Deckers Outdoor (DECK) reported "less worse" results than many feared, which drove the stock up 7% in after hours trading to north of $43. While consensus street estimates of $623 million in sales were slightly missed, EPS of $2.77 beat consensus of $2.61 and a "whisper number" of $2.55. Perhaps more important was the sequential decline in inventory to $300 million (from $486 million in Q3) and a rebound in international growth (+16% y/y after declining 15% and 14% in Q2 and Q3, respectively). A deeper dive into some of the quarter's details follows.
Sales increased 2% despite UGG wholesale sales being down approximately 11%. Retail (+37%) and eCommerce (+31%) offset the weakness in wholesale. I am sensing a secular channel shift taking place here. The question is: "are retailers getting upset about UGG store openings and cutting wholesale orders or is UGG getting more stringent about who can sell their product as they suggested on the quarterly conference call. [Probably a little of both. Coasting through a couple of West Coast Nordstroms (JWN) recently revealed a pretty limited number of UGG SKUs being offered.] Deckers opened 30 stores in 2012 and expects to open another 30 in 2013. Same store sales were down 3.4% in Q4 which suggests demand is not overwhelmingly healthy but an improvement from down 13% in Q3. Wholesale backlog (down 17%) and early Q1 sales trends don't appear great according to management comments on their call.
Gross margins were down as expected to 46.3% (versus 51% last year) and are expected to stay in that range in 2013 per management's guidance (46.5%). Recall that sheepskin prices moderated in the second half of last year but much of the purchasing for 2012 was committed to earlier, so the benefit of lower sheepskin prices is expected to occur in 2013. A price reduction in the second half of 2012 makes it reasonable for margins to be somewhat flat (and may give room for management to discount product that still is not selling…or beat its guidance). Another possible benefit to margins and the inspiration for this note's title is an innovation called UGG Pure which is a wool substitute for sheepskin which is supposedly softer and more consistent than shearling and presumably less costly for Deckers (and for sheep who presumably get to keep their skin!)
SG&A appears to be ramping significantly into 2013 as implied by management guidance of only a 12.5% operating margin. This suggests the company may be marketing more heavily as well as reflects the aggressive opening of retail stores which produce higher gross margins but have higher sales and operating expenses than wholesale.
A few other observations worth mentioning:
(1) First quarter guidance seems very conservative at flat sales and a loss of $0.12 per share. This implies a massive hike in SG&A to approximately 49% of sales assuming gross margins are 46.5%. For sales to be flat wholesale UGG sales would have to be down 15% and eCommerce flattish. I believe management may be giving themselves some room to raise or beat guidance in Q1.
(2) Share repurchases moderated in Q4 from 1.8 million shares purchased in Q3 to 900k in Q4. It will be interesting to see how aggressive the company is on share repurchases this year. There is $79 million remaining on the current authorization.
(3) Management discussed a relatively young athletic brand Hoka One One designed by and for ultra-marathoners. This brand is one reason management believes its "Other brands" can almost double sales this year. Currently Hoka One One is only carried in specialty running stores such as Fleet Feet and on-line retailers such as Backcountry.com and Zappos.com (at full price) and is an authentic brand in an aspirational niche. This could become a catalyst for growth worth watching.
(4) Management was still talking about the weather (for the second year in a row) which is getting silly. At some point the weather or lack thereof can't be an excuse every year.
As you can see from my earlier note Deckers nailed my 2012 EPS on the money at $3.45 and exceeded my revenue ($1,375 million) and very likely my EBITDA estimate ($197 million before adding back stock comp). I have revised my 2013 model and it coincides pretty much with management's guidance for the year which suggests management's guidance is less delusional than it was mid-stream in 2012. My 2013 revenue estimate is $1,517 million, EBITDA is $230 million and EPS is $3.65. While sales are back-end loaded (presenting some risk given low visibility) the sheer impact of opening 30 retail stores is a big contributor as is eCommerce and the renewed growth in international sales. (Note these estimates do not have the benefit of reading through the company's 10-K which has not yet been released.)
From a valuation standpoint the shares are relatively cheap at $43.33 (in after-hours trading) which represents 12x my 2013 EPS and 6.3x my EBITDA estimates. In addition investor expectations are low which leads me to believe the short opportunity is now gone for DECK (and short covering and the buyback could provide something of a boost). I could see the shares drifting slowly into the mid-$50s this year which would put the valuation at 15x 2013 EPS and 8x 2013 EBITDA, both fair for a sputtering, but high quality branded consumer products company.