Recently, I covered the second quarter earnings report for Deckers Outdoor (NASDAQ:DECK), the company behind the UGG boots, and the Teva and Sanuk brands. While second quarter results were slightly better than forecast, the company only maintained its full year forecast. In fact, they essentially warned on Q3, but claimed those sales and earnings would be made up in Q4.
Now I was calling for investors to be short on Deckers all the way down from the $90 level late last year until recent times, when I suggested shares would rally if guidance was good. It wasn't terrible, so Deckers shares have rallied off their recent 52-week low of $39.90, and on Friday, crossed the $50 level for the first time in more than two months. Shares have rallied heavily in the past three days, and volume has been rather high, reaching nearly 7 million shares in two days. For investors looking at the name, is now the time to get in? Let's examine.
The Bull Case:
With shares down almost 50% year to date when they hit the 52-week low, the bull case started with valuation. Deckers was trading at a low price to earnings multiple, and that has been the main argument for bulls. Those on the long side also point to the fact that a bad winter was a one-time issue, and that the growth story will re-materialize in late 2012 and going forward. Also, the company is in excellent financial condition, with no debt, very little liabilities, and a decent cash position. The company has been buying back shares, and announced a new $200 million buyback program during the latest earnings report.
Now that I've detailed the main argument for the long side, I'll tell you why some of those "positives" aren't as bright as you might think.
Growth and Valuation History:
Deckers has been an impressive growth story. Even during the financial crisis, Deckers found a way to grow revenues and earnings per share at a double digit pace. The following table I've put together shows the revenue and earnings growth for Deckers since 2007. Also, I've included the high and low price to earnings multiple the stock has traded at for each of those years (using that year's reported earnings per share and the high and low share price for the year). Yes, I have taken into account the stock split from 2010.
The growth rates for Deckers were tremendous during those years.
Now, Deckers bulls point to the fact that Deckers trades (as of Friday's close) at 11.43 times 2012 expected earnings per share and 9.63 times expected 2013 earnings. They state that the valuation is extremely low and leaves plenty of room for upside.
Is the valuation really cheap? Looking at the 2012 and 2013 numbers, which I've provided below, it might not actually be. As you can see below, Deckers has averaged 35% revenue growth and 44% earnings per share growth over the past 5 years. But Deckers is only expected to grow revenues in the low teens this year and next. Earnings per share are expected to fall this year, and despite a projected rebound next year, the 2013 figure is only expected to be about 4% higher than 2011 levels (and that is misleading, more on that later). So naturally, if the growth is much less, I would expect the valuation to be a bit less. As you can see below, the High P/E so far this year was below the 5-year average, and the low P/E was about at the average.
Don't forget too, these are just the averages. At one point in 2009, Deckers traded for just over 4 times what that year's expected earnings turned out to be. The average P/E over the 5 years using the high and low turned out to be 16.32, so to me, a current valuation of 11.43 times this year's earnings, given the much lower growth, isn't that much of a stretch.
*Compound annual growth rate for revenue and EPS growth rates.
Actual growth - the impact of the buyback:
While buying back stock is generally a positive for a stock, as it is a signal that management thinks shares are undervalued, and they want to put a potential floor in the name, it can sometimes hide growth issues. That's exactly what we have here.
For example, assume a company has $200 million in net income and a 50 million diluted share count. That means earnings per share are $4. But the next year, net income is the same, and the diluted share count is just 49 million. Earnings per share are $4.08. Earnings per share have risen nicely, but net income really hasn't.
Deckers reported $5.07 in earnings per share for 2011. The currently expected figure for 2012 is $4.44. But at the end of 2011, the diluted share count was 39.188 million. At the end of June, it was down to 37.873 million, and we expect more share buybacks in the second half of the year, thanks to the new buyback plan.
So analysts expect earnings per share to decline by 12.4% this year and that includes the buyback. So in terms of net income, we could easily see a 15% decline, or more if Deckers misses.
Now looking to 2013, analysts currently expect $5.27, which would be a 3.94% increase over 2011's figure. But given the share buybacks, it is quite possible that total net income could actually fall over the two year period.
Overall, I'm only a fan of stock buybacks when a company either has way too much cash, or a company is extremely mature in its growth stage. I rather would have seen Deckers maybe announced a $100 million buyback, and perhaps try to use some capital for an acquisition. The Sanuk acquisition has seemed to work really well for the company, and was well timed. Had Deckers not had Sanuk in Q2, overall sales for the period would have been down 5%!
Comparisons to industry peers:
Broadly speaking, Deckers is considered a "specialty apparel" maker. Deckers is known mostly for its footwear under the UGG, Teva, and Sanuk brands, but also makes various apparel and accessories. Deckers also has been trading as a "high-growth" or momentum name, due to the impressive recent growth rates it has had in the past. For those reasons, when I look at Deckers, I look at three other names. First, is Crocs (NASDAQ:CROX), which also makes specialty footwear. I also compare the name to Under Armour (NYSE:UA) and lululemon (NASDAQ:LULU). Those last two generally make more apparel and athletic products, but are comparative in the "high-growth" category.
I will present two tables to form comparisons between the names. The first one will show growth prospects. For each name, I've provided the current fiscal year and next fiscal year growth expected by analysts, for both revenues and earnings per share. A small note, lululemon's fiscal year ends in January. The other three are calendar years.
As you can see, Deckers is poised to show the least growth of these names, in terms of both revenues and earnings. Deckers' revenue growth looks comparable to Crocs, but Crocs' two year total is for more than 5% more growth, or about 22% of Deckers' potential. In terms of earnings, Crocs blows away Deckers.
Now the second table is valuation. I'll provide the price to earnings ratios for each name, for expected earnings this year and next. Again, for lululemon I am using the fiscal year ending in January.
Interestingly enough, both DECK and LULU have rallied more than 10% in the past couple of days. CROX and UA are up in the high single digits, percentage wise.
So when I look at the valuations here, I realize that the lululemon and Under Armour valuations look absolutely ridiculous. They are high, I will agree, but you are getting a lot more growth. I would say that Under Armour is extremely overvalued, but that's another debate.
When it comes to Deckers, the company is valued about as equally to Crocs as it can be, and Crocs is showing a lot more growth this year and next. Personally, I'd be willing to pay that premium for lululemon, a company that has delivered strong results in recent quarters and has consistently upped its forecast. Deckers has basically warned for three quarters in a row, which is why I'm skeptical of the current growth forecast. Deckers is overvalued on a P/E basis when comparing it to Crocs, and Crocs has more growth potential. That worries me.
Deckers guided to just 1% revenue growth for the third quarter. Last year's figure was $414.36 million, and analysts are currently looking for $420.69 million, or 1.5% growth.
We know that Sanuk sales are projected to be up a few million over last year's third quarter, and that Deckers "other brands" will see a decline, after the closure of the Simple brand in 2011. That means that the combined growth of Teva and UGG will be flat to only up slightly. However, Deckers raised its guidance for Q4, which ended up being well above analyst estimates. We'll see in a few months if they cut that forecast, like they have with the last three.
Now, there hasn't been a ton of news lately, but Deckers did announce a restated credit facility agreement, increasing from $200 million to $400 million, and if agreed upon, a raise to $500 million. Now, Deckers doesn't need capital at the moment, since they only have $305 million of liabilities, and their current asset base is more than $683 million (total assets over a billion). But this does give them a little more financial flexibility should they need some money here and there, whether it is for the buyback or for corporate matters, like stocking up on inventory for their heavy sales periods later this year.
Conclusion - Don't jump on the bandwagon just yet:
Thanks to the recent rally, shares of Deckers are now up more than 27% since the 52-week low, and that gives me some pause. Deckers has essentially warned for three straight quarters, and their growth forecasts for 2012 and 2013 are well below the recent five year average. Yes, a P/E of 11 plus for this year may seem a little low to some, based on prior year valuations, but this is a company offering a lot less growth. Also, when compared to other names in the space, like Crocs, shares appear to be overvalued at this point.
Now, I'm not recommending that investors throw all the resources they have at shorting this name. Not yet anyway, that was several months ago. But I wouldn't exactly throw every last penny into it thinking it will be back near the 52-week high of $119 anytime soon. Deckers is a good short candidate right now, thanks to the recent rally. By that I mean that investors should start looking at if they want to short this name, and if we rally a bit more then pull the trigger.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.