Skechers appears as a value-for-money footwear distributor, but a deeper dive shows it has the potential to become a top brand for comfort and durability in emerging markets.
Company Description: Skechers Inc. (SKX) is a US-headquarted designer and manufacturer of lifestyle and performance footwear, apparel, and accessories generally priced to be budget-friendly to men, women and children. The company segments are wholesale and direct-to-consumer (D2C) and distribute products through 5200 company-owned and third-party stores (e.g., department and speciality stores) and e-commerce channels. The company is also an innovator in footwear technologies, such as ‘Slip-Ins’ and ‘Hyper-Burst’, which improve the comfort, weight, movement, and durability of shoe parts. SKX is the third largest footwear brand globally but generates ~50% of revenue domestically, and has South America and Asia as large growth markets. Products are produced by independent manufacturers in China and Vietnam.
Investment Thesis: SKX is a rapidly expanding global large-cap footwear company offering ~20%y/y EPS growth and trades at ~16x NTM P/E, a significant discount to larger rivals. Market participants are overlooking the ability of SKX to further its brand appeal to a broader and younger demographic pool using football and basketball sports partnerships and more palatable designs, alongside its USP of comfort. Reasonably priced footwear will also appeal to emerging markets such as Chile, China, and India, where SKX is enjoying an insurgence and aims to open 155-170 stores globally in FY24. Aggressive advertising campaigns in these jurisdictions will aid SKX in turning these stores to profitability faster than the market expects. Secondly, SKX is scaling its international business through a well-capitalised distribution network and transitioning its customer base onto higher-margin D2C channels. SKX management has shown its ability to offload inventory in a short amount of time and consistently improve its working capital cycle. Therefore, SKX, pursuing a volume strategy, is highly likely to reach its conservative $10bn FY26 sales target (requires ~7.7% top-line CAGR), maintain its double-digit operating profit margins through developing a more favourable product mix and cash flow position and capture more significant market share internationally. These features provide SKX with at least a 15% upside using a DCF.
Industry Dynamics
Fashion and footwear: SKX is an exception amongst most fashion retailers that are expected to focus on raising prices rather than increasing volumes in 2024. However, the emotional brand strength that SKX will use to connect with customers will be pivotal to capturing market share, with fashion brands widely employing effective storytelling ad campaigns and creating memorable shopping experiences. Physical retail is regaining importance, with consumers increasingly shopping ahead of special occasions or to secure limited-edition items, often used in resales. SKX has not yet had a prominent position in the resale market and has not experienced a ‘hype’ phase like New Balance or Puma. However, this behaviour shift is likely to support SKX's volume strategy. Notably, 76% of US consumers plan to spend as much or more on fashion in 2024 year-on-year according to JPM, aiding SKX's e-commerce channels. In the footwear market, sneakers remain the top choice across all age groups at present in the US; further, approximately 45% of women and 40% of men plan to buy performance sneakers (modestly higher than the younger demographic according to MMGNET). Everyday boots, another prominent product category for SKX, are the second most sought-after footwear (~40% of women intend to purchase). Additionally, outdoor-style shoes from performance brands are expected to continue gaining traction. Price increases in the footwear sector are projected to be 2.6% (priced into DCF valuation).
Competitive landscape: key competitors of SKX are NKE, ADS, NB, PUM, RBK and CROX (not necessarily direct competitors on all products, but on investment choice between managers). SKX is seen as the top of their game for comfort by customers and partnered with Goodyear to utilise their rubber technology on outsoles that deliver better grip, stability and durability, particularly important for sports shoes. The footwear industry is highly competitive, but SKX is gaining market share, particularly amongst women and 25% of Americans use SKX and ranks second to Nike for casual footwear. Demand is being fuelled by more affluent customers in the US, with SKX tending to resonate with an older demographic (e.g., Arch Fit is podiatrist-certified), with preference share among adults 55+ ~3x higher than younger customers. However, SKX is using partners such as Thai actor Apo to attract a younger audience in its faster-growing markets.
Drivers of Growth
Despite reaching record highs of ~$75 a share this month, the positive impacts of SKX's demand creation spend and operational efficiency stemming from a long CAPEX cycle, which has delivered a robust omnichannel distribution network, have yet to be fully realized.
Product Mix and D2C: The D2C segment, which operates with higher margins (~65%), is a key focus of SKX’s long-term strategy. This segment contributed 50% of revenues in 4Q23, up from 44% in FY24, marking a 6%-pt increase year-on-year. SKX experienced double-digit revenue growth across all geographical regions in FY23, driven by volume growth in D2C and a ~5% increase in ASPs across its entire business. Notably, SKX’s Chinese sales rose by 20% due to an economic rebound and plans to open 600 stores in FY24. Although the wholesale business saw a decline in 4Q23, a recovery is underway, with management reporting good sell-through rates from distributors in 1Q24. Investments in upgrading SKX’s e-commerce platform and expanding delivery/pick-up options since FY20 have significantly improved customer engagement. The integration of technology into its product offerings, particularly in the athleisure segment with products like GOWalk, GORun, and GOGolf, positions SKX to potentially break into new retail channels, such as Footlocker, with a broader product mix.
Ramping Up CAPEX: CAPEX has averaged 4.6% of revenue since FY19 (excluding FY20), significantly higher than the 3.4% in the four years prior. Management has guided for a similar level of investment in FY24, a gradual decrease is likely to ~3.5% by 2025/26 (it was 2.5% in 1Q24). Investments have been financed by positive cash flows and include the expansion of distribution infrastructure (with only one 2.3mn sqft Chinese distribution centre left to open), a 14% rise in newly owned retail stores over the LTM, enhancements in D2C technologies, and transportation improvements. While new stores take time to become profitable, international stores benefit from lower fixed start-up costs and shorter leases. The long-term effect of this CAPEX strategy will be the retention of operating margins in the low double digits, enabling SKX to compete across all verticals. SKX’s product design and development costs have averaged ~$26mn over the last three years at a similar % of revenue to the last five years.
Distribution in High-Growth Markets: Expanding distribution infrastructure and technology access in high-growth markets such as Chile, China, India, and Thailand is another critical element of SKX’s growth strategy. The active omni-distribution management system creates a seamless customer experience across online, mobile, and in-store commerce and warehouse management. The use of robots to enhance pick speeds and accuracy in supplying 400 Chinese retail outlets supports this growth. SKX’s capital cycle has improved, falling from 111 days to 94 days in the past two years, with inventory days lowered to 114 in 1Q24 from 132 in 1Q23. Management has flagged the potential to double the number of third-party distributors, and SKX has adequate cash reserves to acquire joint ventures (e.g., in Thailand, Singapore and SK) and partnership companies, as demonstrated by the acquisition of a Scandinavian distributor, Sports Connection, in FY23.
Extension of Share Buyback Program: The current $500mn share buyback program, set to end in January 2025, has $205mn unused. The previous buyback program with an envelope of $150mn expired in February 2021 and was paused for a year amid SG&A volatility and ownership control issues. The buyback program will likely be renewed in due course.
Risks to Profitability
SKX's most notable spending is on-demand creation and labour costs, which it uses to push its brand image to a broader audience and increase conversion in an internationally competitive environment.
Macroeconomic and Geopolitical Environment: stickiness in service prices and lagging participation rates in developed markets have led to sustained wage pressures. SKX's full-time employees have more than doubled since FY19 to 9,200; labour costs increased by $104mn in FY23 resulting in a ~2% decline in operating margins. Additionally, cooling goods price inflation may prevent SKX from increasing ASPs, causing further margin pressure. The company has exposure to freight/container costs, which will evolve with geopolitical developments in the Red Sea/Panama Canal. While management stated that 1Q24 was the last quarter with significant freight cost contributions, there is still an observed impact on some European routes.
Indian Regulation: SKX’s overseas factories lack certification for producing footwear with quality and safe rubber, PVC, and other key components in India, which may disrupt the supply chain in the fast-growing Indian market. This regulatory requirement compels SKX to depend more on limited local production, which may affect their ability to meet demand. Despite a temporary extension of the certification deadline, ongoing uncertainty hampers long-term planning. Management remains cautiously optimistic about prospects in India.
Sports Partnerships Failing: SKX has expanded its sports line to football and basketball footwear with players such as Harry Kane, Julius Randle, Joel Embiid, and Terrance Mann, who have had previous partnerships with NKE, ANTA and UAA. However, these athletes are in the latter half of their professional careers and past their peak of popularity, which casts doubt on the partnerships' potential to gain market share among younger players and improve penetration in sports footwear. Additionally, the football ‘SKX_01’ and ‘RAZOR™’ collections retail at a high £200, and the “FLOAT” basketball collection using Goodyear (Resagrip) treads is priced at $150, placing them at the top end of the market, above competitors like New Balance and Puma. To gain market share in the younger demographic, SKX needs to position itself more accurately with its value proposition.
Ownership Structure: The Greenberg family owns about 89% of outstanding class B stock, with immediate family members holding an additional 10.2%. Given the 10 to 1 voting rights compared to class A stock, R. Greenberg controls 53.3% of the aggregate number of votes, allowing significant control but making SKX a difficult takeover target. Management performance rewards are tied to EPS growth. SKX has faced a $1.25mn fine for executives not disclosing payments to family members and using company jets for personal use.
Valuation
Discounted cash flow model: The D2C business is faster growing and part of SKX’s growth strategy, guidance suggests that double-digit growth will be hit for every quarter during the year, and volumes will be carried increasing company-owned stores (the base case assumes 170 stores will open globally after management revised the FY23 end-of-year guidance higher in 1Q24) and e-commerce, the DCF projects 12.4% revenue growth for FY24 and 11.9% for FY25. Meanwhile, management indicated that the wholesale business would grow in the mid-to-high single digits in FY24; the DCF assumes ~8% growth for both FY24 and FY25. Management has a long-term target to get SKX products into 10,000 stores. By FY28, it is assumed the wholesale segment will be roughly growing with GDP, but D2C will be growing in the mid-single digits.
In the short term, gross margins are expected to mildly improve in the wholesale and D2C business to ~44% and ~67%, respectively; little improvement is expected from there as the results from the CAPEX cycle fade. As demand creation expenditures turn less aggressive and inflation stabilises around target globally (or slightly below), operating margins are anticipated to improve to ~12.5% in FY25 and then stay roughly flat across the forecast horizon. Net profit margins are projected to increase from 7.2% in FY24 to 8.3% in FY25, supported by revenue growth and effective cost management. The tax burden is expected to remain at 19.25%. Joint ventures are expected to maintain strong performance, particularly in markets like Thailand, which have shown significant growth (+56% in recent years). These ventures are anticipated to contribute positively to overall earnings, with the potential for increased impact as they expand. EPS is expected to grow ~20% until FY26 before slowing to smaller double-digit gains by FY28.
Cashflows are discounted by a WACC of 8.56%, using a median of adjusted unlevered betas from a dozen comparable companies calculated to be 1.11. Under the current capital structure, matured capital structure and historical data, levered betas are calculated as 1.13, 1.31 and 1.27 respectively. This creates a cost of equity ~9% and debt ~5.7% using market data. A forward EV/EBITDA multiple of 8.3 is used to calculate the terminal value. Scenario analysis is conducted with variations in the number of stores opened within the next year, the bear case is at the lower bound of the SKX target range (155), meanwhile, the bull case assumes management will again upwardly revise store openings (200) and modest adjustments to profit margins; the result of bull and bear case suggests a 29% undervaluation and 2% overvaluation respectively from the current price. Return on invested capital (ROIC) has been consistently >10% for SKX in the last few years; through the volume expansion strategy, improvements in operational efficiencies and competitive product advantages, retained profits will allow ROIC to grow to ~15-17% until FY28.
Sensitivity analysis: A pillar of the thesis is based upon the reduction in the operational efficiencies aiding margin expansion in both the wholesale and D2C businesses. Under the projections, a 1% improvement in gross profit margin will have an 3.9% impact on EPS from the baseline, meanwhile 4.3% for the wholesale business, this is the greater than the scope in the 2024 guidance ($3.95-$4.10). For context, the wholesale business has experienced a 5%pt increase in profit margins from FY22 to FY23, meanwhile D2C business has been stable. This highlights the sensitivity of the wholesale business and the importance of the firm’s long-term strategy.
Catalysts
The market realisation of success regarding SKX volume strategy across international markets: the company's diverse product line-up is increasingly attracting younger demographics in less developed countries with aggressive demand creation spend. SKX reports 2Q24 results around July 24.
The release/further development of SKX's sportswear range (e.g., basketball and football) and greater alignment with SKX’s core value-for-money proposition, offering quality and footwear technology at competitive prices.
SKX continues to generate positive cash flow, which is crucial for sustaining its operations and funding growth initiatives. With a slowdown in the CAPEX cycle, the company is well-positioned to renew its buyback program in FY25.
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