Deckers Outdoor: A Play On Seasonal Demand

| About: Deckers Outdoor (DECK)

For many the Memorial Day weekend ushers in summer fun even if the calendar says the season does not begin for another three weeks. While running this past weekend and it occurred to me despite the troubles dogging consumers - no jobs, no prospects, no savings, etc. - they can still enjoy the outdoors. I set out to find a company that would benefit from an exodus outdoors by beleaguered consumers.

I discarded manufacturers of recreational vehicles and speed boats with their high ticket prices as not likely to be at the top of anyone's have-to-have list this season. There are no pure plays on sporting equipment that are also accessible as investments by the same people who buy the bats and balls. That left shoes - specifically outdoor shoes. After all you cannot enjoy a day in nature unless you are properly shod.

There are quite a few outdoor shoe alternatives for investors. My vetting process revealed a designer with footwear only a shoe collector could love.

Just do it! Cross Nike, Inc. (NYSE:NKE) off the list as probably fully valued at 23.1 times trailing earnings and 18.8 times estimated earnings for 2012. NIKE is more a play on sports personalities than favorable recreation trends. Adidas (OTCQX:ADDYY) is a bit more affordable at 16.0 times forward earnings, but still does not capture our summer fun concept. Check PUMA, SE off the list for the same reason. I am not ignoring the popular footwear made by New Balance Athletic Shoes. It has made the political news lately with support for investment bankers turned presidential candidates, but as a private company New Balance remains off limits to regular schlubs like you and me.

For many, a new pair of Keds started the summer vacation. The century-old brand is now owned by Collective Brands, Inc. (NYSE:PSS), the operator of Payless Shoe stores. At 12.4 times forward earnings PSS is a bit more affordable. Collective Brands also owns Champion and American Eagle brands, making the stock mostly a proxy for the value in brand management and retailing. Same can be said for Foot Locker, Inc. (NYSE:FL) and Shoe Carnival, Inc. (NASDAQ:SCVL), two more popular shoe outlets.

If you are still reading at this point, you might be screaming CROCS! CROCS! Why doesn't she mention CROCS? The popular plastic bubble-like sandals and clogs made by Crocs, Inc. (NASDAQ:CROX) seem to be everywhere in the summer. Analysts appear to be as infatuated as consumers and predict a 17.5% growth rate over the next five years. The consensus price target suggests potential for 40% upside from the current price level. A PE of 10.0 times forward earnings suggests that CROX growth is selling at a bargain price. We are getting close but I am still not feeling the warm, sunny outdoors.

For real outdoor footwear we need to look at the likes of Timberland, Wolverine and Red Wing. These companies make serious foot support for the hiker, hunter and fisherman as well as casual shoes for the guy or gal who just wants to look cool around the camp fire. Alas The Timberland Company and Red Wing Shoe Company are both privately held.

Wolverine World Wide, Inc. (NYSE:WWW) has a similar, competitive offering although the product line is more complete on the work boot end. The focus on the workplace, which has been in a funk of late, is probably why Wolverine has only managed 10% average annual growth over the last five years and does not appear poised to do much better over the next five years. That means its price earnings ratio of 14.0 times earnings expectations next year is just too pricey even for a strong brand name like Wolverine.

In my view, LaCrosse is an uncommon brand of supreme style - and it is all about the outdoors. On the surface Lacrosse Footwear, Inc. (NASDAQ:BOOT-OLD) looks barely affordable, trading at 15.9 times forward earnings. Lacrosse is plugging along at a 10% growth rate and management appears to be counting on military orders to boost revenue and earnings. A forward dividend yield of 4.7% from BOOT is enticing and might justify the earnings multiple, but how long can Lacrosse's 81% payout ratio be maintained?

Our list grows thin! Indeed there is only one public footwear producer of substance left and its….ugh!....another bulky, bubbly shoe. Deckers Outdoor Corporation (NASDAQ:DECK) produces the UGG boot that is popular the world over among women of all ages, all year round. UGG volumes represent two-thirds of Deckers' sales, but its Teva outdoor performance and Sanük action sport brands are gaining ground. Deckers just bought the Sanük brand in July 2011, a move which is helping smooth out the seasonal influences of the winter-time UGG sales in North America and Europe.

Deckers calls UGG a luxury comfort brand. The sheepskin boots have certainly been comforting to DECK shareholders, helping drive earnings at a compound annual rate of 36% over the last five years. The mob of analysts who follow DECK apparently think the earnings growth will slow to 15% over the next five years. Even so that still makes DECK shares a compelling value at the current price level near 10.7 times forward earnings.

If DECK is the winner of this protracted vetting process for the ultimate outdoor shoe investment, let's make certain there is nothing amiss in the financial details. Cash flows are often a give-away of financial misfortunes in the making. After making significant investment in inventory in 2010 and 2011, Deckers' operations have generated ever lower cash flow. The cash conversion rate was 2.2% in 2011 (cash flow from operations/total sales) compared to 14.0% in 2010 and 22.8% in 2009.

Deckers management may have found inventory levels too low by the end of 2010. Additions to inventory of 37.6% in 2010 failed to keep pace with a heady sales growth rate of 113.1% the same year. So in 2011, Deckers doubled inventory even as sales were only ramping at a much slower pace of 46.4% in the year. In the first quarter 2012, the company started selling down that inventory, mostly for the Teva and Sanük brands which experience peak sales in the first and second quarters as distributors and wholesale partners prepare for the summer selling season.

If you think the inventory gyrations will ultimately even out, DECK may be your play on new-found interest in the "outdoors." Taking a position ahead of the UGG selling season in the third and fourth quarters may also be smart timing. Plus a share of DECK is cheaper than a pair of UGGs.

Disclosure: Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.