TIVP034: Crocs (CROX): Fashion Icon or Value Trap? w/ Daniel Mahncke & Shawn O’Malley

26:33It's not only Crocs that made a comeback also Ugg boots, Birkenstocks or Tiva. I guess you can take that as either a good sign or a bad sign. When the entire Crocs and sandals industry is popular at the same time it's either a fad or what's a long-term shift in clothing habits? And when I look at the durability of Birkenstock sales growth, it doesn't look like a fad. And mind you, these were called grandpa shoes for an eternity, at least here in Germany. I think they had a similar reputation here in the States too. Perhaps the clogs and sandal space is a good example of what we briefly touched on in our Nike episode about how retail has become much more segmented.

27:14And 20 years ago, there were only a handful of clothing or fashion brands that decided what the current trends were, might be fair to say. And today, maybe because of social media and TikTok, it just feels like there are so many different players and so many different niches in the clothing world than there used to be. And so popularity in clogs or sandals doesn't replace other parts of the market. They kind of coexist together. And the fashion world has become a lot more individualistic or custom tailored, you might say. And Crocs benefits from that really as much as any other brand. Customization of Crocs is a big part of the story here, I believe.

27:53And I'm pretty sure I've seen everything from just standard colored Crocs to KFC themed Crocs you were showing me offline before our call with fried chicken on them. So this is not a product that people are afraid to layer their personality and some humor. The KFC ones are really beautiful, right? No, but I think you mentioned a great point. I think we even talked about the music industry in the Nike episode as another example for how markets have become much more segmented by now. Thanks to Spotify, there are thousands of new musicians that would have never made it on the radio. What people listen to nowadays is much more diverse than in the days of radio.

28:32And it's somewhat similar to fashion, as you mentioned, mostly because of social media and especially TikTok. But getting to the customization part of Crocs, you can put so-called gibbets on your clocks. And I might overstate the impact, but I think those are extremely valuable and an extremely attractive part of Quarks' business. For anyone who doesn't know Quarks at all, they typically have ventilation holes and gibbets are these small little plastic figures that can be attached to your Quarks. It was actually not Quarks itself that came up with the idea. They were created by Sherry Schmelzer, a stay-at-home mom who wanted to make the family's Quarks a little more aesthetically pleasing.

29:10And those little decorations quickly became a local bestseller, prompting the company Crocs to purchase the company for 10 or 20 million dollars. There are different numbers out there whenever I look that up. To me, it sounds a lot like gibbets have now become a vital part of the company. They account for 8 % of sales and they have extremely high margins. So their share of profits is significantly higher than their sale share. And I believe they're a huge part of what makes Crocs so special. People love to collect and customize things. And I don't know a single shoe brand that does it as well as Crocs does it.

29:44There are these little Chinese plush toys called Labubu. I don't know if you've ever heard of them, Sean, but they are highly popular with teenage girls and younger women. Popmart is the company behind them. And Popmart is now valued at$40 billion. To be fair, they also sell many other toys, not only the Labubus. But the point is, collectibles have huge pull on consumers. And if they are customizable, that makes it even more sticky. And according to Crocs, about three quarters of their customers also buy jibbits. And you can really buy anything as a jibbit. Disney characters, Pokemon, Sushi Rolls, initials, everything you can imagine.

30:22Unfortunately, I am familiar with Lububu. My nine-year-old niece loves them. I actually got a tutorial on Lububu just the other day. And I have seen these jibbits. I didn't know what they were called for years, but you're right. I never really thought about it, but they are everywhere. And I just think Crocs does a really good job of doubling down on collectability, which kind of goes hand in hand with the customizations they do. It's not only the gibbets, but you have these limited edition Crocs that can sometimes sell for multiples of the retail price online. So there's a real collector culture here too.

30:59And I know they work with all sorts of different franchises and celebrities too for some of those limited edition versions they sell. Yep, absolutely. I even found some Crocs that I know you will love, Sean. There's a limited edition NBA All-Star version. And it's also an absolute steal, if you ask me. For less than$700, it could be yours, Sean. But you have to be fast because there are only two left on StockX. So if you want them to tell... It's a good price. It is. It's a steal, like I said. But yeah, the list of special editions and collaboration just never seems to end. From celebrities like Post Malone, Justin Bieber, Nicki Minaj, Bad Bunny or Scissor to food brands like McDonald's, Pringles, Taco Bell, as you mentioned before, KFC.

31:44But also fashion brands like Levi's, Balenciaga and MCM. Like I said, it just never stops. They even have one with G-Shock where there's an actual watch on the shoe. Crocs have increasingly become just a canvas for self-expression, whether through gibbets or creative designs. I know all of that sounds a bit like cliched marketing slogans, but when I see all these things, I personally can totally understand why so many people like them. And I can see how they might become a classic at some point. And yes, when I started learning about Crocs, I would have also never thought I would say those at any point.

32:19maybe one day we'll get an lvmh crocs crossover i'm not holding my breath but maybe we'll see it when we've talked about other fashion brands or even beauty retailers like ulta and estee lauder to a different extent we also mentioned how important social media has become for driving those sales and just to emphasize it again i mean this customization and the gibbets and the special editions, especially for how funky or quirky a lot of them are, it's just ripe for internet virality. So as much as I have probably bet against the Crocs brand for years, kind of in hindsight, I'm not as surprised because a lot of this stuff, it just, it looks great on Instagram and TikTok.

33:07It's funny, it's relatable, and it's fun. You know, when I asked myself why I didn't know about the hype cycle of Quarks before, the answer is pretty obvious. I don't use TikTok. And TikTok is where Quarks really has made a significant amount of business. So perhaps people in the comments will tell me, I'm talking nonsense now, but from all my research, Quarks does a very good job on social media. On TikTok, the hashtag Quarks has been used billions of times, filled with gibbetals, collab unboxings, and fit checks. And not too long ago, TikTok shop was introduced and it has quickly become one of the dominant e-commerce players.

33:42Although it was only launched in the US last October, it has already attracted nearly 50 million shoppers with an average spend volume of$32 million a day. And its global gross merchandise volume has doubled year over year to exceed$30 billion. I say all that because Crocs has become the number one selling brand on TikTok shop, according to Crocs CEO Andrew Reese. I actually couldn't find any official rankings though. I don't think he lied, but perhaps he's talking about a certain time frame or a certain category or perhaps both. The products, though, and collabs are an obvious part of why they work so great on social media.

34:17But they also have a lot of humor that works well. They don't take themselves too seriously as a brand. And as they say, you either love or you hate co-ops. And they really double down on that with every marketing gig they post on social media. Apart from the collaborations, the lockdown tailwind and fashion shows, another macro tailwind has been the athleisure trend that has also benefited Lulu and perhaps even more Lulu than Crocs. Industry forecasters packed the global athleisure market to be around$340 billion in 2024, growing at a double-digit CAGA over the next few years. So it's a huge market.

34:51That's nearly triple the expected growth for traditional apparel. Now, you're more knowledgeable than me about the athleisure trend, Sean, but perhaps you think crocs are something totally different. But I think it's undeniable that there has been a significant shift among Gen Z towards more unconventional ways of fashion. And that is not a fad, but here to stay, crocs are the perfect way to express yourself, reject rigid dress codes, and they are more adaptable than any other fashion product I've ever seen. when i started researching athleisure or my pitch on lululemon i don't think i ever would have thought about classifying crocs as athleisure but in a weird way i can kind of see it athleisure is sort of a rebellion against the status quo that pushes back against conventional social norms and yoga pants and crocs have both rewritten those social norms in the past few decades i'd say and You're probably not going to wear Crocs to Whole Foods or Starbucks like with Lulu.

35:51It's maybe not an upper middle class branding like that, but it's definitely a very functional brand that is both casual and then also stylish in a way now. And it's fun. It's kind of hip. So yeah, maybe the athleisure comparison works better than I'd like to think. I mean, I see where you're going with it. I think there's just this overarching trend of, as you said, a rebellion against the usual norms of what you can wear. and Quox fits pretty well into that. I wouldn't wear them to the gym, but I think the main part is being different when you wear them. And I see a lot of people my age wearing them and those are the people who at least supposedly have a lot more fashion sense than I do.

36:27And I think that's kind of what Quox is going into. Still, they see their totally addressable market at around$160 billion annually. So that's a lot more than just a niche little market for people who want to start a rebellion. And that includes casual sneakers, sandals, and Quox. And judged by the$4 billion in revenue they currently make, this results in a market share of 2 to 3%. I personally do not think Crocs market is actually that big, since I see too much competition in the casual sneaker space. That's a significant chunk of the TAM if they talk about$160 billion. When you get your pair of Crocs, Daniel, I hope that we can show them off on camera for the audience to see.

37:09I think that would be a great way to show that, you know, we actually, we walk the walk. Sometimes we buy the products we talk about, but we've gone on a few tangents now, but we should quickly get back to the turnaround story. And I think time-wise, we landed in the late 2010s. So London Fashion Week brought Crocs back on their feet and all these brands and celebrity collaborations followed just reinforcing the hype. if we want to call it a hype. I mean, honestly, I'm fully aware I could never sit here with a straight face and question the longevity of Lulu while arguing that Crocs might not be a fan.

37:48Hopefully there's room for both in the world, Lulu and Crocs. Hopefully, at least if we choose to invest. Otherwise, I'm totally fine with just having Lulu and their growth story. But what you have to give them credit for, and I'm talking about Crocs now again, not Lulu, is how they chose their partnerships, ranging from everything I mentioned, like Pringles and McDonald's to fashion shows for Balenciaga, they really approached every customer possible. Another thing is how they stayed relevant even after the pandemic. In the pandemic years, with all the lockdowns, Crocs seemed like the clear winner.

38:20Many people used them as house shoes, but instead of seeing that amount decline since then, it's on a clear upward trajectory. It's kind of like they took the first hurdle, surviving after lockdowns, and now it's just about really establishing them as a classic. And what's the plan to take that next hurdle and really make Crocs a brand that won't go out of fashion again, like what we saw in the 2000s? And I guess from everything you told me, the turnaround seems to be based on narrowing the product portfolio and then doubling down on the classic clogs. But then in 2022, Crocs made this very interesting acquisition of Hey Dude, which is a shoe brand that's more focused on comfort, just like Crocs, but with much more casual looking shoes.

39:08And I guess that's maybe part of the strategy here is to try to break into a larger TAM and gaining market share in the casual sneaker space. But then at the same time, these previous diversification attempts under the old management didn't work out very well. So I'd be curious to hear your assessment of this strategy shift. You're not the only one seeing a problem in that acquisition. Crocs paid$2.5 billion, and many thought that's too much money, especially considering the company's significantly weaker brand and product offerings compared to Crocs. Now on the price, technically, I would say they didn't necessarily overpay, at least not badly.

39:47They paid 13 times earnings, which was an okay price for a business like HeyDude. You could argue though that$2.5 billion was just too much in absolute numbers for Quarks. Quarks itself is only valued at$6 billion. And while it was valued at over$10 billion when the acquisition was announced, the announcement itself caused the stock to plummet. And only six months later, Quarks was worth$3 billion. So overall, I would say they reached a bit too far. but that is a thing of the past and the more important questions today are why you buy another brand in the first place and more importantly did it work out since then and your instinct was right that the idea was to diversify that didn't work the first time but we're now talking about a much more established company and the product fit is pretty good hey dudes signature product the wally and wendy are lightweight casual slip-on shoes that are equally controversial as crocs I've read a lot of criticism online from people who find them straight up ugly and others who like the look a lot.

40:49Although I'm not sure if there might be a negative bias whenever you look anything up on Reddit. I don't know about you, Sean, but I don't find them that ugly. They are not the best looking shoes I've ever seen. But to me, they just look, I don't know, pretty average. So, yeah, that's what kind of bothers me. For better or worse, Crocs are incredibly unique to their credit. But the Hey Dudes, they look so plain in contrast. I mean, there's nothing at all exciting about them visually. And I'm kind of surprised they even, this sounds harsh. I'm surprised they even catch enough attention to be controversial in the first place.

41:25But you should tell me, I mean, you're an expert here. How has this integration of Hey Dude gone? Because again, it looks questionable on paper. It seems like a totally different type of brand to integrate. but maybe it's worked out better than I'm giving them credit for. I thought you might would have a different angle here because I see it the exact same way. These shoes, I don't know how they are controversial. They are just the most average looking shoes ever and I don't think that's perhaps the best acquisition for Crocs. I would have expected them to double down on any other unique shoe brand but yeah, the short answer to how is the integration of HeyDude going is not too good.

42:03I feel like we are repeating the same story over and over but Hey Dude just grew too fast and when demand slowed down in 2023 inventories started piling up retailers had too much in stock and wanted to get rid of it since then revenues are in decline a 13 % drop in 2024 and a 10 % decline in the first quarter of this year. Recently margins also came under pressure but that's just the first sign of the new strategy implemented by the new president Terrence Riley. He has experience in scaling up fashion brands and his plan for hey dude is to simplify the product basically what they did to crocs 10 years ago and strengthen the dtc game invest into the community and basically building the same type of controversial but noble brand like crocs that started first with cleaning up the assortment and expanding their own footprint 38 new premium outlet stores opened last year they have begun launching direct to consumer markets in the uk germany france india and australian on the community side hey dude recently hosted its first ever super brand day on tiktok ranking number one among footwear brands on the platform on that day i don't know how much that says about the brand but still and just like rocks they focus heavily on brand ambassadors like for example sydney sweeney well that's a good strategy because we just saw american eagle stock pop on the announcement of a partnership with sydney sweeney so she seems to single-handedly be able to move entire brands and stocks by herself.

43:32But getting back to kind of the fundamentals here, I'm curious how it looks on the DTC side, the direct-to-consumer side for Crocs. And I feel like I keep invoking Nike and Lulu, but they're companies we've both covered in depth on the show. And as we know from those stories, selling wholesale versus selling directly to customers can have both major business and brand implications over time. Yeah, it's a good point. crocs dtc shares about 50 for hey dude the number is slightly lower at around 45 but the dtc sales at hey dude have been growing eight percent year over year even while wholesale declines and average selling prices have grown for seven consecutive quarters so that's why i say the turnaround looks pretty good they are selling fewer shoes though and at better prices that makes sense but we will still have to see if the top line can actually grow further but getting back to DTC.

44:24So Crocs is not like Lulu, which has full control over how they portray and sell their brand. But the shoe industry generally has lower DTC share than most fashion brands. Onn, for example, which is a premium shoe retailer we also talked about when we covered Nike, has a DTC share of about 48%. Birkenstock is at slightly less than 40%. And the industry giants like Nike and Adidas have long-term goals of 50%. But like I said, Crocs is already there. HeyDude is still a work in progress, but overall its numbers are pretty good as well. High DTC share and high margins, but compared to the stronger Crocs brand and considering the price Crocs paid, it is understandable.

45:03Investors are skeptic. So the status quo in my mind is that the acquisition has done currently more damage than good, but management is quite optimistic that they will turn this around. And I kind of see it as optionality in the future. Talking about margins and buybacks, how about we go deeper into Crocs' financials and capital allocation? Sure. So in 2024, Crocs reported just over$4 billion in revenue, growing mid-single digits year over year. And about 80 % of that came from the core Crocs brand, which grew by 10%. As I said, HeyDude declined by 13%. And at the end of the year, they only had a bit more than$800 million in sales.

45:42What makes Crocs stand out is their really excellent margin profile. We talked a lot about Lululemon's superior margin profile to competition in their episode, but Crocs is right there as well. Both companies have gross margins of close to 60 % and mid-20s operating margins. Crocs is actually slightly higher than Lululemon there. Part of the reason is the asset-light business model, the vertically integrated phone production, as we talked about earlier, and of course, the strong pricing power. When we discussed Lululemon, I mentioned that retail brands with significant pricing power that are not true luxury brands tend to lose that power over time.

46:20Not all of them, but most. Now it's impossible to know in real time which brands can sustainably take higher prices and earn higher margins. And the question also is, what does sustainable mean? Where do you draw the line? Lulu has shown these outstanding numbers for over a decade, almost two decades. At that point, calling it a fad is very difficult. Crocs has survived the end of the lockdown era. That has to come for something, but we're still only talking about three to four years of actually superior performance. The returns on capital look pretty solid too, and not as good as Lulu, but still significantly better than what Adidas has to offer and also higher than Nike.

46:59And the difference is that when you look at the graph that we're showing on screen right now, you can see that Crocs' ROIC was negative back in 2016. And so we discussed it a bit already, But it shows, once again, that compared to these other companies here, Crocs arguably doesn't have the same moat because they've been delivering these excess returns on capital for only a few years and it's inconsistent. Yeah, that's kind of the risk that you have. But right now, numbers are undeniably strong across the board. When we look at the free cash flow margin, Quarks is by far the strongest company, boasting a 22 % free cash flow margin that generated$920 million in free cash flow last year in 2024.

47:39A lot of that has been reinvested into buying back shares. Since 2023, the share count declined by almost 10%. And just in February of this year, Quarks added another billion dollars to its buyback program, which means that now there's a total of$1.3 billion authorized for buybacks. And that represents about 20 % of the company. At the current market cap, that's, I would say, pretty attractive. Last year alone, they bought back over$560 million worth of shares. And in the first quarter of this year, they will purchase shares worth about$60 million. So it's hard to say at what speed they will buy back shares going forward.

48:15But based on the current stock price and assuming that free cash flows remain stable, I would assume it will be paid out over the next two to three years. The management said that they will be opportunistic about buying back shares. So if the multiple goes up, they probably won't buy or if the price goes up. If the company or the price stays low, they will probably buy back shares. The other pillar of capital allocation, though, is paying down debt. In 2021 and 2022, mostly due to the hey-to-do acquisition, Crocs issued about$3 billion in debt, which is a lot for a company of their size. However, they were very focused on paying it down as quickly as possible, cutting their debt in half since then.

48:52And management committed to a net leverage range of 1 to 1.5. And they are right back in that range again. So that's why I think the buyback program has been expanded. And it's probably the main focus going forward. Yeah, I mean, the Hey Dude acquisition, it sounds like it explains it. Because I was trying to figure out how for a second there, this company with a$6 billion market cap could have$1.5 billion in net debt. And also still be profitable. because you wouldn't think that, you know, that you think they would finance the business with their own earnings and not necessarily need to take on all that debt.

49:25And so given interest rates at the time when they made that acquisition, I'm sure it seemed much more cost effective than it would now to do that kind of deal. But man, it still looks like such a huge commitment of capital to a brand. It's almost the opposite of Crocs in a lot of ways. And it's just totally lacking the same flair and personality. So I find it disappointing. It doesn't make sense to me. But at this point, Hey Dude is part of the company now and there's nothing I can do about it. And on paper, the valuation multiple for the overall business looks very low. And whether that's Hey Dude diluting the value of the overall enterprise and the multiple that investors are willing to pay for it or just some sort of de-worthification going on, it's hard to say.

50:12But before we get to the valuation more in detail, though, I think we have to touch on Crocs's Asia strategy and really what's going on in China. And you mentioned before we started recording that Crocs is starting to look a lot like Lululemon with its early success there, as if we haven't invoked Lulu enough on today's call. But there has been rapid growth in China. And more importantly, it's full price growth, meaning the expansion isn't just being driven by heavy discounting, but it's actually people are paying full price for this stuff. And it's not dragging down margins to grow incrementally in these new markets.

50:47That's right. Whenever we want to figure out where the next big wave of growth is coming from, it seems like we have to look east, at least or particularly into China. That's where growth is coming from for most fashion brands nowadays. And Quark's management describes China, South Korea, Japan, India, and the core of Southeast Asia as their so-called tier one markets. International tier one sales increased by 20 % in 2024, expanding the Crocs brand's international mix from 38 % overall two years ago to 44 % today. And unsurprisingly, China is the biggest contributor and the second largest market behind the US overall for Crocs.

51:25Sales grew an astonishing 64 % in 2024 and was still more than 30 % growth last quarter despite that difficult comparison. And when we discussed Estee Lauder, I can still remember I said that the time when Western brands can just go into China and succeed just because they have kind of a foreign flair to them is over. And that's where Crocs, with their extreme level of customization, in my opinion, does have huge advantages. Their China products have tons of local tweaks, other colorways, different franchises and collaborations, different gibbets. The shoes can look completely different from the US or even European editions.

52:01And in terms of sales, Crocs chose a digital first approach with a DTC focus. So Douyin, which is the Chinese name for TikTok, JD and Tmall, account for the bulk of sell-through in China. And thanks to the DTC approach, gross margins are very high as well. As you said, it's full price growth. Their gross margins reach 60 % just as they do in the US. And despite the digital first approach, even their store count is growing quite fast as well. Just last year, the store base increased from 36 stores to 51. That's a lot of growth in relative terms. But of course, part of the truth is that they are at the very early stages of expansion.

52:41Lululemon has about 90 more stores, if I'm not mistaken. And we don't even need to talk about companies like Nike. For them, 50 stores would be, I don't know, nothing more than a rounding error. Having said that, as we said prior, it seems like Kroc's strategy on their DTC channel is less to build a lot of stores and mostly about selling digital. It does seem like betting on China is even more material to the story here with Lulu. And it was a big part of the story with Lulu too. And I'm sure that hasn't helped sentiment around the stock recently. Anything connected to China has really fallen out of favor, but years of suppressed Chinese consumption and all of these horror stories about growth plants in China falling very short of the ambitions that various Western brands have outlined to investors over really the last decade, I actually kind of think it's maybe a good time to be contrarian and think that, okay, well, that pessimism is probably more than baked into the stock already, such that if things actually do continue to work out for Crocs longer term in China, that could be a huge boost, obviously not just to the business, but actually to the share price.

53:46Because if the market isn't giving them a lot of credit for this business line, and it continues to be substantial and growing. That will need to be reflected in the valuation at some point. Anyways, I am curious about the rest of Asia. South Korea and Japan usually move early on fashion trends. That's sort of my understanding. And they've got that mix of streetwear culture and comfort first style that feels like it could be a natural fit for Crocs. And so I wanted to ask you, are we seeing the same kind of momentum in those markets or is it more of a slow build up there. And then we shouldn't overlook India because it has this massive consumer base and a growing middle class too.

54:23So maybe if you can speak to that as well, whether Crocs has started to make inroads there or is that more of a longer term opportunity. And while also on the topic, maybe you can speak to whether this is just a push for the Crocs brand or if Hey Dude is also getting involved in Asia. Yeah. It's easy to see how expansion is a pretty big part of the thesis here. So South Korea already has 95 company-owned stores. Japan is only at 21. And in both markets, revenue is growing at high single-digit to low double-digit rates. And the margins, just as in China and in the US, are quite high, also about the 60 % mark at gross margins.

55:04And since Crocs is operating the same DTC and digital-to-fersed approach everywhere they go, I think that's what we can expect whenever they expand into other markets. South Korea is viewed as a more mature market than Japan, though. The market share is even larger than in the US. It's about 2 % to 3%. And Japan is still considered one of the growing markets. And since production is in Asia anyway, I think that these sales don't face any tariff headwinds either. So there's less uncertainty, at least on that front. As you said, macroeconomics are still another thing. Crocs is also building a design hub in Shanghai in the back half of 2025 to produce China-exclusive collaborations at the speed of local street culture.

55:43similar to what we have seen with Estee Laud as well. We actually moved design hubs or at least research hubs into China directly. India is now also part of those tier one markets. Last year, there was a soft launch on big Indian marketplaces. And product wise, management is mostly leaning into Sandals and the Brooklyn Wedge, which is a certain family of crocs. Asia's long, warm seasons, they just make it Sandals territory nine months of the year. So that's a natural market fit for crocs. and they use, as always, the same celebrity playbook over in India, over in China, over in South Korea. Famous actress Rashmika Mandana is the face of Quark's India campaign and she has over 45 million followers on Instagram and as far as I know, she's one of the most popular celebrities in India.

56:32However, regarding Hey Dude, they don't really want to go the same route yet. The plan for that brand is to primarily focus on stabilizing and growing the US operations and only then expand internationally. The first markets will be those where Crocs is already established and can help them even more so than going into Asia without any huge infrastructure there already. And these markets are the UK, Germany, France and Australia with India also on the list but mostly far into the future. Well, how about we talk a little bit more about Crocs' balance sheet and financial health before we get to the valuation which should be next.

57:11And one of the things I looked at with Lululemon was their cash to sales ratio. And their trend for them has basically been that they have less and less cash on hand relative to sales as the business has grown. And that is not necessarily what you want to see, but there are also a lot of reasons that can happen and it can have to do with buybacks. And so how does that really more broadly inventory turnover look for Crocs? Crocs does show a similar downward trend and its cash to sales ratio. is actually only 4 % for Lululemon. It was at least 12%. However, as in Lululemon's case, and even more so here, actually, buybacks have played a pretty significant role in recent years.

57:52Buybacks obviously lower the cash balance, but when done at the right prices, as I would argue is the case with Crocs here, they are great for shareholder returns in the long term. And another reason for low cash to sales ratio has been the cash spent on reducing debt after the hey-to-dead acquisition. And once again, I think that's a valid reason to spend cash. As a shareholder, I would prefer them to pay down debt as fast as possible, at least if we see those high debt levels compared to the market cap. Another factor to consider when investing in a fashion retail brand is its cash conversion cycle.

58:26The cash conversion cycle essentially indicates how long it takes your goods to be converted into cash. So when Cox orders a new shipment of these high fashion NBA clocks, how long does it take on average until those NBA clocks are turned into cash. And historically, Quark's cash conversion cycle has shown some volatility, but generally turned it downward, indicating improving efficiency in converting products into cash, a key sign of disciplined working capital management, and also tight control of inventories, which is something that the management definitely prioritizes. Recently, though, we've seen a notable spike, and while Quark's intentionally built up inventories like most fashion brands due to the fears that tariffs could materially increase import prices.

59:08The biggest factor was a sharp increase in accounts receivable. So basically the money Quark's is still waiting to collect from customers and management hinted that some wholesale partners are taking longer to pay than usually because possibly they face some liquidity pressures in retail and also of course uncertainty around the consumer. At the same time Quark's paid supply is a bit earlier than usually in Q1 and that's kind of accumulating at the same time. So inventory is not really sitting around longer in warehouses which would be a bad sign for demand. In fact Crocs is once again I have to say that best in class in terms of turnover as well so they currently turn around inventory about four and a half times a year well ahead of Adidas, Lululemon and also Nike and it's the only brand in this group that actually improved on this metric over the last couple of years.

59:59So the spike is mostly caused by timing, working capital frictions, and front-loaded inventory shipments. But management expects this to normalize throughout the years as the payments come in and inventory levels normalize. Well, I think it's time for our favorite part of the show, and that is valuation. And I think it's still been an interesting one because it's been such a popular pick in the value investor community. And partly I think it's because it just screens so well. You look at the profitability, capital in the last few years, revenue growth rates, and then you look at the multiple. And it's like, you can't help but ask yourself, how the heck is this thing trading at less than nine times earnings per share estimates for the next 12 months?

1:00:42It's just, it doesn't, it's hard to reconcile with what's actually been going on with the business. That's true. As soon as you start a screener, one of the first stocks that will always come up, at least if it's value biased, I would say, it's always Crocs. That probably also explains why it's all over the comments in our comment sections on YouTube, Spotify, basically wherever. So getting to the valuation, in my base case, I assume that nothing spectacular happens, but the brand just keeps executing as it did over the last couple of years. So revenue grows between 5 % to 6 % annually, driven primarily by growth in the international market and particularly as we mentioned in China and the North American clocks market is already fairly penetrated by quarks so I expect modest maybe four percent growth in that market combining volume and also price increases judging hey dude is pretty difficult since we haven't yet seen it operate after the restructuring however quarks management still believes in the brand and the turnaround and they seem pretty reasonable and realistic with the description of the current state so I kind of trust them going forward as well.

1:01:47It also reached the third place on TikTok store which they don't shut up about basically so Crocs reached number one but it's still a good place for HeyDude to be at so they definitely know how to play the social media game and I do think this will help them in the long term. For 2025 I still assume a high single digit sales decline for HeyDude followed by a slow recovery which leads to low single digit growth over the entire five-year period. In terms of margins, I assume they are more or less maintained at the current levels. If we compare it to Crocs and they kind of get the same synergies going and the operating leverage, they might increase, but I don't want to bet on that, at least not in a base case.

1:02:26And like many of our portfolio companies, Crocs is also a buyback story. I've used the same valuation mechanism as in my PayPal model, where there's basically a table showing you at what prices the company might buy back shares in the future and how much of its earnings they would have to allocate for that if their earnings power persists and the stock keeps trading in a multiple range between 5 and 10 those are the multiples i've used for this table it should be relatively easy for crocs to retire three to five percent of shares each year and that alone like single digit growth maybe mid single digit growth plus the share buybacks with a slight earnings multiple increase from 6.5 to 8 times trailing earnings and an 8 % discount rate as always plus a 20 % margin of safety just due to the uncertainties surrounding quark sustainability as a brand.

1:03:15I still arrive at an estimated fair value of about$105 and more or less that's exactly in line with the current market price. And if we indulge our inner bull I'm sure things will look better but how about you paint that picture the best case scenario for us. It's always more fun to paint in a best case scenario than a base case or even a bear case. So in my best case scenario, the international business really kicks in. I assume 15 % growth for the international business and a slight increase in the base case for the North American business. Hey, dude, we just double digit growth as well, but only starting in 2027.

1:03:50So after the restructuring, which will almost certainly happen and take a lot of time. So I didn't bet on a lot of further margin improvements, though, because I feel like the current margins are already pretty high. there are few to no other shoe brands that can deliver the same margin profile. And with the exception of HeyDude, I think most of the operating leverage has already been achieved in the past few years. So in this case, as you share a decline rate of 5%, so basically the upper end of the 3 % to 5 % that I beforehand already talked about, and an exit multiple of 11. So a bit more of an exit multiple expansion.

1:04:27And when Crocs hits these growth numbers, the multiple should expand, in my opinion. So it's only fair to kind of boost that a bit. And combining everything, this leaves us with a good amount of upside and a price target of above$190. But again, that's mostly driven by multiple expansions since I didn't really change growth or margin numbers that much. And just for good measure, how about we do the bear case too? I guess that's where it's going to get most interesting here since I think we both agree with the current valuation. there's plenty of room for upside, even if the business just sustains and doesn't really do anything special.

1:05:02And so really the fear is the downside of how bad things will be if the business really meaningfully erodes and crocs starts to look like a fad. So the premise of my bear case has been to basically determine how much crocs would be worth if we assume demand is significantly weaker and the business basically starts to decline. then this would turn into a full-blown buyback story without having a great business basically producing more and more cash flow each year so i kept the four percent share decline rate in place and as you can see in the model this should still be possible to finance for crocs despite almost 10 declines in net income and no growth in revenue which are my assumptions for the bear case if i do all that i still arrive at those outcomes by reducing gross margins to 50 percent the level they had prior to the pandemic and an operating margin of 18%.

1:05:54And just to say it, 18 % is still way above the levels that they've seen just five years ago. With no multiple expansion, but also no decline, since it is already trading at a very cheap multiple, I'll arrive at an estimated value in the mid to high 40s and that will be about a 60 % decline compared to the current levels. So all in all, it's only a question of whether Crocs is here to stay or just a fad and similar to lulu with the main difference being that you and i are very confident that lulu is way beyond the point where you gotta ask yourself whether it's a fad and the numbers suggest so as well lulu has delivered for over a decade probably more close to two decades what quarks has only shown since the pandemic and as value investors we want to minimize downside risk first and then think about the possible upside the upside is unquestionable in this case but at over$100, there is also the risk of Quarks losing its flair.

1:06:48And I think there's definitely an argument to make to buy it at$100. But having not too much conviction between the brand, I do not see it every day, just like you see Lulu every day. I think I would wait for a price a bit lower than these$100. I think this is one of those cases where if you genuinely have conviction in the brand and the products, there's probably enough of a margin of safety to justify making a bet at current prices. It's such a low multiple, even though the business could fall off dramatically. And I think Wall Street is already kind of predicting that over the next year or so, expecting 2025 and 2026 to be much less profitable than 2024.

1:07:25It still does feel a little picky to say that we need another 20 % decline to be interested. But I also don't know the company as well as you do. And we do already have some brand specific retail bets in our portfolio, including Nike and Lulu. And then on top of that, you have Ulta, which is a more diversified beauty retailer, but still is very much in the retail business. So I don't know, I think if you wanted to, Daniel, you could probably talk me into a position in Crocs at this valuation, especially if we can dig up some more consumer level data on the brand. So for example, you probably don't have this off the top of your head, but I would be so curious to know what percentage of customers return as repeat customers after an initial Crocs purchase, for example.

1:08:09And is the product so good basically that people keep coming back for more? Or are these mostly one-time novelty purchases of, I bought these kind of funny, ironic custom Crocs, and I'm going to wear them for a week, but I'm not actually coming back to seriously buy them. And if there were more of this customer retention, as we've seen with Lulu, I think that would be a much stronger argument for the brand's durability. So I don't know. I have mixed feelings. I think I'm generally a little bit more inclined to invest in retail than you, Daniel, but it sounds like you're not keen to take any action with this name today.

1:08:48You talked about the consumer data, and that's exactly the kind of data that I would have needed to get that last level of conviction. But unfortunately, there is no official data on that yet. There are many customers who have half a dozen of Crocs, even more so, but those are not the average Crocs customer. So those are the people that have a personal connection with the brand or are actual collectors and that's why they own so many crocs I would be interested in getting data on people who buy their first pair of crocs and then see if they come back within a year or maybe two years to buy the next and I think that's data that we probably only get perhaps in a year or two and if I could see those average customers getting back to the brand buying new pairs I would definitely be even more inclined to buy crocs stock i'm buying my first crocs right now so who knows maybe i will buy my next pair of crocs in six months and then we'll definitely revisit this and say the product is so good that we will become buyers of the stock but as you said i think there's a good case to make that you can invest in the stock right now personally i wouldn't feel too comfortable about the brand yet and since i'm the one pitching um and lack that bit of conviction i would currently not advocate for initiating a position.

1:10:03I'm thinking now that maybe I've got to get a pair. Maybe I'll get a TIP customized pair of Crocs and we can wear them to the Berkshire Shareholder Meeting in Omaha next year. That sounds good. I mean, see, then we only have two data points that would suggest people could become repeat customers. I think that's definitely enough to buy the stock. Twice as many data points as just you, though. Absolutely. So I think that will make for a way better investment case, definitely. Then you can even save up on the next 20 hours of research. All right. Okay. Having said all of that, we should maybe stop with the joking.

1:10:37And why don't you give us the hints for the next episode or perhaps the next company we will add to the portfolio? Okay. Well, just to correct for the kind of aftertaste that crocs can leave in one's mouth, I felt like we needed to do the polar opposite. So I went into something that is prestigious. It's got luxury. it's got sex appeal it's kind of all there but then also unlike crocs is that the valuation is very very rich and so maybe there's another hint that was a little vague this is a company with nothing short of a cult-like following and really this will maybe give it away it has a history of dominating the sport of f1 in particular so maybe that's too obvious but i know there are a lot of people out there who actually may not know F1 Formula One racing all that well either.

1:11:27So maybe it's still hard to guess. True. It's not too obvious, I would say. And I don't even know yet, but perhaps when the day comes that those two brands have a collaboration, the ones we pitch next week and Crocs, that will be the day when we start buying the stock. Yeah, I agree. All right. So I will leave you today with a bit of an unusual quote, but I thought about it multiple times doing my research so i just had to include it it's by the fashion icon carl lagerfeld and he said quote sweatpants are a sign of defeat you lost control of your life so you bought some sweatpants nowadays sweatpants are everywhere many people thought the same thing about crocs nowadays they are everywhere so let's see for how long and with that we will see you next sunday

1:12:21Thank you.