Crocs Core Brand Generates Plenty of Cash Flow, but HeyDude Continues to Struggle

A highly recognizable brand trading at 7 times forward earnings is rare. For Crocs (NASDAQ: CROX), that valuation is tied directly to the struggles of its HeyDude brand. The segment's revenue fell 12% in the first quarter, continuing a trend that forced the company to take a $737 million impairment charge last year.

With HeyDude accounting for 18% of total revenue, the market's focus is understandable. The shoe brand's wholesale channel has been a disaster, and its gross margins trail Crocs by 15 percentage points.

That said, the iconic Crocs brand, which accounts for more than 80% of revenue, generates plenty of free cash flow. More importantly, the quality of its revenue is improving as sales shift toward more profitable channels.

Image source: Getty Images.

Direct sales drive growth

While wholesale revenue for the Crocs segment declined in the first quarter, direct-to-consumer (DTC) sales grew 13%. This shift toward company-owned websites and retail stores drives higher margins per sale and a more direct connection to its customers.

The brand's geographic mix is also improving. International revenue grew to 55% of segment sales in the first quarter, up from 51.5% year over year. Growth in markets like China and India is offsetting concerns about saturation in North America and presents a growing market opportunity.

Meanwhile, HeyDude's wholesale channel collapsed in the first quarter, with sales falling 25% as the company works to clean up excess inventory with its retail partners. The brand's 44.5% gross margin trails the core brand by a wide margin and is a significant drag on consolidated results.

An attractive entry point

Management expects HeyDude to stabilize and return to growth in the second half of the year as it laps the inventory cleanup. The risk is that the brand's problems are more than just a temporary issue, and its decline continues to weigh on the overall business.

If it stabilizes, however, the drag on consolidated margins and growth should lessen, allowing the core business's strength to become more apparent. The sandals category is quietly approaching $500 million in annual revenue, showing that the company can successfully expand beyond its iconic clog.

Management raised its earnings guidance after the first quarter to around $13.48 per share for the year. At today's price, the stock trades at a forward P/E of just 7, a valuation that reflects the uncertainty surrounding the company's ability to reliably grow.

For investors who believe the core brand's strength is sustainable, the current price offers an attractive entry point.

Bryan White has no position in any of the stocks mentioned. The Motley Fool recommends Crocs. The Motley Fool has a disclosure policy.