Chit Chat Stocks - Skechers (SKX) with Ben Claremon

Episode Date: March 3, 2022

Skechers designs, produces, and markets footwear for men, women, and children. The company has a wide range of offerings. Skechers makes casual shoes, hiking shoes, and even light-up shoes. The company is headquartered in California. Listen as Brett and Ryan ask Ben Claremon questions about the company, its business model, and valuation. Enjoy the show! This episode is sponsored by Quartr, the new way of doing company research. Access conference calls, presentations, transcripts, and more for FREE on your mobile device. Download Quartr on the App Store here: https://apps.apple.com/us/app/quartr-investor-relations/id1552412128  Download Quartr on the Google Play Store here: https://play.google.com/store/apps/details?id=se.quartr.android Subscribe to 7investing with the code "CCM" and get $10 off: https://7investing.com/subscribe/aff/4/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Interested in more of Ben's work? Follow him on Twitter here: https://twitter.com/BenClaremon?s=20&t=Rvi3WbDtLheM2-rKPV5CNw Contact us: [e-mail]  Timestamps Sketchers | (3:27) Valuation | (31:00) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. Today, we have an interview, a deep dive with our friend Ben Claremont. He is a PM or a portfolio manager at Cove Street Capital. And we talked about Skechers, which was pretty fascinating because it's a business I am very familiar with the product. I think most American consumers are, but it's a business I'd never really looked at. Did you have any highlights from the interview? Yeah, I think his overview of where they're going to get their operating leverage. I think the overview of the management was great. He went through how there were a lot of red flags on the proxy statement beforehand and how they have this dual-class ownership structure, the family ownership stuff, but how that may have changed

now. And then also why they've been so durable in the marketplace and why they stuck around, even though the brand value may not be thrown around as being as high of a quality as someone like Nike or Lululemon, they've been able to compound the revenue over a very long time period. Yeah. And before we get to the interview, we want to talk about our sponsor. It's Quarter. If you are a longtime listener, you are familiar with Quarter, but they are the investor relations app for your phone. You can get your conference calls, conference call transcripts, presentations, all from one place, pretty much any company. I'm looking at the app right now and they've got, if you haven't seen it recently, update the app, go check it out. They've got a whole new explore page. I think I might've talked about this last time, but you can go to make a trends. So let's see war on cash. Click on that. All right. They've got visa. You can follow, check out all their conference calls square, uh, or I guess block.

There's a, there's tons of different options now. It's really cool. It's revamped. They continue to build out new stuff. If you're on iOS or Android, you can download it. It's free. Go ahead, check them out. And it's quarter, Q-U-A-R-T-R, no E. They also are on Twitter. They've got some funny memes. I think their meme content is top-notch. So follow them there as well. It's quarter underscore app. But without further ado, let's get to our interview. welcome to chit chat money on this show host ryan henderson and brett schaefer interview industry experts and riff on the world of investing as a quick reminder chit chat money is a ccm media group podcast ryan and brett are also general partners at arch capital

and arch capital may have positions in the securities discussed in this podcast anything discussed on chit chat money by ryan or brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. Today, we are joined by Ben Claremont, second time on the show. First time, I want to say was about, gosh, what, three or four months ago. And we talked about EW Scripts, if I'm remembering that correctly. And today, we have a bit of a different company. it's a name I bet a lot of people have heard of, maybe haven't looked at the company, but we're talking about Skechers. Oh, and then I guess as a reminder, Ben is a portfolio manager

at Cove Street Capital. Ben, welcome to the show again. Excited to talk Skechers. Yeah. Thanks for having me back. Looking forward to it. So do you want to go through, I imagine people know kind of what they do, but do you want to go through, I guess, the ins and outs of Skechers business model? Yeah, happy to do that. And one of the things I love about Skechers and retail companies in general is that it's a pretty simple model. The only real complexity comes from how they go to market outside the US, especially in developing markets. And I will go a little bit painstakingly through that because it is, you know, aside from the fact that they sell

shoes and apparel around the world and it's like in retail settings and in e-commerce settings, that's the easy part but it's the nuances of how they do it outside the us that we'll get into a little bit um so they they really go to work to go to um market in two channels which is first is direct to consumer um and that includes stores and e-commerce and then you have a wholesale division where um they go to market in a few different ways one is direct so if you think of how do the shoes shoes like selling shoes directly to Macy's to put on a Macy's floor right so that's that's the easiest one to understand but then outside the U.S. they work with distributors joint ventures and subsidiaries and we're going to get into the nuances of those in a minute but again that's

where the the little bit of complexity shows up the company is three segments and and all of the business channels are exist within these three segments and so one is direct to consumer and that includes company-owned and joint venture stores. They have an international wholesale segment. And within that is where the bulk of their total stores are. And so through that segment, they sell Skechers products to distributors and licensees who operate Skechers stores in over 170 countries. So at the end of fiscal year 2020, sorry, their 2021K is not out yet. So I don't have like all the updated numbers of like the exact nuances of where the stores are but just just to for for context there are about 2500 stores that were only kind of operated by distributors

and licensees um at the end of 2020 um and then they also have a domestic wholesale business which is really the simplest business to understand they sell shoes to jc penny and macy's and and specialty shops, um, all around the country. Um, and so before we go into those channels, I just want to take a step back because you said something that I think is important is that people have heard of Skechers. A lot of people haven't looked at the company. And so let me just give you a sense of, of the size and the scale of this company. So if I asked you what the third largest shoe brand in the world was, do you think you'd say Skechers? No, you probably wouldn't, but it's true. Um,

The company was founded in the early 90s right here in the South Bay of Los Angeles. We could probably almost see a Skechers building from where I'm sitting right now. And, you know, I would say that we have a long relationship with the company. We know, you know, our founder knows some of the family members. We have a good relationship with the CFO. Their offices are seven minutes from here. So, you know, I think sometimes proximity gives you just a little bit of an extra understanding of how things operate and how people how people think. And so I think we we have the benefit of that at Coe Street.

So the company just surpassed six billion in sales for the first time. That's a real number. You know, there aren't a lot of like apparel companies and shoe companies in the world that have six billion in sales. It's really important to note that the majority of those sales come from outside the U.S. I think often investors in the U.S. don't appreciate the strength or the reach of the brand internationally. And we'll talk a little bit about brand positioning and brand perception outside the U.S., but I would just, as you're thinking about this business, think about it. This is an international growth story, right? Like the growth that we're going to discuss of how they've gotten there to $6 billion, some of that is domestic for sure, but a lot of that's the international growth. And so how are they positioned in the market?

They go to market with a focus on comfort. And I think like if there's a unifying trait, regardless of the type of shoe, comfort and then probably value is another thing that they focus on. Skechers wants its products to be everywhere people shop for shoes, whether that's virtually or physically around the world. So I wouldn't definitely, I mean, and my guess is your brand perception is consistent with this, but this is not a brand exclusivity story. Like if you were investing in Louis Vuitton or Prada or something like this, Skechers actively wants the products and the brand to be ubiquitous.

So I'll stop there before I go into the segments. Any questions on what I just went through? No, I just find it interesting that, and we talked about this before we hit record, that my initial perception before looking at the business was this is sort of a stagnant dad shoes type company. Yet then when you go to the website, the, the offering is much more versatile. There's a lot more to it. And it's been, it has a very different track record than what I would have thought. I know Brett has a question on gross margins, but do you have anything else on the business model before we move on? Yeah. I just want to, I want to talk about the three segments because I do think it's important to frame it because it's going to get

to your questions about margins, operating leverage, like the things that you want to understand as an investor, it all, you know, from a bottom-up basis, it starts with the segments. So let's start with direct-to-consumer because I think that's probably the most exciting one for them. So if you look at the Skechers brand, there are 4,300 stores in 180 countries. But as I mentioned, not all of those are within the direct-to-consumer segment. A lot of, sorry, direct-to-consumer segment. A lot of those are within the international wholesale segment where they are selling to their distributors and licensees. At the end of 2020, they had about 520 domestic stores and 330 international stores that were company-owned. Take a step back and

think about that. There were only 330 international company-owned stores. That's a pretty small footprint given the number of people in the world, the number of countries they're in, So I think that would indicate to you that over time, you could expect them to build incremental stores around the world with a fair amount of white space. And so, you know, getting to what Ryan was addressing is that the sales CAGR in the direct-to-consumer segment from 2017 to 21 was about 11%. And that's even with a drop in 2020 due to COVID. So they've been able to compound direct-to-consumer revenue at a really nice rate, even with all of the COVID headwinds. The most interesting thing about this segment is it's by far the highest gross margin segment.

They generated 67% gross margins in 2021. So what's been happening, if you look at the financial statements, is that the growth in the direct-to-consumer segment has been dragging up the company's gross margin. So, you know, in 2017, it was under 47% on a gross basis, and it's over 49% today. So that couple hundred basis points of margin improvement is how you've seen operating margins start to improve as well. The big opportunity for Skechers in general, two things. One, I think, is continued international penetration of the entire brand. But the second thing is e-com is really a big opportunity. and if this sounds like a conversation we should have been having in 2012 it is because i would argue they were pretty late to the game in e-commerce um you know as of june this is gonna be an amazing stat as of june 2021 they only had live e-commerce sites in five of

the markets where they operate wow there's 180 countries and in five markets they had um live e-com now you can look at that as kind of two ways you can say well you know what is wrong with these people? Like, didn't they see the writing on the wall, you know, in 2012, that e-commerce was going to be a big thing. And to some extent you could say yes, but you can also look at it as an, as an opportunity because they've made a ton of investments to become in kind of like, you know, whatever, whether, whether the table stakes for e-commerce or even become more best in class, they've made a lot of investments there. And so they started to go live with updated e-commerce sites and platforms around the world, most recently in India and the UK,

for example, and with a bunch more countries to go live in 2022, they've also said that they hope to be live with e-com in almost all of their countries by the end of 2023. So this push, somewhat belated, I think is a large facet of the growth opportunity over time. And so I think there's a pretty long runway. And the hard part for an investor is to magnitude, scale like it's hard to even assess how big this could be when they're only live in five countries and you know over two years they're going to be live in another hundred countries so one one question before we go on and i don't know if you have the number in front of you but how much of their overall sales come from e-commerce digital channels so um i don't have that as i said the

2021k is not out yet um they stopped reporting that number a few years ago um and so i don't have there may they may have given some directional guidance like with you know whatever sub x percent but i don't i don't have that number at the top of my head um right now and i like that was one of the things i wanted i want to like dig into a little bit i mean we know this company but like as they stopped reporting that number um you know we haven't had a lot of granularity there in recent times all right uh that was a great overview i think everyone can kind of understand what Skechers business is now. But the thing that kind of popped out to me was the DTC gross margins. That was at least the first thing that popped out to me when I was looking at this business.

And you explained why that's the case. It's growing pretty quickly, at least compared to the overall business. The one thing I want to pin down, though, is how much do you think it can help with overall profit margins? I know they're right around, and correct me if I'm wrong, I think they're at 9% for the overall business right now. Correct me if I don't have the numbers in front of me. Do you think that DTC could help them push up to, you know, 15% operating margins, 20% operating margins over time? What kind of, you know, what are you guys expecting as investors in this business? Okay. Well, let's just start with what the company has said about margins. So in 2019, the company almost cracked double digits and they

hit operating margins of 9.9%. So if you listen to what they say, getting to double digits margins is the near-term goal. You're right, Ryan. The number was about 9.5% in 2021. They're right near that hitting double-digit numbers. The company's goal, as stated, without a time frame associated with it, is to get to low team's margins over time. The company also has a 2026 stated goal of $10 billion in revenue. That's relative to $6 billion today. Adding almost $4 billion in sales over the next four or five years. And my sense is that the operating leverage, assuming they could get to those levels, would push operating margins higher.

But to get into your specific question, some of the ultimate margin depends on the mix. So if international wholesale grows faster than direct-to-consumer, the gross margins on that business are about 20 uh 2000 basis points lower so as opposed to mid-60s more like mid-40s so if that business grows faster you won't see the margin increase be as impressive so to some extent the answer we can see their targets you know in both near-term double digit longer term low teens as low teens mean 13 14 15 i don't know right like like these so much of this depends on what grows fastest, and to some degree, also, you know, how fast they can grow in e-com. The company has said that e-com margins are accretive to segment margins. So that means that

that 67% gross margin in the direct-to-consumer segment, e-com sales are accretive to that. So, you know, there could be tremendous, if there's tremendous growth in e-com, it's going to drag margins up. So the simple answer is, I don't know. Most analysis five years out is going to be fraught and difficult. But just think about the dynamics. The faster growing segments, which are direct-to-consumer and within that e-commerce, have higher than average gross margins. So you would assume that that drags the whole gross margin for the business up. And then in theory, you'll see a fair amount of operating leverage. But to be fair, this company has invested aggressively in SG&A in order to be able to create the platform for growth.

Is there a segment that you think will grow the fastest? I mean, I guess I'm not super familiar with footwear wholesale. Is there like sort of a shift to DTC or what kind are you seeing? you know this gets a little bit into the nuances and the complexity of the business um so tell me where who owns and operates the stores and i'll tell you you know where you know where the growth is so if the growth is in developing markets where they don't own their own stores and they're selling through distributors and joint ventures um and licensees then you're You're going to see growth in international wholesale, and that's going to be a lower gross margin than if they are physically opening stores in China, for example, through their JV or some other markets like Mexico, where they own the subsidiaries and it's basically

their stores. So again, all we can really do is go back and look at the track record of success. and the two segments that have been growing the fastest are direct-to-consumer and the international wholesale. Part of that is, on the international wholesale side, some of that's just opening up a lot of new doors with their partners. I would assume that's where they're going to continue to see growth. The fact is, if that grows faster than direct-to-consumer, it's not going to have the same positive impact on margins, except for the fact that you're going to be generating a lot more gross margin dollars over time.

And then the question is, how fast does SG&A grow within that? My sense, and the company has said that they would cap SG&A growth at revenue growth, which means that's almost like margin neutral. But to get to their low teams operating margins targets, the math simply tells you that you have to have revenue growth faster than sgt and a growth in order to to see margin expansion so um little hard to know exactly where it's going to come from what's going to grow fastest what the eventual margin is but i think the key point for to understand is that at you know at the stock price today we don't think you need to get to 10 billion in revenue and 13 operating margins let's

say low teens is 13 percent for to make money from here are given the complexity given you know just you know the uncertainty of where the growth is going to come from and and how margin creative it's going to be our numbers are much more pedestrian than that and we still find it a very compelling investment okay so you talked about the 10 billion dollars management has that is one of the big goals is there anything and i know we've this might sound a bit repetitive but it is so important to the, you know, the thesis, even though you said that we don't need it to make money, but if it does happen, you know, obviously that's, you know, a little cherry on top. How do you think they can get to $10 billion in sales? Is it all international or is it going

to be, you know, domestic as well? Yeah. So if you just think about the math off of 2021 numbers you know, if I'm doing my math right, that would be about 9.6% cater to 2026. So that's, that's a pretty solid growth, right? I mean, most of us would take a business that's in, you know, kind of a mature industry, which is apparel and footwear is not like a, you know, it's not like a whiz bang new tech thing, right? This is selling shoes. And so there is some TAM growth, and there's growth around the world. But you know, that that's probably, that's probably taking share somewhere, given that level of growth. And just just to provide some reference, over the last five years, the revenue of Kager has been about 12%. And that

includes the drop in 2020 due to COVID. So somewhere still lower than historical growth over the last five years, but still pretty good growth. And the law of large numbers, which suggest that it's harder to grow off a $6 billion base at that pace versus a $3 billion base. So to some extent, lower growth should be expected. But getting specifically to your question, The ingredients are there based on the investments the company has made in infrastructure, new stores, omni-channel capabilities, and especially e-commerce. And so where is the growth going to come from? China will probably be a big part of that. The growth in China has been really impressive.

If you just compare Q4 2021 versus Q4 2019, they're 32% higher in China. It's already a billion-dollar market for them. um so that should continue to be a growth a growth engine obviously um there's plenty of discussion about growing anti-western brand sentiment in china that wouldn't be helpful but skessers has been in china for a long time they actually opposite occupy a premium brand position there um um and i was joking i mean this is not they're not selling louboutins right this this is these are still athletic shoes. But my point is the gap between brand perception of Nike and Skechers is pretty wide domestically today, but it's not quite as wide in China. So they've said that

China growth is accretive to margins, the company margins, because of that elevated brand perception and their pricing power. Another market that's really exciting for them is India. I think many western brands recognize that being successful in india is not the easiest thing um but sketcher's been investing there pretty aggressively they have a new distribution center planned in 2023 they recently brought bum they recently bought their corporate headquarters in india so um we should see growth indoors number of stores whether that's you know company operated or or jv operator distributor operated stores as well as growth in e-com um and then i think southeast asia is another growth i mean if you just listen to john vandemore i think he does a

really, who's a CFO, I think he does a really articulate job of saying, you know what, we just have a lot of growth avenues and Southeast Asia is a wide open market for us. And so it's really hard for us to say one thing, this is the one thing that's going to get us there. And I will say that as an investor, I don't know if I want to underwrite one growth opportunity, one growth avenue, because what happens if that slows down or whatever hits a speed bump or something throws you off your trajectory, then the growth engine stops. I think Skechers has a lot of different places it can win as it has methodically kind of rolled out the brand across markets. And so there will be some growth in the domestic wholesale business. The company thinks it can

grow mid-single digits in domestic wholesale. I think it's probably low single digits, but we'll see if the company's right i think we'll see margin accretive direct to consumer growth around the world and then pretty aggressive expansion of international wholesale because they're still as we mentioned they're they're under penetrated in you know in the company-owned stores around the world they're under penetrated in terms of like really big markets that are growing that where the brand can have a lot of runway so um you know i don't it's it's it's thinking about a security where you have multiple ways to win. And I think Skechers has a number of growth avenues. Most of them, a lot of them are margin accretive. And, you know, I don't want to,

I know I'm going to be wrong in terms of like the exact rates over the next five years. And so that's why we build in a certain level of conservatism. And I think it's worth bringing up now that, you know, relative to that target, which is, you know, kind of $10 billion in revenue and let's call it 13% operating margins in 2026, you know, my numbers are more like $8 billion and 10% operating margins and still attractive from here. So clearly, if they hit those numbers, the management plan numbers, the stock's going to be worth a lot, lot more, right? And so that's just kind of like gravy and upside.

And if you look at the history of this company, they have continued to beat people's expectations regarding how well they can do and they've continued to kind of like um change people's perception about a the brand and b you know what that brand how that translates into growth i was reading through the conference call and one of the or i guess all throughout a lot of the analyst questions kind of talked about the supply chain stuff and i forgot to throw this in the notes but how has that impacted them has it has it had a big impact and then what are they is there any way they can kind of mitigate it you know it's it's it's impacting everybody i mean if you think if you read through um you know the recent calls um logistics costs are up so it's

hurting gross margins i think they're having to air freight a lot of product um and that's really really expensive and so if you're looking kind of backward like it's impacted margins it's probably they probably they've said that we would we have more we would love to have more inventory than we actually have because we could sell it um and so they probably left some sales on the table and i don't know does that ever come back do they lose that sale it's kind of hard to understand um you know so i think this is going to be a headwind for 2022 um i mean they have put out some you know whatever continued impressive growth numbers and both growth uh both revenue and eps for 2022 i'm looking out longer than that but in the short run i think 2022 is going to be somewhat

hindered by all of that um you know i think for this to be a good investment you have to be willing to look out five years um and i think you have to say that the greenberg family that you know that started this company is likely the first store in that you know 1992 or 91 or something like that in manhattan beach right and now has you know 40 some hundred stores and six billion in revenue that they know what they're doing. Um, and that, you know, throughout that period, just think of how many, whatever, um, interim issues they dealt with, whether it was nine 11, whether it was most recently with COVID, you know, whatever, whatever thing that has happened geopolitically, um, or economically, this company hasn't been able to expand the brand through it. Um, and so, you know,

I'm a believer of that, but I can't promise that over the next four quarters or a year and a half that the growth or the margins are not going to be impacted by all of the things you read about in the newspapers. Do you see any pricing power for them? I think they may have mentioned that they were able to get a little more pricing, but I think there might have been less discounts or so. Yeah. So I think one of the most under-discussed things on Wall Street today is the pricing power that we've seen in brands, especially like apparel, handbags, shoes. So what's happened to some degree is that the promotional environment is completely different than it was when everyone had decided that retail was going away and that malls were going to die and whatever, that 2018, 2019 narrative.

Part of that was because it was so competitive that the companies were promoting like crazy. And so that really affected margins and growth for a lot of companies. And that has totally flipped because of COVID. And so the promotional environment is very, I think, timid. And so if you look at the pricing power that Skechers will report the number of pairs of shoes it sells in certain segments, and you can get a price per pair, and you can see the pricing power. And so they have less due to raising prices, but more so to the promotional environment being just much more reasonable. they have been able to increase what's what's aur the average unit retail price um i question to

some degree this the sustainability of that pricing power i'm not saying that they're going to be losing um you know whatever like price per pair is going to go down necessarily like a lot but my point more being that the promotional environment i think will normalize a little bit i don't know if we go back into a crazy environment where it's just like you can't no one can make money, but I do think it'll come back over time. So I look at that as I'm modeling this because I like to model from a bottom-up perspective. I'm not modeling in a whole lot of continued pricing power, kind of like pricing stability given the partnership that Skechers offers to its wholesale partners around the world. I think what Skechers, their goal is to

over deliver comfort and style relative to the price so basically have a shoe that is a really good value when you think about the price relative to comfort and style um and your performance and they design the shoes to have a good gross margin within that framework and so i don't see and of Of course, anything can happen, but I don't see a whole lot of pricing pressure on that. And I think the best case, looking realistically, is stability in pricing with an expected, maybe more promotional cadence as the world kind of emerges from the COVID malaise that we've been in over the last two plus years. Okay, we have a few questions on valuation, but before we get to those, we're going to hit a quick ad break. this episode is brought to you by kpmg as a business leader how can you innovate build trust and move forward in a digital era kpmg can help by bringing together the right talent and

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Tonight, La Quinta. Tomorrow, you triumph. Book your stay at LQ.com. Okay, welcome back in. I guess one question before we get to the valuation component. And you, when we were talking, I guess, when we were exchanging emails before the show, you mentioned that I should definitely ask about this, which is the AB shareholder structure and then the Greenberg's control of the company. So why is that such a big part of the thesis

and just thoughts on that generally? Yeah. And I think it's one of the things that held us back from investing in this company for a long time. um you know we are we are fans of owner-operated businesses um family control businesses are often you know whatever you know that some some guy in omaha owns a lot of his in controls berkshire right and so but it's not it's not an it's not always a good thing right because you want someone who's aligned with shareholders who understands what shareholders need but also can take short-term pain for a long-term gain and make investments that maybe don't look great right now, but over the long run are going to pay off. So I think this has been a constant

source of conversation here. It's like, do we underwrite what the Greenbergs have done and have created? And so I'm just going to take a step back and give you a little funny anecdote that explains our thinking here. And so I guess lecture every year to UCLA value investing students within the undergrad program about assessing management and assessing corporate governance. And I give students homework before the class that consists of reading two proxy statements. And the example I use of a bad proxy statement is a 2018 Skechers proxy. If you open up that document, you will see a staggered board a dual share class a laundry list of related party transactions only five independent directors multiple family members on the board so like in terms of

governance stuff um in addition there's a lot of red flags um and so you know as i'm trying to get the students to think about what what's a good proxy and what's a potentially not a good proxy right like i want them to go through all this and see all of these things and say is this is this a good is this is this a good thing is this a bad thing you know who are you partnering with you know is it as an as a shareholder is a minority shareholder is this is this a positive thing um you'll also see the compensation was based on quarterly sales numbers which i don't know if i've ever even seen that like that is such a short-term number it's a sales thing so i mean are you growing at the expense of margin so you know i use that as an

example of a bad proxy because I think for Skechers, you used to be almost uninvestable because of all of this. Now, I will say the proxy has gotten a lot better. The 2021 proxy is not out yet, but if you look at the 2020 proxy, things are better. They're still compensated on quarterly EPS, which is not something I love, but at least there's a profit component in there. They've moved their equity comp to include total shareholder return in EPS, which I think when I first looked at, it was all time-based. There was no performance-based equity comp. They now have six independent board members. But the broader point is that as of the last proxy, the Greenberg family owned 91.6% of the voting shares and 15% of the A shares. And so what that means is that

this is a controlled company. And the fact is, as you're thinking about this as a potential investment or something they're looking at is the greenbergs are going to do what they believe is right for the company over the long term and i know the company is getting some pressure from an activist um a company named tremlett capital um and i'm all for outside shareholders having to see the table regarding the future of the company but knowing this company as well as we do you know we find it hard to believe that any major change is coming you know yes it's nice that they're going to be, that they have a $500 million stock buyback authorization over the next three years. They definitely are going to generate a lot of cash over the next few years. They have

$500 million in net cash on the balance sheet. So they definitely can buy back stock. But I think as an investor, and I kind of mentioned this, is you kind of have to trust that they know what they're doing. The long-term results are very, very impressive. But within that, you can critique that there's been a lot of room for this company to quote unquote grow up you know they're no longer a copycat designer you know that like when you read the k there was like seven pages of patent infringement um liability discussion you know i think this company was almost unabashedly a fast follower of other shoe companies styles and designs in the past and what's changed is that I feel like they've gotten the scale and the ability to create innovation and design and new designs on their own, especially when it comes to comfort.

And then also, as we were talking about offline, is that John Vandermoer, the CFO, has just been an incredible addition to this company. He's a super professional CFO. I think with John as CFO, the company's aggressively invested in the systems and technology that the company was late to invest in. And all of this should be helpful when it comes to long-term growth. So the broader point here is that you have to know who you're partnering with. And the Greenbergs may have a time horizon that is a fair amount longer than most investors or their clients.

so you know the things that you kind of wish had been done tomorrow you know may take two or three years um and so you know that i think you have to appreciate that and just look at the track record and say all right well so how has that approach worked over time and i would argue it's been um been pretty pretty solid the results but we you know we shouldn't we shouldn't expect them to lever up to buy back stock or stop spending to boost margins right they are going to continue to invest. They're going to continue to have a very conservative balance sheet. But I think taking the broader perspective is everyone wins if this company can get to $10 billion in sales. But they may do things in the short run to depress margins, to depress cash flows that

make the short-term results look crappy, all within that broader $10 billion sales growth goal. you also said i think you mentioned that there is an activist that's or pressure from an activist is there anything an activist can really do here if there's 91 voting power to the family you can shame the company you can you know you can make them you can put out a presentation saying that they've under performed in this way or they've you know been late to e-com and all that stuff i think the company would admit some of those things you know but you know there's there's not a lot to do, right? This is, so this is the good and the bad investing with control companies is that you have an owner operator who has a long-term time horizon. And, you know, if this

person, he or she, or the board understands what they're doing, that can create a lot of value over time. But you have limited ability to influence the situation as an investor, regardless of how many, you know, what percentage of the boat you, you know, the A shares you own. So I just think it's something to consider. And as I said, this was, this was a situation that we were not willing to underwrite until we saw a new cfo uh an improvement in the proxy statement um a scale um that added a diversity of growth streams and and earning streams that would you know almost so that this company wasn't bad driven anymore you know the shape ups were really big for three or two or three years and then you know they fall off and then their their revenues way down right like

That kind of fad-driven, hit-driven, copycat, Me Too brand, I think has morphed into like a legitimate global brand that has the ability to take share. And that was kind of a light bulb moment for us that finally made us comfortable making this investment. Okay. Let's talk about the valuation briefly. Just for context, do you have any of the, what is the size of the company and then how are they generating in i guess how much do you think they'll generate normalized profits and

then what does the company need to do to make this a good investment yeah um so let me um i just want to be totally accurate with my i forgot to check out the market cap so as of today the market cap is um so 7.3 billion market cap so let's stop 47 stock 7.3 billion market cap um and so let's let's talk about valuation um let's since we've talked a little bit about the management plan and the goals of this company um let's let's start off with that so if in 2026 they generated $10 billion in sales with the low end of their margin goals, which would be 13%, that would imply about $1.3 billion in operating income. This company basically has no debt, so interest expense is not high. Tax rates have been in the 20% range. And so if you just take

those numbers and add they've they've been they've been kind of like flat to neutral and shares outstanding over time but let's just be conservative and say the shares increase over the next few years that would be you know 1300 uh 1.3 billion operating income translates to about 640 in eps on a 47 stock so that's um that's a multiple of seven and a half times um the last five-year average PDE is about 20 times. So that would suggest to you a fair amount of upside if you could trade at 20 times 640 in earnings, that's $130 stock. That's 173, kind of 170% upside. All right. Obviously that's the management case. If most companies hit the management plan, the stock will go up. That's not news. But that's just to give you a sense of like,

If the company hits on all cylinders for the next five years, you're talking about a $130 stock. So I am personally a lot more conservative in nature. And I recognize, as we talked about, it's just a little hard to handicap the probability that they can continue to grow at a 9.5% CAGR on a revenue basis or what the eventual margin is going to be. So, you know, so as I'm sitting here today, thinking about what would be a fair price in three years for this stock, you know, I have about $7.8 billion in sales in 2024. That's a 7.2% CAGR off of 2021 numbers.

And that gets you to about $3.33 in earnings. and uh if you put the 20 multiple on that that's a 67 stock price and that's a 42 percent upside from here um and and just for some context the sell side numbers for 2024 based on cap iq are 450 so i'm at 333 versus 450 that's a big gap and you could almost say that if they hit my numbers the stock's going to go down um because because they would be they would be underperforming relative to what people expected um so that's that's one way to value the company just very simplistically like we don't focus on earnings per share we do dcfs we do some of the parts we do evd but we like to triangulate value but i just like for for a simple way of thinking about it

management plan if you put a 20 percent 20x multiple on the management plan you're getting 170 stock if you're getting if you put that 20 multiple on on what i think they can do in a few years. That's more like a high 60s stock. And that's kind of corroborated with a 10x EBITDA multiple on 2024 numbers. That gets me kind of high 60s as well. And then on a DCF, which is something that we focus on a lot, it's just a little harder to talk about because you don't have it in front of you. But if I have a 9% WAC, that gets you a $55 present value on our conservative numbers. So all three of those things are suggesting that on somewhat conservative numbers relative to what the company thinks they can do, that you have a fairly undervalued

stock with a significant amount of upside if they can indeed hit their numbers. And so understanding that I'm going to be off regardless of what I put into my model, I like a company where I think the intrinsic value is higher than the stock price today that you would buy more of on the way down, especially if they missed, you know, quote unquote, Wall Street's expectations, because you think that there's a compounding nature, right? So I think if you have a three to five year time horizon

and Skechers has a bad quarter because of whatever, their margins are down, their sales aren't what people expect. If you believe in the trajectory, you would buy more on the way down, right? And so we all, we have this Buffett and Graham framework, which is like, is this a Buffett, which is a business is getting more valuable every day.

Or is this a gram, which is a cheap security that has some kind of marginal business or secular problems? This business, if you just look at the success, has kind of leaned towards a Buffett. And you want to buy a Buffett as it goes down. Now, I say that with a little bit of trepidation because the margins and the return profile aren't aren't necessarily on when you look at that when you look at them today you know are they indicative of buffett i'm not sure right and but some of that's because they've they've intentionally depressed their returns on invested capital and their um their margins in the short run in order

to create a platform for growth so you know i think this company has has continued to have to prove itself to the market and to investors. First, you have to believe that this family is aligned with you. Then you have to believe that the brand has transcended some of what it was a few years ago or many years ago. You have to believe that the brand perception is strong enough outside the US that they can continue to grow there. I think if you're wondering why this company trades at relatively pedestrian multiples, relative to the growth opportunity relative to its history, I think it's because people just don't believe it. And I don't, I'm not going to argue that we're at some unbelievable inflection

point where people are just going to wake up and say, wow, this is actually, you know, this is a compound or this is more of a Buffett stock. I just think they're going to have to prove it through the trajectory of earnings and revenues and cash flows. So I don't, I don't, I don't expect, I think this is an investment where you wouldn't expect some overnight re-rating. What you would expect is just a chugger, just a compounder, something that if they can execute, you're going to see a higher stock price in five years. And there's going to be a huge amount of free cash flow that they could allocate to buy back shares or to something else over that period of time, which I think gives you a buffer in terms of a margin of safety.

What are your thoughts on the share repurchase program? Yeah, I mean, I think I don't want to overplay it because I think it's not their focus. I think if the stock stays around here or goes lower, they will buy stock here and there in the short run. I think the bigger point is, what does cash flow look like? Or the bigger question is, what does cash flow look like if they can hit their targets? Because I think they would generate a ton of cash flow if they can hit their growth numbers. But I mean, if you think about what they've done with their cash, they haven't been

particularly acquisitive. Over time, they will buy out a distributor or JV partner. So when a market gets mature enough that they feel like they can operate it more like on a company-owned basis, they will buy them out. But it's really hard for me to imagine them buying another shoe or apparel company um i think they think that investing in the sketchers brand which is you know which is you know a guy that's akin to organic growth has a higher return than buying someone else's brands um and like for example uh if you talk to john vandermore he'll joke with you that it's that the level of their apparel sales are almost like it's like almost embarrassing given their shoe sales like they think that they have a huge opportunity in peril that they just haven't

been able to hit and that they you know they they're trying to execute on now so just that like why would you buy another apparel brand if you think that you have a huge runway with your own brand um and so just in general they think there's a huge organic growth opportunity so i don't i don't think they need to buy growth so if i'm thinking about where the capital is going to go first it's going to go into opex and capex to grow the footprint and their capabilities around the world they'll continue to build retail stores i think every once in a while you'll see them buy out a distribution partner and kind of the residual is the buyback um and so you know i don't they don't wake up every day thinking like we need to have a buyback to support the stock

i think they're they are thinking that we we generate a lot of cash we have a lot of cash on the balance sheet so why not have a 500 million dollar buyback just to just to buy it opportunistically um you know i think if you think about the family overall Well, their net worth is highly tied to the pace of the stock, you know, to where the stock is and the pace of the stock appreciation. But it's not their focus every day. I think for and this is and you can you can take this for what it is and you can you can like it or not like it. But I think their focus is on growing the business and their belief is that the stock price will will get dragged up if they can perform. So, you know, I would, you know, regardless of activist pressure, I would be surprised if they did something that was like more typical, you know, activist shareholder friendly in the short run, rather than just continuing to chug along and focus on the long run.

So a big question with Skechers and people thinking Nike, Adidas, all that good stuff is competition is fierce in apparel and footwear. How is Skechers, and I think people kind of be surprised at this because they have been able to defend themselves over a few decades. How have they defended their position in the marketplace for so many years? I mean, it's even better than that. They've more than defended themselves. I mean, I don't think the footwear category grows as fast as they've grown so they've they've taken share from others and in as as as as they've grown it's really been an amazing story and i think getting to the people don't just just don't believe in it people ask them all the time how have you done it and i've thought about this myself

like like you look at the numbers and you're just like i don't it doesn't make sense like you is is this a great brand is it a good brand is it a me too brand is it a copycat brand like what is how have they done it and and and getting to my my one of my like few points i made a few minutes ago was like it hasn't been one thing you know and i don't i don't and as i said i don't i don't want a company that only has one thing going for and i want a lot of ways to win so um i think the whole the success has been more holistic than relying on one element and let me just give you some of the attributes that i think have contributed to it and i think there's you know it mimics kind of what the company's talked about but i've kind of like thought about and try to collate the list

of things that that i think have differentiated it and allowed it to take share is one they're really good partner for retailers like they're on time they have a breadth and a depth of product that people that that are that within accessible price category um you know the tam is large for the the market that that they serve in terms of you know it's like a value focused customer They have a broad assortment that includes, you know, anything from work to athletic to, you know, to casual, as we talked about. So they have a really broad assortment, which makes them a really good partner for having shelf space, right? Instead of having, you know, a bunch of different, because there are tons of shoe brands. Obviously, we think about the big ones, but there's so many different shoe brands.

You know, they can be kind of a one-stop shop for some of their customers, right? From a wholesale perspective, I think they've become a very good partner. When it comes to e-commerce and direct-to-consumer, they've just been diligently building the brand outside the U.S. They've been able to build a premium brand position relative to what it is domestically in places like China. I think that's been really helpful over time. It's been one of the reasons why margins have been dragged up over time.

Um, you know, I think they've, they've become a very competent player, um, after, you know, after kind of years of not investing enough in systems and e-commerce, like they're, they're kind of, they're bringing their systems and, and, and, um, and, uh, technology in, you know, kind of into the modern days. And that, what that means is that, um, you know, they have a platform for growth that can continue um and but you know i think as a partner uh both on the wholesale side you want somebody who you know is kind of like you know he has at least a table stakes when it comes to technology um i think they've become a little tighter when it comes to operations and and

become more of a professional company and that's i think john vandermore deserved a lot of credit there um they've just methodically expanded into new markets and adjacent markets and that's how you get into 170 plus countries. But I think from the consumer's perspective, they've really had kind of a bottom-up focus on the consumer and what the consumer needs as opposed to being like maniacally focused on raising prices and the average unit retail, right? Like having a value focused as opposed to being so focused on price. So as I said, think of it as over-delivering on style performance and comfort relative to the prices they charge um and you know i and i think if you like obviously they advertise a little bit and you know they have the celebrity sponsorships

with kind of like b and c list celebrities i'm sure that helps with brand awareness but i mean i don't you know i know you guys were wondering about that i don't think that's a key variable i think it's the holistic like accumulation of all the things that i just mentioned being a good partner to wholesalers, being a good wholesale partner to retailers around the world, establishing the brand outside the US, and bringing in really good JV partners. That's another thing. When you go into a new country, you have to be really selective who you're going to work with. I think if you look at the growth in doors and revenue that they've had in these countries, it's been impressive and it appears that they found good partners there so again it's like it's not one

thing and the competition will continue to be fierce um but you know i don't i think as a as a shareholder and as someone who's trying to take a longer term perspective there's just a lot of white space right regardless of of what country or what mode of distribution that they're going to be going through? Or is it virtual e-commerce or is it in-store? I think there's plenty of white space. And it's almost crazy to say it's a $6 billion brand that they're underpenetrated. But as they've spent the last few years building the infrastructure for growth, it's not like they're going to flip a switch and all of a sudden the growth is going accelerate. I just think it's an enabler of continued growth. So yeah, I mean, it's

getting to the point. I don't know where it's going to come from, but it's been there. The infrastructure is there. Now they just need to execute. Okay. One last question. And you already kind of touched on your, I guess, valuation case. So I want to try to flip it. And we asked something sort of along these lines last time you were on the show but if you were writing if you had to write a short thesis today for sketchers what would the rationale be well i mean i mean i already i've i'm pretty good at getting about talking against myself so i mean i've highlighted a number of these things one is the the av shareholder structure right like it's possible that um the greenbergs are not aligned with us as minority shareholders and they will do things that

are you know in theory could benefit them versus us right and and so some of that so again you have to trust these people that they know what they're doing and that they have your interest in at heart um so i think that's the that's always been our number one like we we in our process i don't i remember we talked about this but we we do for every idea we talk about the short points and number one short point for sketches was always the um the uh um the the the ab share structure and the family control and, you know, the maybe, you know, I'm not, I'm not fine with an owner operator with a long time horizon, but the question is, you know, like we have clients and we want them to, to, to benefit from, from, from, you know, this investment. And so if they're, if they're,

they're, they're thinking they'll hit their goals in 20 years. I mean, that's probably a little longer than we would want. So that's number one. Secondly, you know, China has been a big growth market for them. They've been really successful there. As I mentioned, they have a premium kind of a premium brand there relative to their domestic brand um if if that were to slow down um whether it's new doors new partnerships or just like you know the ability for the brand to grow that would i think be a certain drag i mean it's already a billion dollar business on a six billion dollar company so if that were down 20 in a year that would make it a lot harder to grow so i think china you know given everything that any western brand faces when operating in china i think that's

that's a that is a little bit of a risk um what else uh i mean i think the ultimate margin trajectory may not be anywhere near what they think it is um and i think that's a i think that is a concern for us it's always been a concern for us you know i don't want to be totally backward looking and say only look at the business and say well this is what they've done historically um you know what could it you know not not not think about what could they get to but for sure like this their margins have been sub operating margins have been sub 10 percent the entire for the history of the base of this company and so you know is that is that in is it an indication of the growth spending that they they do um in in opex specifically in sgna um or is that a ceiling

Is it just that the operating leverage won't be there? And I think that's where I have the most conservatism in my model in terms of what margins could they eventually get to. I mean, if they hit low teens, well, then that would be amazing. But I think anyone approaching this should consider the fact that maybe the 10% is the ceiling and you're not going to see anything better. um i don't worry a whole lot about um capital out like very like on shareholder friendly capital allocation i don't i don't see them like paying eight times revenue and 30 times evita for you know some big acquisition that that doesn't sound like i mean if it that would be a big shock to me so i think it's those three it's management in terms of and and and you know how in how

control and the families control ultimate margin trajectory and then what happens in china um are going to be really key variables um and if and if you know adverse things happen there um you know it's gonna it's gonna certainly be more difficult to to for the stock to hit the prices that we think it can over the next few years okay that's all the questions we have uh brett unless you have have any more? Nope. All good. Okay. I guess for any listeners that want to keep track of you or Cove Street, what's the best place to do that? Yeah. Thanks. Thanks for that. CoveStreetCapital.com. We have a lot of information. I do a fair number of presentations on our ideas. I also have my own podcast called Compounders, where we interview public company CEOs about how they've created

value over time um so you can check that out we you know we just released an episode today and i think we've done 26 or 27 episodes now um also uh twitter um at ben claremont you can find me i tweet a little bit mostly about podcast stuff but i'm also on twitter um but i'm also always happy to talk to people if you reach out to me over twitter um talk about ideas or um you know about compounders, whatever. I'm just happy to meet new people. Perfect. That's going to do it for us. We want to remind our listeners that Brett and I are not financial advisors. Anything we say or discuss here on Chitchat Money is not formal advice or recommendation. We are, however, general partners at Arch Capital, so clients may have positions in the securities discussed in this podcast.

Thank you all for listening. We'll see you next time. Bye.