We were very impressed with Q4 results of Decker's Outdoor (DECK) last week. In a pre-earnings story put out on Jan. 27th, we expressed concern about a back-ended Q3 and an alarming rise in accruals. We also pointed out what we believed to be a weakening operating cash flow trend emerging. Now that the earnings rush is out, what are prospects for DECK going forward?
Q4 2010 sales grew 54% over the seasonally slower prior third period and slightly more than Q4 2009. Accounts receivable in Q4 '10 declined a modest -18% as compared to a -38% change in last year's Q4. In contrast, days-sales-outstanding increased 20% to 24 days during the latest period versus 20 days last year.
Inventory levels declined -36% in this recent Q4 (from Q3), versus a -59% change in the year ago period. As a % of sales, inventory was 29% and 24% in the 2009 and 2010 fourth qtr. respectively; a 20% change year-to-year.
"Capacity" in the form of P/P&E continued its double-digit growth in the past two periods against significantly higher sales growth in the similar quarters. However, revenue-to-PPE declined modestly from 21.42 to 20.97 in the latest period, the lowest of all seven quarters reviewed.
Cash-Flow: DECK generates healthy levels of operating cash-flows and we note a widening spread between OCF and balance sheet cash-flows. However, the dual cash flow trend has declined in each of the past three periods and the Merriam Report signals are displaying a double bearish trend (recent and confirmed). Enter graph here.
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Clearly DECK produces very solid operating cash and the confirmed bearish signal was only triggered by a very modest decline from the Q4 ratio of last year's reading.
Thus, the trend should be observed rather than any single period change. In observing DECK's trend, we would conclude that although DECK's earnings are supported predominantly from "true" operating cash, the percentage by which it does, has been declining for the last three quarters. A continuation of this trend would potentially impact DECK's earnings quality in the future despite expectations of future sales growth.
Investors can find other clues to future shifts in balance sheet structure by keeping an eye on changes in assets and liabilities, and the adjustments for them in the statement of cash flow. In using DECK as an example, accounts payable and accrued expenses grew 197% between Q1 2010 and Q4.
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Revenues during this same time rose 177%. Not a huge problem now, given the push into Europe and Asia, but it would be a concern if these spreads continue to widen going forward.
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Next, look at the statement of cash flow to see how management adjusted for these changes. Looking at DECK's year-end statement, you can see adjustments for payables and accrued expenses account for almost 26% of net cash provided by operating activities.
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Recent revenue growth would mollify this somewhat, but should sales moderate, you would want to see less of these adjustments.
Revenue Metrics and Capital Productivity: DECK displays very healthy improvements in each category we observe.
Accruals: Understanding the seasonality of DECK's sales does explain the roller coaster accrual trends. We pointed out that the Q3 spike was largely due to adjustments for receivables and inventory (reversed in the latest period), which appears to be expressed in the Q4 accrual ratio figure.
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Also, growth in international markets will impact accruals going forward as terms of delivery and payment of merchandise often require additional time for transactions to complete.
Summary: Overall a very impressive earnings statement and on the strength of their Q4 results, we raise our estimated fair-value to $88. At current levels, the shares are modestly undervalued (-2% as of 3/5/11). Earnings quality is B+.
While we do not want to steal any thunder from DECK bulls, the post-earnings glee appears to have subsided for now. Shares held short remain elevated at more than 12% of float (as of 2-15-11). It's likely the earnings (and after hours spike to 96) chased some shorts away, but the remaining bears probably won't be so easy to spook.
A trading range between 82 and 89 might be productive for short-term traders and investors with a longer-term horizon may find better value at 80 or under.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
