Cheap Uggs

By David Talley - June 21, 2012 | Tickers: COH, DECK, WWW | 0 Comments

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After a couple of weak quarters, investors (read: momentum traders) have abandoned Deckers Outdoor (NASDAQ: DECK) in droves. The once loved stock is now trading 60% off of highs, making new 52-week lows regularly. Wall Street seems to think Deckers' fantastic run is over; however, at current valuations, the company begins to interest me. 

Headwinds to Tailwinds?
Deckers' stock peaked last year just after third quarter earnings, as investors began to worry about rising sheepskin costs and the effects of an unseasonably warm fall period. The stock has trended down ever since, as the following quarters missed expectations. Warm weather, whether or not the actual cause of the light sales, was cited as the reason for the miss.

These headwinds exemplify the problems of relying heavily on one product and perhaps warrant some multiple compression (investors should pay less for a company with these added risks). However, if one believes that cold winters will return and sheepskin costs will fall (as management has stated is the case on their first-quarter earnings call), the decline in the stock's price appears overdone. Moreover, as these headwinds revert toward their averages, Deckers' revenues and margins will look better on a year over year basis. 

Fading Fad?
The recent stock decline seems to imply at least some investors believe the Uggs fad is fading. However, most evidence supports the idea that the brand is quite strong. On the first-quarter call, CEO Angel Martinez said he was “satisfied” with the fall order book. Although not a ringing endorsement of the brand, it shows retailers still believe in the brand. Also, at the June 6^th Piper Jaffray Consumer Conference, the company commented on recently completed market research, noting strength in all categories.

It is also important to note that the Uggs brand is perpetually panned as a fad. Because the boots are a seasonal product, it is easy to interpret the lack of buzz about the brand in the summer months as the busting of a bubble. This is also not the first time such speculation has taken down Decker shares. In 2005, the stock peaked out at $15 and fell to $6 over the next few months, as investors worried the Uggs fad was over. Meanwhile, those who remain skeptical of the fading-fad fear-mongers each year have been rewarded. 

Still Growing
Not only do I believe Uggs are not a fad, I believe the Ugg brand has plenty of room to grow. Although I don't like many of the products that Deckers' makes (including the sandals and shoes of their other '”strong” brands Teva and Sanuk), the Uggs brand offers many fashionable products outside of their signature boots. These strong products should gain traction as Uggs opens more stores and increases advertising on male and spring/summer footwear lines. 

Valuations
Finally, Deckers is trading extremely cheaply. At 10x current earnings and 9x next year earnings, the company is trading well below its five year average of 18x. Also, analysts see Deckers growing earnings between 15-20% over the next few years, implying that the company is cheap relative to its growth rate. Wolverine World Wide (NYSE: WWW), maker of Chaco, Merrell, and Patagonia footwear, trades at 16x current and 13x forward earnings. Hence, Deckers trades at a steep discount to its most often cited comparable company. Moreover, if you believe like I do that Uggs is filling out a high-end, fashion-oriented portfolio, comparing Deckers to Coach (NYSE: COH) may be more appropriate. With Coach trading at 18x current earnings and 15x forward earnings, we see that Deckers is cheap relative to its peers. With the company expected to earn $5.47 a share in 2013 and a conservative 15x multiple, I expect shares to trade north of $80 next year.

Bottom Line
I believe Deckers experienced a hiccup caused by its over-dependence on one product. However, I feel the Uggs brand remains strong and will ultimately grow into a diversified portfolio of men's/women's footwear, clothes, and accessories. I believe current shares are deeply undervalued both historically and relative to its peers; however, with no catalyst in the near term (second quarter earnings aren't until late July and are seasonally the worst quarter for Deckers) and the stock not responding well to the positive comments out of the Piper Jaffray conference, I see no immediate need to dip into the stock. I will consider building a position into second-quarter earnings and throughout the third-quarter.

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