Deckers (Nasdaq: DECK) Has 40%+ Upside

(This is a highly-abbreviated version of a full SumZero report republished with the author's consent)

Contributor: David Epstein
Location: Los Angeles, CA

Recommendation: Long Deckers (Nasdaq: DECK)
Timeframe: 6 Months to 1 Year
Current Price: $55.25
Target Price: $78.00

Quick Thesis:
Deckers shares have declined 32% in 2012 as an unusually warm winter negatively impacted boot category sales (consumers postponed boot purchases) and rising sheepskin costs pressured margins. However, Sheepskin costs recently declined 35% from the peak prices and a growing sheep flock in Australia should help to increase sheepskin supply in the future. In addition, the 2011/2012 winter was the fourth warmest winter in the U.S. on record and more favorable winters in the coming years as well as the desirability of the UGG brand position Deckers to benefit substantially.

My channel checks suggest that Deckers’ brands continue to perform at retail and are benefiting from years of careful development and management by the company’s experienced management team. The company is also benefiting from strong international growth as the company is transitioning to a direct model from a distributor model. In addition, the company is benefiting from aggressive growth in highly profitable company-owned retail locations.

Deckers’ guidance incorporates a draconian scenario and market sentiment is incredibly negative on the stock. My discounted cash flow analysis suggests a one year price target of $78, representing upside of about 48% from current levels and a sufficient margin of safety. My price target of $78 implies that DECK shares trade at 13x my FY13 EPS estimate (well below the company’s historical average NTM P/E of 15x). Additionally, the company’s strong balance sheet with net cash of $229 million provides downside protection for investors. I recommend that investors aggressively accumulate shares at current levels as the risk reward tradeoff is very attractive.

Key Points:

*The UGG brand has significantly expanded from just the core boot and its strong position in the market should enable Deckers Outdoor to continue growing its sales.

*The company has focused on protecting the UGG brand image by choosing only high-end retailers to sell the brand and this has preserved the brands image as a luxury comfort brand.

*Transition to direct distribution in international markets should lead to robust growth and higher margins. The transition to a direct distribution model has already benefited the company as international sales increased 82% in 2011 to $432 million.

*Deckers has about 350 shop-in-shops worldwide in 2011 versus 258 in 2010 and I expect the company to continue aggressively opening shop-in-shops in 2012.

*The company has significantly grown its owned retail stores to 45 at the end of 2011 from just 7 at the end of 2007. Moreover, retail accounted for about 18% of 2011 Deckers Outdoor revenue. In 2012, the company plans to further build out its store base by opening 25 new stores (mostly in international markets).

*Deckers continues to generate industry leading returns on invested capital (ROIC).

*Concerns over inventory obsolesce are unwarranted as most of the inventory increase is to support strong bookings, retail growth and acquisitions.

*Strong backlog indicates that demand for UGGs is robust.

*Customer concentration risk is dissipating.

Valuation:
Depressed valuation provides an excellent opportunity to buy a premier global luxury brand at an attractive price. Deckers Outdoor trades at a discount on a forward P/E and forward EV/EBITDA basis to its peer average and at a discount to its historical averages (see below) as concerns about the strength of the brand and input cost have pressured DECK shares.

Given the strength of the UGG brand and the company’s industry leading returns on invested capital, I believe that Deckers’ shares should trade at least in line with its peers. Deckers shares trade at just 11.4x my FY12 EPS estimate and at just 8.8x my FY13 EPS estimate. On an EV/EBITDA basis, Deckers shares trade at just 5.8x my FY12 EBITDA estimate and at just 4.6x my FY13 EBITDA estimate.

The company also has a strong balance sheet with net cash of $5.85 per share. I believe that as the company grows rapidly in international markets and investors get additional clarity into the 2013 input costs, Deckers’ multiples should move higher. Additionally, consensus estimates are based on the company’s conservative guidance and I expect the company to exceed its guidance and for estimates to move higher throughout 2012.

The company’s strong balance sheet, desirable brands, competitive advantages and conservative guidance should provide downside protection for investors and a sufficient margin of safety. The negative impact of higher input costs appears to be fully incorporated into the company’s guidance and sheepskin cost pressures appear to be dissipating. This could lead to significantly improved financial results in 2013 through improved gross margins and this has not been incorporated into street estimates.

Applying the company’s five year historical NTM P/E multiple of 15x to my FY13 EPS estimate of $6.00 suggests a one year price target of $90, representing upside of 70%. Applying just a 10x multiple (below the 20x peer average forward P/E) to my FY13 EPS estimate leads to a price target of $60, representing about 15% upside from the current price. Even my downside scenario suggests a discounted cash flow derived price target of $62.

My base case discounted cash flow analysis suggests a price target of $78 and a NTM P/E multiple of 13x, representing upside of about 48% from current levels. I recommend that investors aggressively accumulate shares at current levels as the risk reward tradeoff is very attractive and DECK shares offer a sufficient margin of safety.

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