This Sheepshoe Maker is a Long-Term Buy

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I have written about Deckers Outdoor (NASDAQ: DECK) when it was trading at only $29.48 per share, noting that it was a cheap, high-return stock to buy. Recently, it made a big daily jump of more than 10% because of two analyst upgrades. Jefferies Research and Sterne Agee have given the company price targets of $50 and $65, respectively, on this sheepskin shoemaker. DECK is now trading at $41.61 per share, with a total market capitalization of $1.47 billion. Should investors initiate positions in this company now?

Dated back in the end of October, DECK has bent to the bearish momentum of the market by lowering its FY12 guidance. It expected sales in 2012 to have year-over-year growth of 5%, much lower than the previous guidance of 14%. In addition, the EPS would experience a decline of 33%, not 9% or 10% as in the previous guidance. After that, its shares have been sent to the lowest since the end of 2009, at around $28.60 per share. In the last 5 years, DECK’s investors have really been on the roller coaster, and the stock delivered a nearly 19% loss during that period.

<img src="/media/images/user_14219/screen-shot-2012-12-06-at-125303-am_large.png" />

The 5-year stock performance has lagged behind its peers, including Nike (NYSE: NKE) and Wolverine World Wide (NYSE: WWW). It was the only stock that created losses for shareholders, whereas Nike gained 48% and Wolverine gained nearly 67%.

The majority of the business revenue comes from one famous shoe brand, UGG, accounting for more than 87% of its total sales in 2011. The business has experienced a slowdown due to the rising cost of raw material (sheepskin) and recent unusually warm weather. However, Jefferies now becomes bullish on the stock because of the performance improvement of its main brand. Jefferies commented:

“We see significant upside in the coming quarters due to improving performance of the UGG brand which we think is far from dead. Further, we expect growth from the retail store rollout, international expansion, brand extensions, and the smaller brands. Meanwhile, margin tailwinds are on the way. With valuation attractive, we would aggressively buy DECK at current levels. Resuming coverage with a Buy rating and $50 PT.” 

Sterne Agee has upgraded DECK from Neutral to Buy because it saw the comeback of the company in 2013. It said that the FY12 EPS estimate was lowered from $3.16 to $3.06, but the FY13 EPS was estimated to range from $3.31 to $3.78. Thus, the price target of $65 was set. Actually in May 2012, Ron Baron remained bullish on the company, saying that the sheepskin price has reached its peak and will decline in the next year. That would lead to the increase in 2013 earnings, and the unusual weather pattern would revert to the mean. However, after his comment on the company at the end of May, one month later, he reported that he has sold out DECK shares in the second quarter of the year. 

The good thing about DECK is the debt-free position and the consistent historical double-digit return on invested capital. Trailing twelve months, its ROIC was 18.12%, along with a net margin of 11.10%. Nike has a little higher ROIC, 20.6%, but lower net margin of nearly 8.7%. Wolverine delivered the lowest return among the three, of 15.86% ROIC and 7.7% net margin. 

In terms of valuation, DECK seems to be the cheapest among the three.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>DECK</strong></p> </td> <td> <p><strong>NKE</strong></p> </td> <td> <p><strong>WWW</strong></p> </td> </tr> <tr> <td> <p><strong>Forward P/E</strong></p> </td> <td> <p>9.1</p> </td> <td> <p>15.8</p> </td> <td> <p>14.8</p> </td> </tr> <tr> <td> <p><strong>PEG</strong></p> </td> <td> <p>1.4</p> </td> <td> <p>1.4</p> </td> <td> <p>1.5</p> </td> </tr> <tr> <td> <p><strong>Dividend yields (%)</strong></p> </td> <td> <p>N/A</p> </td> <td> <p>1.5</p> </td> <td> <p>1.1</p> </td> </tr> </tbody> </table>

DECK has only a 9.1x forward P/E and 1.4x PEG. Nike had the same PEG ratio with DECK but much higher forward P/E, of 15.8x. Among the three, only DECK didn’t pay dividends, whereas the dividend yields of Nike and Wolverine are 1.5% and 1.1%, respectively.

The only thing that I am worried about is the building up of its inventory. Trailing twelve months, the days inventory has shot up to nearly 117 days, compared to the range of 88 – 97 days annually since 2005. It might indicate that DECK had a hard time of selling its shoes. The high level of inventory might affect its earning results in the fourth quarter of this year.

Foolish Bottom Line

In the short-term, DECK might experience weak earnings in the next quarter or two because of the recent inventory buildups. However, with a cheap valuation and high return on invested capital, I think investors couldn’t go wrong in buying UGG brand owner at the current price.

hoangquocanh has no positions in the stocks mentioned above. The Motley Fool owns shares of Nike. Motley Fool newsletter services recommend Nike. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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