Deckers: The Latest High-Growth Stock To Collapse

| About: Deckers Outdoor (DECK)

High-growth stocks are dangerous, ones where investors expect continued growth at rates that may not be sustainable. If you want some examples, take a look at the consumer goods sector. When the bubble bursts for a company with a product that may be considered a fad, look out below. A few years ago we saw the fall of Crocs (NASDAQ:CROX), the company behind those shoes with the holes. The growth was there for a while but then it wasn't, and the stock tumbled. Crocs rebounded, but in 2011 got hit again. Recently, Crocs dropped after another round of disappointing guidance.

In 2011, we saw a number of collapses, two of which were consumer goods names. The first was Green Mountain Coffee Roasters (NASDAQ:GMCR). Hedge fund manager David Einhorn gave a negative presentation on the stock, but it was growth that did the company in when it missed revenue expectations by $50 million that quarter. In 2012, the name has fallen again as questions remain regarding its expiring patents and relationship with Starbucks (NASDAQ:SBUX). The second was SodaStream (NASDAQ:SODA), which manufactures machines that allow you to make soda at home. SodaStream collapsed in 2011, even though it has consistently beat expectations. Growth is slowing, and when the word "fad" comes up, investors run away. Of course, let's not forget Netflix (NASDAQ:NFLX), the content provider that raised prices and tried to kill off its DVD segment. Shares went from over $300 to nearly $60. Netflix's future remains in doubt, as many would argue that it doesn't have a workable business model. All of these names have one thing in common: The growth was there, until it wasn't -- or at least not as much as people wanted.

Now, in 2012, the next collapse is Deckers Outdoor (NASDAQ:DECK), the company behind the Ugg brand name. The company also owns the Teva brand and has completed an acquisition of the Sanuk brand. Ugg boots have become very fashionable, but at times sales of them have been as much as 90% of the company's quarterly revenue.

If you don't follow Deckers, I offer some background in the articles linked below. I've been watching this name since late 2011, and I've been dead on when it comes to Deckers. In late December, I called the name a short opportunity when a Wall Street analyst stated that it could be in trouble due to a warm winter. That hasn't been good for Deckers, but that is not the company's only problem. It hasn't been able to control costs, something I've mentioned along the way.

Before I get into the latest quarter, here are three articles I've written that detail issues with Deckers over time:

Toward the end of last week, Deckers reported its fiscal first-quarter earnings report. Deckers reported revenue that was up 20.24% over the prior year, but only in line with Street estimates and slightly ahead of the 19% Deckers had forecast. Technically, that was a disappointment as Deckers has been known for giving conservative guidance, so a small beat can be seen as a miss. Earnings is where it gets ugly. Deckers forecast a drop in earnings per share of 50% from Q1 in 2011, which saw a profit of $0.49. Analysts were expecting $0.25. The company reported just $0.20. Net income was down 59%. Deckers had forecast a rise in product costs, due to higher prices for sheepskin costs -- but that wasn't the only culprit. Weather was to blame as well, and the company was forced to make some closeout sales with lower margin Teva and non-classic Uggs, which pressured gross margins.

In recent days, I've had a discussion with some people on this site about Deckers. They believe that Deckers can turn things around because revenue is growing, and that input costs will eventually ease. That may be true, but Deckers is not just having problems with input costs. It is having problems selling its non-traditional Uggs and other products, which are lower-margin products to begin with. That forces the company to take part in "closeout sales," where the products are sold off at reduced prices. In the first quarter, sales of Uggs were up just 6.5%, and Teva sales were down 1.1%. In fact, of the $41.5 million increase in revenue over the prior-year period, $32.4 million of the increase was due to sales from the Sanuk acquisition. Deckers' main products didn't really account for much growth.

If you think Deckers can get by waiting for input costs to stop rising, think again. Deckers is in the process of expanding and opening its own retail stores, which has resulted in sharp increases in selling, general, and administrative costs. These stores might help sales rise, but how profitable will they be? Just look at the following table, which shows Deckers' Q1 revenue increase, cost of goods sold increase, and SG&A expenses increase over the past few years.

Q1 Y/O/Y Change 2009 2010 2011 2012
Revenues 37.62% 16.17% 31.38% 20.24%
Cost of Goods Sold 46.56% 3.59% 31.21% 29.93%
SG&A Expenses 36.09% 24.00% 51.33% 36.44%
Click to enlarge

Cost of goods sold has risen sharply in three of the past four years, but more concerning is the SG&A number. The one year Deckers was able to control input costs, SG&A costs rose at a much higher rate. The past two years have seen even increases. Deckers won't be growing revenue at 30% or 20% levels going forward, so input costs had better get under control if it can't keep SG&A expenses down. Here is the impact on Q1 margins:

Q1 Margins 2008 2009 2010 2011 2012
Gross 47.31% 43.89% 49.96% 50.03% 45.99%
Operating 17.49% 14.40% 18.48% 13.76% 4.84%
Profit 11.58% 9.19% 11.48% 9.36% 3.20%
Click to enlarge

Even in 2010, when the company kept input costs down and gross margins increased by more than 6 percentage points, Deckers wasn't able to carry a lot of that through to net income. In 2011, gross margins were slightly up, but operating income took a dive. In 2012, gross margins were down, but still were more than 2 full percentage points higher than 2009. However, look at the operating and profit margins: way down. This isn't a one-time issue.

These impacts have been felt on the balance sheet as well. The company completed the Sanuk acquisition in 2011, dramatically changing its balance sheet. A year ago, goodwill and intangible assets made up just 3.51% of Deckers' total assets. At the end of Q1 2012, that number was up to 21.66%. Because Deckers is highly affected by seasonality, it does not make sense to look at its financial ratios from quarter to quarter. However, you can look at them from year to year, so I've thrown together three financial ratios I always look at:

Financial Ratios 3/31/09 3/31/10 3/31/11 3/31/12
Current Ratio 8.68 8.31 9.51 6.81
Debt Ratio 10.42% 11.35% 10.44% 15.02%
Working Capital $328,593 $438,079 $585,905 $552,540
Click to enlarge

The current ratio, although still high at 6.81, took a dive from last year. The debt (liabilities-to-assets) ratio jumped tremendously. Working capital also decreased. If you look at current assets, cash declined from $437.9 million a year ago to $228.6 million at the end of Q1. I'm not worried about the cash number yet, because some was used in the Sanuk acquisition. The most troubling number here is inventories, which rose from $107 million a year ago to $208 million plus this year. That jump, as a percentage of total assets, went from 14.21% to 21.26%. As a percentage of current assets, the inventory number soared from 16.36% to 32.18%. It is extremely worrisome to me that the inventory number has risen so much, given that the company does not expect a ton of sales growth this year. Is Deckers going to be able to sell those products, or are we going to see more closeout sales? Fourth-quarter inventory numbers were also high, so there might be a large amount of old product out there. That is not a good sign.

So what is the immediate result of Q1, and how are things going to look for the rest of the year? Not good. Deckers took down guidance for the year, and here is what the company had to say:

  • 2012 sales expected to be up 15%, compared to previous guidance of a 14% increase.
  • Gross margins to decline by 250 basis points, compared to previous guidance of a 200-basis-point decline.
  • SG&A expenses to be 30% of sales, compared to previous guidance of 39%.
  • Diluted earnings per share down 9% to 10%, compared to previous guidance for flat earnings.

How has that looked over time? Well, I've put together a table of analyst expectations over the past five months, as well as Deckers' provided guidance here:

Expectations Revenue Growth EPS Growth
12/20 20.2% 17.5%
2/23 19.8% 14.2%
4/21 15.8% 1.4%
4/28 14.7% -2.0%
Deckers' current 14.0% -9% to -10%
Click to enlarge

Given that earnings just came out a few days ago, most analysts following the name have not yet taken down their numbers. So expect to see additional decreases, especially the EPS growth number.

In 2011, Deckers posted an earnings-per-share number of $5.07. Given the company's guidance, we are looking for a little more than $4.50 this year, and I think we'll be closer to $4.25 by year-end. The worst part is looking forward: 90 days ago, expectations for 2013 earnings called for $6.84 in earnings per share. Now expectations call for just $5.82, and I think that number will go lower. Don't forget -- this company is buying back stock, which is actually helping EPS numbers, so net income numbers are even worse than they look.

For Q2, Deckers announced that it expects revenue to increase by 8% year over year, compared to the nearly 16% analysts were expecting. Deckers also forecast a second-quarter loss of $0.60, compared to last year's $0.19 loss. Analysts were looking for a loss, but of just 40 cents. Think about this as well: Last year's Q2 did not have the Sanuk brand, so that 8% revenue increase could attribute to most, all, or more than all of the revenue change. That means the core products, Uggs and Teva, could see year-over-year sales declines.

Some of the people I've spoken to have said that Deckers is a buy based on pure valuation, because Deckers is trading at just 11.3 times this year's earnings. That might seem cheap, but just look at Crocs. Crocs is trading at 13.6 times this year's earnings, but it is also providing more revenue growth and 18% earnings growth, not an earnings decline of roughly 10%. Deckers might seem cheap on valuation, but what if they keep taking down numbers? Ninety days ago, analysts were expecting $5.90 in earnings this year. Now a realistic target is $4.50.

I still think Deckers is a short idea, although shorting it immediately after a 25% drop may be a bit of a reach. It might be a better idea to wait for a small rally, then short it. Deckers has too many negatives right now. Revenue growth, which was 37% last year, is expected to be just 14% this year and probably even less in 2013. Earnings per share are going to fall, and 2013 numbers might only rebound to 2011 numbers. The company is having a hard time controlling costs -- and it is not just input costs. I'm not calling their product a fad, but sales have slowed and weather is just part of it. The company's high inventory levels also concern me. Deckers has been the latest high-growth name to collapse, which I expected, and I think there is the potential for more disappointment going forward.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in GMCR, NFLX over the next 72 hours.