3 Reasons Another Shoe May Drop for Skechers

3 Reasons Another Shoe May Drop for Skechers

Last summer, Skechers U.S.A., Inc. (NYSE: SKX) was reopening stores, launching new products and expanding overseas. Growth investors loved the results and the stock ran above $50.

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It’s been a steady downhill jog ever since for the sneaker retailer.

Skechers recently posted another disappointing quarterly performance as earnings fell short of the consensus estimate by almost 10%. The miss was compounded by a weak fourth-quarter outlook, a less-than-ideal situation with the key holiday shopping season ahead.

With the stock trading 30% below its all-time high, Skechers may seem to be in the bargain aisle. At 13x forward earnings, however, the valuation is roughly on par with the industry.

Beyond the valuation, several hurdles lie ahead as the company limps to the finish line in 2022. Here are a few reasons why there may be more skid marks on the Skechers’ slide.

#1 – China’s Extreme Covid Policies

Like Nike and other athletic brands, Skechers is dependent on the Greater China region to drive much of its growth. China revenue accounted for 20% of total revenue in 2021.

So while overall sales jumped 21% to $1.9 billion last quarter, sales in China were flat. This prevented the company from turning in a blockbuster top-line result.

The high volume selloff that ensued may appear to be a nitpicky overreaction. But since the company has poured so much money into China in anticipation of high growth, the lack of growth was appropriately viewed as a buzzkill.

To be fair, things are largely out of management’s hands. China’s strict zero-tolerance Covid policy led to insurmountable lockdowns and restrictions. 

And with the Chinese government still not budging from its policy despite speculation that it may, economic growth in the region could be stifled for the foreseeable future. Until restrictions are lifted, Skechers’ exposure to China will deter buyers from trying on the stock.

#2 – Supply Chain Constraints Persist

The supply chain disruptions continued in Q3 and were once again cited as a reason why profits weren’t better. Bottlenecks at shipping ports and freight congestion are causing Skechers distribution network to operate inefficiently. In turn, fewer products are showing up at wholesale warehouses and athletic retailers’ shelves (including at Skechers own stores).

An inefficient business often translates to declining margins, and that’s what we are seeing at Skechers. The gross margin dropped 2.8% to 47.1% last quarter, and while increased transportation costs were factored in, the supply chain problems created inefficiencies throughout the business. Skechers operating margin slipped to 6.9%, an uncomfortable level of profitability in the ultra-competitive sneaker market. Raising prices is only getting the company so far.

Logistics issues are expected to persist in the current quarter and were a reason why management offered soft guidance. At the midpoint, it is forecasting current-quarter revenue of $1.755 billion, which would represent single-digit growth for the first time since the early pandemic periods.

The good news is that demand for the latest Skechers innovations is healthy. Unfortunately, until congestion at distribution facilities improves, margin trends will remain unhealthy.

#3 – Street Estimates Have Downside

In the wake of the Q3 bummer, the consensus earnings forecast for 2023 has started to trickle lower — but probably not by enough. For the first three quarters of next year, analysts are projecting EPS of $0.81, $0.79 and $0.85 respectively. 

Not only do these imply a big improvement from what’s anticipated in the current quarter (EPS of $0.36), but they would be the best bottom-line results Skechers have turned in yet. If other downward revisions follow as they should, the market is not likely to take kindly to this and more selling could ensue — especially with the stock down 16% year-to-date and investors looking to dump tax-loss candidates.

Yes, demand is strong and the top line is growing well, but there are just too many cost headwinds to expect 30%-plus profit growth ahead, even off a weaker base. Materials inflation, higher freight, and labor costs, and the strong dollar are simultaneously tugging against Skechers margins — and not expected to disappear anytime soon. About half of Skechers sales come from outside the Americas region. 

Add to that the weakening economic landscape which could turn strong demand into moderate demand. Further lockdowns in China could dent consumer spending even more. 

Yet another reason for earnings to fall short of expectations is Nike’s ongoing litigation against Skechers regarding patent infringement. This holds the potential for significant legal expenses and, worst case scenario, ends in a large settlement. 

Bottom line: Skechers faces increasing pressure on both the sales and cost sides of the ledger. At some point the stock will be on clearance, but it’s nowhere near there right now.