Having fallen 17% over the last year, Skechers USA Inc. (SKX, Financial) could offer turnaround potential. The company is making a significant investment in China as it seeks to capitalize on growth in household expenditure and a rising middle class. In recent quarters, the sales growth of the business in China has been in the double-digits, and this trend looks set to continue.
Changing customer tastes have boosted the company’s sales, with marketing agreements and collaborations continuing to build brand loyalty. Although there are risks to its prospects from the potential of a full-scale trade war, a flexible manufacturing footprint and a relatively low valuation suggest a recovery could be ahead.
China growth
A potential catalyst for Skecher’s financial performance is its growth outlook in China. In the third quarter, it shipped 5.6 million pairs of shoes to China, with revenue from the world’s second-largest economy rising 21.9%. This contributed to an increase in the portion of the company’s revenue that is derived from international markets, with the figure now standing at 55%.
The company is investing heavily in China with around 20% of an increase in general and administrative expenses in the third quarter being focused on the country. The $7.5 million investment was focused on preparation for Single’s Day as the company seeks to continue its double-digit sales growth performance.
It sees a significant growth opportunity in the country, where it now has 793 retail stores out of a total 2,802 locations worldwide. Over the next decade, China’s household consumption is forecasted to grow 6% per annum, with a middle class that is expected to represent 65% of all households. This is due to drive increasing demand for consumer discretionary items, with Skechers' management not being able to put a number on the potential growth opportunity within the country due to it being "too large."Â
Marketing potential
Skechers is benefiting from changes in customer tastes, with the resurgence of the chunky shoe trend across the globe boosting demand for its D’Lites product. They are generally accepted as being the originator of the trend, which has allowed the company to partner with retailers that cater to this particular market. It has also provided extensive media coverage, such as features in fashion and sneaker publications, as well as a presence at New York Fashion Week.
The company’s marketing campaigns seem to be resonating with customers. It has collaborated with influencers such as David Ortiz and Camila Cabello, while also investing in its operations through a new distribution center. It has also expanded its collaboration with anime series One Piece, while running commercials on children’s programming for its kids lightweight sport footwear. This investment in its brand has contributed to a sustained rise in costs over recent quarters. A strengthening exposure in a range of categories, though, could lead to improved customer loyalty in the long run.
Tariffs
The International Monetary Fund estimates that the tariffs already announced by the U.S., China and other major economies could mean that global gross domestic product in 2020 is 50 basis points lower than it otherwise would have been. Given that Skechers is investing heavily in China and already relies on international markets for a majority of its sales, this could create financial challenges for the business. Moreover, more than half of its production takes place in China. Although part of that production is sold in China, the potential impact of future tariffs on the company’s financial prospects could lead to weak investor sentiment.
The tariffs enacted by the U.S. government so far, though, have not had a direct impact on the company’s operational or financial performance. It has also sought to increase its production capacity outside of China, while its lack of ownership of any manufacturing facilities means it may be relatively flexible in terms of where products are produced. A price-earnings ratio of 14.9 using fiscal 2018’s forecasted earnings per share figure of $1.84 also suggests that investors have factored in a margin of safety versus Skechers' intrinsic value.
Outlook
The growth potential in China could catalyze Skechers’ financial performance in the long run. Further investment in the country could allow the company to capitalize on rising household expenditures and the growth of the middle class. Although there are risks from its production being focused on China at a time when further tariffs may be ahead, its flexible production model could provide it with the opportunity to diversify its manufacturing base.
The company’s price-earnings ratio suggests that it could offer good value for money following its 17% decline over the last year. With further investment in its marketing function and continued changes in consumer trends, the stock could deliver a successful recovery.
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