Deckers: Examining The Short Case

May.30.12 | About: Deckers Outdoor (DECK)

After the company released its terrible first quarter earnings report, I mentioned that I would revisit Deckers Outdoor (NYSE:DECK) a few weeks later. Deckers shares had blown up again, and had officially joined the "high-growth implosion" club, alongside fellow members SodaStream (NASDAQ:SODA), Green Mountain Coffee Roasters (NASDAQ:GMCR), Netflix (NASDAQ:NFLX), and Crocs (NASDAQ:CROX). Deckers hit a 52-week low of $50.18 after the earnings report, and has rallied more than $8 from that point. I stated in the above article that I would wait for a rally to short the name. Today, I am going to examine the short case for this name.

Before I get into the numbers, I'll give you a brief overview of the situation. Deckers is the company behind those UGG brand boots you see everywhere. They also own the Teva brand, another outdoor footwear line, which they added to in 2011 with the acquisition of the Sanuk brand. Deckers' products have gained tremendous popularity in the past few years. The company is reliant on somewhat of a cold winter, as UGGs represent a huge percentage of their overall sales. We had a very mild winter in the United States, and that led to lower sales and higher inventories.

Green Mountain might have also experienced a lack of sales due to the warm winter, because you don't need as much coffee when it is 70 degrees out. Now, some have said that UGGs are becoming a fad, comparable to what happened to Crocs a number of years ago. I am not here to say that today, but it could be argued if sales continue to be sluggish going forward.

So let's look at some numbers. I've compiled three main tables to show how the UGG and Teva lines have performed in recent years, as well as the overall company revenue number. The percentages I am showing in the tables below are the year over year increases for each quarter, and for the full year. I'll start with UGGs.

UGG 1Q 2Q 3Q 4Q Year
2009 66.9% 22.9% 19.1% 15.7% 22.3%
2010 14.2% 34.6% 20.2% 23.8% 22.7%
2011 42.2% 8.0% 47.3% 37.7% 37.6%
Click to enlarge

As you can see, growth was strong in 2009 and 2010, and got even better in 2011. However, the mild winter has really sunk in. The first quarter of 2012 saw just a 6.5% year over year increase in UGG sales. The second quarter numbers are not expected to be much better, and I'll get into that later. Now let's look at Teva numbers.

Teva 1Q 2Q 3Q 4Q Year
2009 -5.7% -10.6% -19.5% -14.8% -10.2%
2010 21.4% 38.4% 51.7% 26.2% 30.5%
2011 16.8% 29.1% 7.3% 45.9% 23.1%
Click to enlarge

After a weak 2009, Teva sales were very strong in 2010. However, they slowed down a bit in 2011. The first quarter of 2012 saw Teva sales down 1.1% over the prior year period, the first decline since 2009. Generally, the second quarter is stronger than the first, so there should be some rebound coming.

Now we get into the revenues. The growth accelerated from 2009 to 2011, as you can see below, but we must discuss why. If you notice, the 3rd and 4th quarter of 2011 saw huge revenue increases, which from that point on are highlighted in bold. Deckers completed the Sanuk acquisition in early July, so from the 3rd quarter of 2011 on, all results include the added sales from the Sanuk purchase.

Revenues 1Q 2Q 3Q 4Q Year
2009 37.6% 12.5% 15.8% 14.7% 17.9%
2010 16.2% 33.7% 21.7% 23.6% 23.1%
2011 31.4% 12.5% 49.1% 40.4% 37.6%
2012 20.2% 8.0% N/A N/A 14.0%
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The 1st quarter 2012 number above is the actual result. The 20.2% increase was disappointing, and 80% of that increase was from Sanuk sales. Overall, sales from existing products did not do well.

The 2nd quarter and full year numbers for 2012 are from the guidance given by the company. Second quarter revenues are expected to see a high single digit rise in percentage terms. That includes the fact that Sanuk sales were $0 for the same period in 2011, meaning UGG and Teva sales are not expected to do very well. Also, a 14% rise in yearly sales, which includes a full year from the Sanuk brand, is not good. The slowdown is more dramatic than it might originally appear.

But that is just at the top line. Deckers has some similarities to both Netflix and SodaStream as well. They are seeing a lot of costs increase, and it is not just the main costs. For those that follow my writing about Netflix, they know that content costs are soaring which is eating away at gross margins. Deckers is seeing sheepskin prices soar right now, so their gross margins have been hampered. Similarly, SodaStream and Deckers have a lot of selling, general, and administrative costs. They are not the most well known brands, so they need a big marketing push. That can be expensive.

It hurts even more when you get a scenario like 2012, when revenue growth all of a sudden slows. No matter which high growth name you are talking about, Netflix, SodaStream, Green Mountain, or Deckers, you can't exactly cut costs overnight. That will push down operating margins, and will hurt the bottom line as well. Just look at the yearly margins for Deckers below (profit margins are based on net income applicable to Deckers shareholders, which subtracts out noncontrolling interests).

Margins 2008 2009 2010 2011
Gross 44.28% 45.63% 50.24% 49.30%
Operating 16.96% 22.29% 24.88% 20.68%
Profit 10.73% 14.36% 15.81% 14.45%
Click to enlarge

2012 margins are going to come down even more. Deckers' Q1 gross margins fell 4 full points over the prior year. Operating margins plunged from 13.76% to 4.84%. Net profit margins fell as well from 9.36% to 3.2%. The second quarter, which has seasonably posted a loss in recent years, is expected to show a much bigger loss this year.

So where does that leave us? Well, Deckers took down their guidance in the Q1 report. 2012 Revenue guidance was decreased from 15% to 14%, and analysts are currently expecting just 13.3% growth. Deckers announced that they expect earnings per share to fall 9% to 10%, versus a previous forecast for flat year over year earnings. Analysts have since adjusted their estimates, taking them down from $5.13 to $4.53 (2011 saw $5.07). This is even worse when you realize the company is buying back stock, which helps earnings per share figures.

When we look at the second quarter numbers (the current quarter), Deckers forecasted revenue growth of 8% and a loss of $0.60, compared to the prior year period's loss of $0.19. Now, that revenue number will be disappointing, as I mentioned above, since it will include growth from the Sanuk brand. Currently, analysts are estimating a $0.60 loss, but they are slightly more positive on revenue growth, with current estimates for 8.3%.

So why am I still not a believer in Deckers? Well, the valuation doesn't make sense to me either. Yes, Deckers has fallen from $90 to $58 since I initially discussed the short case in December. That is a large drop, but we've gone from expecting about a 10% increase in earnings and 20% revenue growth to 14% revenue growth (company forecast) and about a 10% decline in earnings. For a high growth company, that's not a good sign. Just look at the following table, comparing Deckers right now to Crocs.

Growth / Valuation DECK CROX
2012 Revenue Growth 13.3% 17.0%
2013 Revenue Growth 12.5% 14.0%
2012 EPS Growth -10.7% 17.7%
2013 EPS Growth 20.8% 18.5%
P/E (2012) 12.91 12.36
P/E (2013) 10.69 10.43
Click to enlarge

So Deckers is showing smaller revenue growth, even after an acquisition, and lower earnings per share growth. Now, I don't count earnings per share growth for 2013 as being "higher" for Deckers because of the fall in them for 2012. Despite Crocs showing more growth, Deckers trades at a higher valuation. All things being equal, that should not occur. In my opinion, Deckers still may be overvalued at current levels.

In conclusion, the Deckers short case is still intact. While expectations have certainly come down, Deckers needs to post a good number this quarter, or we will definitely lose the $50 level this time. In fact, should the company lower their forecast again, it is not out of the question to see $40. Just look at the plunge Green Mountain took.

Many of these high growth, or momentum, names trade similarly, so Deckers will plunge on a bad report, even though it has already fallen quite a bit. While you could definitely short the name here around $58, you might want to wait to see if we can break into the $60 to $65 range, which would provide a better shorting opportunity.

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