Deckers Outdoor Corp. (DECK) reported its fourth-quarter 2011 financial results late last week. While profits were high, guidance was disappointing but not unexpected. Deckers, is a profitable company with quality products but investors should remain cautious about their growth moving forward because of rising costs of materials and the mania surrounding Ugg's beginning to subside. However, some believe that sales are strong and DECK has yet to fully expand into international markets.
Deckers Has All Its Eggs In One 'Uggly' Basket
Let's remember that Ugg boots account for roughly 80% of Deckers revenues. When you look at Deckers competitors, such as Nike (NKE) and VF Corporation (VFC), we can see that the competitors have product lines in everything from denim to backpacks. If one of their product lines suffered, they have a safety net of about 30 other product lines to keep them afloat. Deckers doesn't have that luxury.
DECK said in its Q4 Earnings Conference Call that sheepskin prices have been locked in for 2012 at a 40% increase and that will likely squeeze margins. After reporting Q4 and guidance, rising costs will really hurt the company's bottom line with Deckers expecting revenue growth of just 15% in 2012.
Deckers says that it has implemented programs to help mitigate the impact from higher sheepskin and raw material costs. These include, "selectively raising prices, increasing the mix of non-sheepskin product; exploring new footwear materials, new production technologies and U.S. production, and supply chain efficiencies such as reduced freight costs and others." Raising prices on an already higher-end product could limit the number of consumers that are willing to buy.
Ugg's Not on Trend
It's unlikely that Deckers will ever again have the sort of massive growth that put Uggs and the company on the map. Fashion trends are always fleeting. The mania that surrounded Uggs a few years ago is coming to a close. This is not to say that Uggs won't remain popular - just that growth will inevitably slow. Although Uggs keeps churning out new types of killer boots, their forays into other types of shoes is a little shaky. Paying $160 for a pair of shoes that look like they came from Target is not what the high-end Ugg customer is looking for.
Uggs' competitors have also been taking some market share. Bearpaw, which is literally making knock-off boots without real sheepskin, is being sold at Nordstrom and other major shoe retailers and is an easy second choice to Uggs at about half the cost. That said, the core customers will most likely continue to buy Uggs boots. Uggs are a "Best of Breed" brand like Apple, and for customers for whom price is not object, the Uggs name is synonymous with quality.
Plugging DECK in to Tweaker, revenue growth for Deckers is expected to be 15%. We can put in a range of 14-16% and take the profit margin down a notch from consensus views of 7.7-9.5% to 7-8%. This puts Deckers at High Risk at any price over $70.00. The price target at this rate would be $65.00 (middle white line).
But what will happen if growth slows to 10%? We can plug in a growth rate range of 10% and keep the profit margin. DECK looks highly overvalued in this case.
To be clear, the Uggs brand won't disappear overnight, but rather experience a slowdown in growth vs. prior years. It's not the end of Deckers, it's just probably the end of 'Ugg-mania', which could mean that shares of DECK should fall drastically in 2012 unless they can build themselves another quality product line to maintain their currently high valuation.