Skechers USA (SKX 25.77, -7.48, -22.50%) opened sharply lower today (-28%) after
reporting Q2 earnings results last night and guiding for Q3.
Skechers operates primarily as a maker of footwear for men, women, and children. It primarily sells products wholesale via department stores and shoe stores (Foot Locker, Finish Line, Famous Footwear), but it also has its own retail locations and sells shoes online. In terms of pricing, SKX sees itself as being in the sweet spot between private labels and the big guys (Nike, etc.).
SKX has been making strides in recent years by revamping its product offerings with enhanced designs and comfort innovations. SKX's higher-end performance shoe segment has been seeing strength, and the company has continued expanding very nicely in international markets, particularly in China; in recent quarters, the company’s total international wholesale and retail sales combined have represented over half of total sales, and this quarter saw shipments in China set a new quarterly record while the company increased expenses in the country to support expansion. Skechers has also benefitted from an industry trend toward athletic shoes.
What strikes us about SKX is that they seem to successfully appeal to various age groups, from kids to teens to adults, and to both men and women. It's rare that kids would want to buy shoes that their older parents would buy. However, SKX seems to walk this tightrope quite nicely while other footwear and apparel companies stumble. The company’s appeal with multiple demographics comes partly due to signing endorsement deals with various celebrities who appeal to different age groups. Recent sponsors include Rob Lowe, Meghan Trainor, Joe Montana, Howie Long, Sugar Ray Leonard, Brooke Burke-Charvet, David Ortiz, and Kelly Brook.
Turning to the Q2 results, EPS fell year/year to $0.29 from $0.38 in the prior year period. That was quite a bit worse than prior guidance of $0.38-0.43. Revenue rose 10.6% year/year to $1.135 bln, which was in-line with prior guidance of $1.120-1.145 bln. The Q3 guidance was rough as well: SKX expects EPS of just $0.50-0.55 and revenue of $1.200-1.225 bln. Both are below market expectations, and EPS is well below expectations. Of note, Q3 is the retailer’s all-important back-to-school season, so the tepid guidance for this period is a concern.
So, what happened? On the positive side, in terms of revenue growth, China contributed significantly, with sales up 44.1%. However, this increase in sales was partially offset by a 7% decline in domestic wholesale and a 6.1% decline in distributor sales, due in part to weakness in the Middle East, where the company, as in the first quarter, saw slowdown with its largest international distributor for the region. Excluding distributor sales, the company’s international wholesale business was up 34% in the quarter.
On the expense side, total G&A expenses rose by $65.6 mln to 32.7% of sales from 29.8% in the prior year period. On the call, SKX said the increase reflects its continued investment in long term global growth initiatives and included $29.4 mln to support growth in China. It also included an increase of $11.7 mln associated with operating 54 additional company-owned SKECHERS stores, of which 12 opened during Q2. Also, SKX said its operating leverage was lower than the prior year due to higher international advertising and distribution related costs. Higher operating expenses, including legal costs and adverse FX impacts, and a higher tax rate also hurt results.
In terms of product, SKX reports that the resurgent popularity of retro looks and Skechers D'Lites mark the company as the originator of one of the hottest trends in footwear. At the core of this in-trend chunky look is comfort, which Skechers incorporates into diverse product lines, from its Relaxed Fit brand to its Skechers Sport shoes to its sandal collections. Excitement over Skechers D'Lites has allowed SKX to broaden its distribution and marketing to reach millennial consumers, such as by bringing chart-topping artist Camila Cabello on as a sponsor to promote Skechers D'Lites, in efforts to keep company products resonating with their audience.
In sum, Q2 was a rough quarter for SKX, and forward-looking guidance offered no relief from present disappointments. There is not one specific reason for the shortfall. SKX said during Q&A that its non-core business is under pressure, but its core business continues to grow. Its non-core business is made up of lower price alternatives. Lots of closeout product in that market channel has hurt SKX. The company also conceded that its U.S. business in general was a little tougher than they thought it would be when they provided Q2 guidance in April.
The stock is trading sharply lower today. Our sense is that the Q2 miss is disappointing, but the weak Q3 guidance is what is really spooking investors. The back-to-school season is SKX's bread-and-butter, and lowered guidance for that period is a sign of current significant struggle. The stock gapped lower by almost 25% in April on Q1 results, and it's gapping down again today. Hopefully the company can show some improvement in 2H18, but investors are understandably cautious with SKX right now.
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