The news for Deckers (DECK) hasn't been great over the past several months. The slide in its share price began when the Street became more cautious on its fundamentals in December, and it recently culminated with flat earnings growth guidance for its fiscal year 2012 due primarily to higher input costs.
Though the raw expense of boot materials (sheepskin) may weigh on the company's fundamentals in the near term, we think the market has generally overreacted to the these headwinds. Regardless of how fashionable men think the company's flagship Ugg boots are (often nicknamed "Ugg-ly), we think they're among the most dominant women's winter footwear brands, along with Sorel (COLM) and North Face (VFC). And why wouldn't they be? Other than their subjective and questionable appearance, objectively they are among the warmest and most durable winter boots for women (and men). Football star Tom Brady's advertising campaign may not have struck a chord with too many men, but we still think Ugg's is a fantastic brand with some staying power.
But however great the boots may be for winter weather, a great deal of America, where Decker's does about 70% of its business, hardly experienced any harsh winter weather at all. In fact, February, often the most dreaded and miserable of the winter months, was by all accounts mild and bearable. Though this makes for happy citizens across traditionally cold markets, one can clearly see that this isn't good for a brand predicated on miserable winters. And we wonder if this will threaten the firm's ability to hit its 19% revenue growth target for the first quarter of this year.
Though we think the unseasonal winter weather is an anomaly, retailers like Nordstrom (JWN) may hold greater power in the supply chain, as in our opinion, Uggs aren't viewed as "must-haves" anymore. Further, Nordstrom took steep discounts and was forced to sell several popular styles through its discount arm rather than at full prices. We think this could hurt Decker's margins in the near-term, but we think the relationship will balance out in the long run.
But what about men's footwear?
That's a great question. What is Deckers doing with its men's footwear? Sure, they have some smaller niche brands that account for around 13% of sales, but the company is still mostly its flagship Ugg brand. Can they branch out to men's and other women's shoes?
Yes and no. We think the men's Ugg slipper may have strong prospects for growth, but its target market is somewhat narrow (i.e. people looking for $90-$110 pair of slippers). Decker's CEO Angel Martinez claims that the men love the famous fur, but only on the inside of the boot/shoe. This may be true, but we think men are probably only comfortable with it in the house (where no one will see it). Though we haven't traveled to every market, we haven't seen a lot of men wearing Ugg boots, even if Tom Brady does.
After viewing the complete offering of men's shoes available at Deckers, and on the basis of anecdotal evidence, we just don't envision "men's" becoming a very meaningful part of the firm's sales. For one, the market is highly competitive, and we doubt that Ugg will ever really be able to shed its "female reputation." Additionally, we're not impressed with the company's fashion sense. In our view, most products look like super-expensive Nike (NKE), Converse, Clark's, and Sperry-inspired footwear.
Decker's has had phenomenal growth during the past several years. In 2011, for example, sales jumped 38%, but inventories more than doubled. Though this partially reflects higher raw-material costs, we think most of the build is comprised of past successes and new products.
If the men's products and new women's products don't sell, we think Decker's may have to write-down some more of its inventory (and a lot more than the $7 million charge it took in 2011). Further, cash flow in 2011 was mediocre at best. With inventories soaring, the company only generated about $30 million in operating cash flow in 2011 versus $140 million in 2010 and $185 million in 2009. We view this decrease as substantial, especially considering that gross margins fell 90 basis points, despite some pricing increases, and SG&A grew by over 300 basis points.
Overall, the Ugg brand continues to resonate with women, and we wouldn't be surprised to see the company post continued strong sales growth in coming quarters. However, given the risks associated with its inventory build as well as the uncertainty regarding the future success of its men's footwear product suite, we wouldn't consider adding the company to our Best Ideas portfolio until it fell into the mid-$50s (and only on improving technicals at those levels). This view is substantiated by the margin of safety we assign to the company's shares, and our point estimate of Decker's fair value, which we peg just below $80 per share (its shares are currently trading in the high $60s). For investors looking for a high-quality firm in the specialty retail space, we prefer Nike, though its shares, too, are fairly valued.