Is Deckers Outdoor A Short Candidate?

| About: Deckers Outdoor (DECK)

Shares of Deckers Outdoor (DECK) took a tumble last week after a Sterne Agee analyst downgraded the stock from Buy to Underperform, and cut the price target from $130 to $72. The analyst noted that sales of UGG boots, which accounted for 90% of the company's third quarter revenue, have been rather disappointing this year. Combine that with unusually warm weather, and this holiday season could be bad for the company. Shares fell more than 9.5% on the news, and are down nearly $20 in the past two weeks. Given the recent bounce of last week's low of $84.78, the stock looks like a potential short candidate. Here's why.

Despite Sales Growth, Where's the EPS?

Deckers is a growth company right now, and revenues are growing quite well. Current estimates call for about 33% revenue growth this year, and another 20% next year. The problem for Deckers is that those numbers don't make the bottom line. Take a look at the following table. The sales growth rate increased from 2009 to 2011 (expected), but the EPS growth rate has come down quite a bit. In fact, in 2011 and 2012 earnings per share are expected to grow at a rate less than sales. If the company cannot improve its margins while revenues are growing at a 30% clip, what happens when revenues slow down to, say, 10% growth year over year?

Growth 2009 2010 2011* 2012*
Sales 17.95% 23.10% 33.40% 20.20%
EPS 58.29% 36.15% 24.81% 17.50%


2011 Margins to Date Have Been Disappointing:

The following table shows the margins for Deckers in the first nine months of each year.

Margins 2008 2009 2010 2011
Gross 43.49% 42.49% 47.23% 48.00%
Operating 13.78% 16.26% 18.98% 13.97%
Profit 8.69% 10.54% 12.09% 9.61%

Deckers did a nice job improving its operating and profit margins from 2008 to 2010, but those numbers fell off substantially in 2011. Deckers is improving gross margins, which is good, and has said it expects gross margins to be about 50% for the full year. That might seem impossible given the 48% so far, but remember, about 40% or so of the company's yearly sales come in this quarter. Gross margins were 54.2% in last year's 4th quarter, so if it can at least maintain that number, the company will hit that projection (If 4th quarter sales represent about 42% of fiscal 2011 sales, it will need at least 53% gross margins to have a 50% number for the full year).

Like I said above, remember that most of its business comes in the fourth quarter. While that will help the gross margin number, the company has had increased operating expenses so far this year, which it expects will continue in the fourth quarter. We've seen the margin hit the company has taken so far in operations and profit this year, and I wouldn't be expecting too much in this quarter. If sales were to miss, given the warm weather and disappointing UGG sales I mentioned above, it could turn out to be a huge miss on the bottom line.

Turnover Ratios Declining:

The following table shows the company's turnover ratios from the first nine months of each year.

Turnover Ratios 2008 2009 2010 2011
Receivables 4.17 4.21 5.22 4.49
Inventory 2.08 1.91 2.13 1.67
Assets 0.97 0.93 0.88 0.83

All three ratios have taken large dropoffs this year compared to 2010, and the inventory turnover and asset turnover ratios are at their lowest levels in the four year period. You might expect a couple of these ratios to decline as the company grows, but these are sharper declines that I would like to see.

What are the causes of these declines? Well, the receivables turnover declined because the company had a large balance of receivables at the end of the third quarter. Accounts receivable were more than 30% of current assets, a number the company hasn't seen since 2008. Receivables as a percentage of total assets is also slightly higher than 2009 numbers, after decent improvement was shown in 2010. The company also had a large inventory balance at the end of the quarter, which is why the inventory number dropped off. While the company should be gearing up for the holiday season, it is important to look at the following numbers. The following shows the inventory balance as a percentage of current assets, note the unusually high number.

2008 2009 2010 2011
45.07% 42.34% 32.46% 47.62%

Either the company is really expecting a great holiday season, or it has built up too much inventory. The latter would be extremely troublesome if it is forced to discount that inventory, or have too much left over after the holiday season. Both the large inventory and receivables balance caused the asset balance to rise in the quarter, lowering its asset turnover ratio. While 9-month sales are up 100% in the past three years, assets are up 147%. It will be interesting to see if this is a one quarter issue, or a sign of things to come.

Financial Ratios Show Similar Results as Above:

I'm not going to focus on these numbers as much, because a lot of them have been impacted by what I've mentioned already, but here's how they stand as of the end of the third quarter.

Financial Ratios* 2008 2009 2010 2011**
Current Ratio 4.48 4.72 4.80 2.87
Quick Ratio 2.32 2.54 3.10 1.22
Debt Ratio 19.35% 19.17% 19.34% 31.31%
Return on Assets 8.44% 9.76% 10.65% 8.01%

*As of 9/30/11

**Based on year to date income divided by average assets.

The company added $45 million of short term debt in the most recent quarter, and a large increase in other liabilities has certainly put a crimp into the current, quick, and debt ratios. The company increased working capital from $272 million at the end of September 2008 to $481 million at the end of September 2010. However, over the past year, working capital has increased by just $7.5 million. Going forward, the company will need to show that these financial numbers had a one time jump and that this is not a sign of things to come.

Analyst Expectations Too High:

In the latest quarterly report, the company boosted its full year revenue and earnings guidance. The company believes it is currently on track for 33% revenue growth, year over year, and 22% earnings per share growth. Analysts are currently looking for 33.4% revenue growth and 24.8% earnings growth. If analyst expectations rise any further before they report, we could be in for a disappointment. To be fair, Deckers has beaten analyst expectations in the past four quarters.

Looking at fourth quarter numbers, the company projected year over year guidance of 29% growth. Analyst expectations currently call for 30.8% growth. The company also projected four quarter earnings per share to rise by 33%, while analysts currently call for 37.9% growth. If expectations are too high, a miss is possible.

Industry Headwinds:

Specialty footwear can be a volatile industry, heavily dependent on weather and incomes. It is possible that UGG sales will see a pull back this holiday season, and the analyst did note that prices seemed to be higher this year. This holiday season so far has seen mixed results, but everyone wants something that is on sale. Unless people are getting really good deals on UGGs, they may put their money elsewhere. The unseasonably warm weather has also seemed to put a damper on sales for cold weather products as well.

Another name in the industry, Crocs (CROX), took a hit after it lowered its sales and earnings guidance for this quarter. That sent shares down about 40% and they have not rebounded since. A couple of weeks ago, fellow competitor Brown Shoe (BWS) trimmed its outlook based on expectations for a weak holiday season.

Deckers raised its fourth quarter and full year guidance when it reported last quarter. We also saw raises in guidance from Wolverine Worldwide (WWW), and Steven Madden (SHOO). We'll also get a better idea of how footwear sales in general are doing this week when Nike (NKE) reports its quarterly earnings.

About a quarter of the company's sales come from outside the U.S., with a large portion of that coming from the UK and Europe. I don't have an exact percentage on how much that region accounts for, but it is something to think about when looking at the company.


While the company is growing year over year on both the top and bottom line, Deckers has not performed great over the first nine months of this year. The company's financial position has weakened a bit, as have its margins. We've seen warnings from fellow names Brown Shoe and Crocs, and the recent analyst downgrade could be the canary in the coal mine. The weather has been a bit warm, and if UGGs are not selling well, the company will have a terrible quarter.

Deckers to me is looking like a short right now on any pops, and I might be adding it to my theoretical short portfolio at next update. With 11% short interest at the end of November, this isn't a candidate that you need to worry about a short squeeze with. However, given the growth the company is showing, it will jump on any good news. I see a good quarter coming for the company, but I don't know if it will be enough to satisfy what many are looking for.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.