Deckers May Be a Risky Fad Stock

Deckers Outdoor (DECK) is a niche, luxury footwear design and marketing firm. Deckers has 4 product brands. The most important is UGG Australia, the well known (and expensive) luxury sheepskin footwear. UGG provided 70% of Decker's total sales for the just completed 2008 fiscal year.

The second brand is Teva, focusing on sport sandals. Teva was fully acquired by Deckers about 6 years ago and provided about 12% of 2008 sales. The company also has two additional lines which are less important to current results but are expected to contribute to growth. The Simple brand (2%) is a line of "sustainable footwear", designed using environmentally friendly materials and processes, more popularly known as Green Toe. TSUBO (0.5%) was acquired last year and is a high-end casual footwear line, including dress shoes, sandals, and women's heels. The remainder of sales comes from brand licensing for additional merchandise like handbags, apparel, and so forth.

So, as is the norm, let's look at the positives behind an investment in DECK. There are some good reasons to believe this stock can outperform. First, growth potential. Deckers has grown revenues at an annualized 27% since 2003, and this pace has been escalating, with the past two years revenue growth coming in at about 45%! That's some serious growth. UGG has benefited from substantial cache, mainly celebrity endorsement and media attention. Decker's management plans to grow by introducing new product lines under the existing brands, expanding licensing, acquiring new brands, and pushing it's footwear internationally, where currently the company earns 16% of sales. Assuming the brand portfolio, particularly UGG, can remain strong, there are plenty of growth legs left here.

Underpinning the growth case is the company's financial strength. Deckers has nearly $200 million of cash and no debt. Free cash flow generation is strong, particularly for this kind of growth, with about a 13% margin. The company has done a great job investing capital, averaging an impressive 114% MFI return on capital figure over the past 5 years. Nominal (real) return on capital is also excellent at nearly 36%. Deckers has grown substantially and efficiently, and these figures have been sustained over the past 5 years.

Fleeting fundamentals

However, this stock was never really a candidate for the MagicDiligence Top Buys list. While it has 2 of the 3 investment pillars (growth and financial health), it lacks the third and most important one, moat. A lot of people have compared this stock to Crocs (CROX), a recent disaster that plummeted from $70 to a current price little over $1 in just over 2 years! Clearly, the fad potential is here.

UGG is popular due to celebrity endorsements, which are most often quite fleeting. Celebrities move on to something else, consumers follow, and demand disappears. This is a major risk. Of course, most consumer product companies have little durability to their competitive edge to begin with. Decker's faces competition from a slew of strong competitors, including Nike (NKE), Timberland (TBL), Columbia Sportswear (COLM), and others. There is nothing stopping shoppers from skipping Decker's products and buying something else.

This is to say nothing of the near term risk of consumer weakness. A $200 pair of boots seems excessive when jobs and investments are in major peril. Consumers are more likely to opt for something less expensive for the time being.

MFI investors should add DECK at their own risk. At a 50% earnings yield, a lot of potential risk is priced into the stock, and its financial health and emerging product diversification makes it (in my opinion) less suspect than Crocs was. However, there are numerous examples of this kind of stock falling into oblivion. It's too risky for my tastes.

Disclosure: Steve owns no position in any stocks discussed in this article.

Comments

[BxCapricorn:]

This title really caught my eye. We have been wondering what kind of voo-doo was keeping DECK above $100 for quite some time. It's rise was phenomenal, and a good friend shorted them over and over, with great success. To see it attempt a comeback recently, reminds me what a short-covering pump and dump this recent market rally truly is.

Mar 12 08:32 PM

[mac.barron:]

You are 100% right: DECK is the next Crocks.

Short away.

Mar 15 07:43 PM

[TheCaptain:]

DECK is absolutely not the next CROCs when it comes to the product itself. When it comes to the life-cycle of a trend, once it has reached its peak it either dies off or it transcends into something different-it becomes an every day staple. I do think the excitement and crazy momentum around Uggs has worn off. However, Uggs are now a staple for most women's wardrobes. That simply makes it steady. Compare it to CROCs if you can find comparisons, but anyone who thinks Ugg boots will simply not be worn or fall out of fashion the way Crocs shoes did knows nothing about retail or fashion.

Mar 16 01:36 PM

[bminfo247:]

Because of many failures in this space, current operating retailers, are facing a different sellscape since the sector itself is less crowded though demand has come down. Take a look at Yahoo Finance:
finance.yahoo.com/news...

Sep 11 11:00 AM