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Introduction

In this article I'll have a closer look at Deckers Outdoor Corp (NYSE:DECK), a footwear apparel manufacturer, which produces the well-known Uggs and Teva brands. I decided to have a look at it after writing an article about Crocs (CROX), one of its indirect competitors.

I'll first of all discuss the company's earnings and balance sheet in Q1 2013 and discuss the future prospects of the company according to analyst estimates. This will eventually lead into my conclusion and investment thesis.

The Q1 Earnings and the 2013-15 outlook

Deckers announced revenue of $263.8M, up 7.1% from last year's $246.3M. This resulted in a net income of $1M or$0.03/share. Whilst this doesn't sound good, it's important to note Deckers is extremely dependent on seasonal sales, as the UGG-boots (which made up 84% of the $1.414B revenue last year) enjoy their peak sales moment in the fall and winter months. The net profit of $0.03/share is also much better than the loss of ($0.12)/share the company predicted at the presentation of its FY 2012 numbers.

The company also provided a second quarter and a FY 2013 outlook. Deckers expects to report a loss of $1.10/share in Q2 on flat revenue, which isn't a very big surprise, as the second quarter is typically the company's worst quarter in the year.

Looking further ahead to the outlook for the entire year, Deckers expects a 7% increase in revenues over the $1.414B revenue in 2012, to $1.513B for 2013. The gross margin is expected to come in around 46.5%, which would be a 4% increase versus the gross margin of 44.7% in 2012. According to analyst estimates, it's expected that net profit will come in around $130M, which would result in a net profit margin of a respectable 8.6%. In this table below you can see the evolution of the company's net profit margin from 2010 to 2015. Whilst there was an obvious decline in the net profit margin from 2010 till now, the analysts seem to be expecting a recovery with net profit margins back over 9% from 2014 on.

Year

Net Profit Margin

2010

15.8%

2011

14.5%

2012

9.1%

2013

8.6%

2014

9.21%

2015

9.28%

The company also provides earnings estimates on its website, and you can clearly notice an increasing trend.

Year

EPS

2010

4.03

2011

5.07

2012

3.45

2013

3.68

2014

4.32

2015

4.55

The Balance Sheet

At the end of Q1 2013 Deckers' balance sheet looks very robust, with $410M in working capital. This is a remarkable achievement, as the company bought back $220M worth of its own shares in 2012, and was allowed to acquire another $80M worth of shares under the same share repurchase program. We expect Deckers to complete the buyback program before the end of the year, reducing the total amount of outstanding shares to just 33M vs 38.7M a year ago.

There is however one issue on the balance sheet I'd like to address here. I'm a bit concerned about the high value of the inventory, which stood at $257.10M, considerably higher than the value of the inventory at Q1 2012 of $208.5. There usually is an inventory buildup towards the stronger sales quarters in Q3 and Q4, but I will keep a close look on it, as the inventory turnover ratio (in this case I use 'total sales/inventory') is decreasing dramatically (as you can see in the next table - keep in mind, the higher the ratio, the better), which might indicate some problems to get the inventory sold.

Year

Inventory Turnover Rate

2010

8

2011

5.5

2012

4.7

If I compare this number to the Inventory Turnover rate of Crocs (NASDAQ:CROX), Deckers is doing considerably worse.

Year

Inventory Turnover Rate

2010

6.5

2011

7.8

2012

6.8

Conclusion and Investment Thesis

Deckers' future seems to be bright, as the company will be able to restore its profit margins and its balance sheet looks extremely robust.

My only concern is the continuously increasing inventory on the balance sheet. This can partially be explained by the fact the company's sales number is increasing as well, but my main concern is the fact that the inventory grows at a faster rate than the company's sales. This might indicate a problem to sell the shoes in inventory, which will eventually lead Deckers to a fire sale of unsold goods and might cause a substantial loss on the value of the inventory. Even if Deckers would only have to write down 30% of the value of its inventory, that would still be a loss of book value of approximately $2/share. Whilst this obviously isn't dramatic, it's definitely important to keep an eye on the evolution of Deckers' inventory.

I think Deckers is a bit too expensive at the current share price of $51, as it is trading at approximately 14X 2013 earnings and 12X 2014 earnings. Instead of buying the stock, I would write put options at various strike prices and expiry dates. If you would write a Put 40 expiring in December of this year, you'd receive $2.00 in an option premium. If the share price expires south of $40/share, you get the shares at $38.00 ($40-$2.00 premium). If Deckers doesn't fall below $40/share, you can keep the $2.00 option premium, which would result in an annualized return of 10%.

I currently have no position in Deckers Outdoors, but might write put options in the future.

Source: Is Deckers' Increasing Inventory Cause For Concern?