 153,019 outstanding shares. Hence, the calculation will be as follows: (1.231 – 227 + 151) / 153,019 x 10 = $75,48 in Ten Cap price.

The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Skechers' free cash flow per share at $5,89 and a growth rate of 12%, if you want to recoup your investment in 8 years, the Payback Time price is $81,14.

I believe that Skechers is a great company. I really like the management as well. Skechers has had mixed financial performance historically, including some years with negative free cash flow. However, Skechers managed to achieve its highest free cash flow ever in 2023. Competition will always be a risk for Skechers as they operate in a highly competitive industry. However, Skechers has managed to stay competitive since 1992, and there is no indication that they will not continue to do so in the future. Skechers relies on third-party manufacturers, and although these manufacturers can terminate their relationship with Skechers at any time, there is no indication that they will do so, given that Skechers has become one of the largest companies in the industry. If macroeconomics worsen, it will affect Skechers, but macroeconomics will eventually improve, so it isn't a concern for me. I really like that Skechers is expanding its direct-to-consumer segment as it has higher margins than the wholesale segment. However, it is worth noting that one of the reasons direct-to-consumer sales reached 50% of total sales in the fourth quarter of 2023 was due to a decrease in wholesale sales. I appreciate that Skechers has ventured into new categories that could potentially become significant growth opportunities in the future. Skechers is also expanding in China, which could be advantageous for long-term investors. I like Skechers, but if I were to buy shares, I would prefer to do so at a price below $50. This would provide a 20% discount in the Margin of Safety calculation. The reason I don't want to buy Skechers shares based on the Ten Cap price or Payback Time price are that both increased significantly in 2023, and I want to see if the numbers are sustainable moving forward.

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