“Ugg” – That’s the sound of Deckers (DECK) investors checking their account balance today…
The stock is down 8% in early morning trading after a downgrade by Sterne Agee. The boutique research firm noted that its channel checks indicate a weak environment for Deckers Outdoor UGG boots.
According to the report, individual retailers are seeing less demand for the “boots with the fur” which is especially bad news during the holiday retail blitz. As with most specialty retailers, the fourth quarter represents the most important season for earnings – so if the assessment from Sterne Agee is accurate, DECK could turn out to be a major disappointment for investors.
According to the report, the weakness could hurt 2012 earnings as well. A fundamental shift in consumer tastes and retailer inventory decisions could dampen the long-term outlook and consequently the earnings multiple investors are willing to pay to own this growth stock … From Sterne Agee:
The disappointing results will likely lead to 1Q12 cancelations due to adequate current inventory levels, and a much more conservative approach to fall 2012 orders. Change in consumer buying patterns this year is likely to affect the cadence and nature (backlog v. replenishment) of 2H12 orders.
The good news for DECK investors is that the stock isn’t extremely over-priced. The stock price has grown more than 400% in just over two years, but earnings expansion has kept pace enough to keep the stock at a relatively reasonable price point.
Using the current price (accounting for this morning’s gap lower), DECK is trading for less than 15 X 2012 earnings expectations of $5.95 per share. Analysts are assuming 18% earnings growth from 2011 to 2012 – so the multiple of 15 is in-line with the growth expectations.
But considering the fickle nature of high-end apparel shoppers – along with a challenging economic environment – it’s easy to see how analyst estimates could turn out to be drastically overstated. If the UGG brand is truly becoming “ubiquitous” (borrowing the term from the downgrade report), Deckers could be presented with the choice of killing margins to move product – or watching their primary revenue stream evaporate.
This standard pricing decision is difficult for typical “middle-class” retailers who face a traditional supply / demand curve featured in most economic textbooks. But in the “high-end” world of fashion and apparel, there is an additional level of complexity.
Luxury or premium buyers actually prefer to pay a higher price for specialty retail items. Whether it is because of the perceived value associated with a higher price, or because wearing a premium brand cements their affluent image, the traditional supply / demand curve can be inverted as higher prices drive more demand from high-end consumers.
But if Deckers’ UGG boots lose their luster with affluent customers, lowering the price won’t be very helpful in generating more revenue. Across the globe, the middle class has been shrinking. Even a discounted pair of UGG boots will still be more expensive than low-end apparel offerings – so it’s unclear exactly who Deckers would be targeting if it lowered prices to increase demand.
Ironically, the same paradox can be true about the stock. Since DECK has been a momentum stock for so long, a major break in the stock price could send its shareholder base running for the hills. Momentum traders no longer want anything to do with the stock, and DECK is still too expensive (and uncertain) to capture a value investor’s attention.
Deckers’ downgrade also raises questions about other high-end retailers.
- Is demand for UGG boots falling because of a change in consumer taste – or because affluent consumers are spending less?
- Is the weakness confined to apparel or are other retail channels experiencing weakness?
- If DECK is symptomatic of the entire high-end retail area, is this a temporary pullback or a more serious demand issue?
Looking at a few different luxury or premium retailers, there are certainly pockets of weakness to be concerned with:
Tiffany & Co. (TIF) has fallen below the 200 EMA and investors are only willing to pay 15X next year’s expected earnings
Lululemon Athletica (LULU) gapped lower after a disappointing earnings release – and now appears to be following through on the bearish pattern. The Mercenary Live Feed set up a bearish put spread to take advantage of this decline.
Polaris Industries (PII) is still trading in a healthy pattern, but analysts expect earnings growth to decelerate from near 50% in 2011 to 19% next year.
We’ve already seen significant weakness in retail companies catering to the middle class. If the upper-end retailers begin taking it on the chin as well, it will be a major blow to our consumer-driven economy – and in turn to the broad market trends.
Don’t forget that protection of capital is our primary objective…
Disclaimer: This content is general information only, not to be taken as investment advice or invitation to buy or sell securities. As active traders, we may or may not have positions in securities mentioned. For full disclaimer click here