5 Worrisome Numbers From This Company's Earnings

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

When you can come up with five different problems in a company's earnings report, that alone should be reason enough for investors to be skeptical of future results. Deckers Outdoor (NASDAQ: DECK) used to be one of my favorite investment ideas, because I relied too heavily on analyst projections for future growth. At one point, I saw the stock trading for about half of its expected growth rate and assumed that the company was a bargain. However, the company's results didn't live up to expectations, and I finally wised up and sold the shares. Since that point, Deckers has issued two disappointing earnings reports, and unfortunately for investors the future doesn't look any brighter.

Worry #1 – Sales & EPS Decline:
In the most recent quarter, Deckers reported that revenue was down 9.17%, and diluted EPS decreased just less than 26%. What's equally disheartening is that the company's former strength in direct retail sales became a huge weakness, as same-store sales decreased over 13% on a year-over-year basis. The lone bright spot was the company's e-commerce division showed an increase in sales of 29.3%.

In a somewhat surprising admission, the company essentially admitted that it increased prices on its UGG brand, past what consumers were willing to pay. Due to some expected cost decreases, the company is now reversing the stance and lowering prices. The problem is, the UGG brand shows significant weakness and there are multiple issues across the company that have not been addressed.

Worry #2 – Declining Gross Margin:

In the past, Deckers could rely on its higher gross margin as a positive factor that helped the company generate better earnings. However, in the current quarter the company reported a gross margin decline of 49% last year to a decline of 242.3% this year. This was significant, as this drop left Deckers' gross margin below the multiples of their direct competitors.

For example, V.F. Corp. (NYSE: VFC), which acquired the Timberland brand, recently reported a gross margin of just over 46%. Under Armour (NYSE: UA) has introduced its own line of boots and outdoor shoe wear, and showed a gross margin of just under 46%. Skechers USA (NYSE: SKX) is yet another competitor that sells outdoor footwear, and even Skechers has a gross margin of 44.62%. This gross margin decline is very likely to continue, as Deckers has a huge inventory issue that may force the company to markdown prices even further.

Worry #3 – Inventories:

I'll never forget Peter Lynch saying that inventories were a key measure to keep an eye on when looking at a retailer. In fact, he specifically stated that when inventories grow faster than sales it's a warning sign. If too much inventory is a warning sign, then Deckers must be flashing about 50 red flags to investors right now. One way to compare inventory levels across companies is to look at the relationship of inventory to sales in the current quarter. Look at the difference in inventory levels at each of the companies, and I think you'll see the problem:

<table> <tbody> <tr> <td> <p><strong>Name</strong></p> </td> <td> <p><strong>Inventories To Sales Current Quarter</strong></p> </td> <td> <p><strong>% Above Competitor</strong></p> </td> </tr> <tr> <td> <p>Deckers</p> </td> <td> <p>129.00%</p> </td> <td> <p>N/A</p> </td> </tr> <tr> <td> <p>Skechers</p> </td> <td> <p>67.22%</p> </td> <td> <p>91.91%</p> </td> </tr> <tr> <td> <p>Under Armour</p> </td> <td> <p>52.27%</p> </td> <td> <p>146.80%</p> </td> </tr> <tr> <td> <p>VF Corp.</p> </td> <td> <p>70.80%</p> </td> <td> <p>82.20% </p> </td> </tr> </tbody> </table>

Clearly Deckers is carrying too much inventory. It would be one thing if sales were growing fast, but they have been declining. The problem is even more significant with the company's largest brand, as UGG inventories are up 254% versus last year. I know initially management expected that stronger winter sales this year would help eliminate some of this issue, but guidance suggests otherwise. While it's true that the holiday selling season is normally the strongest for the company, this would also be the case at each of their competitors. It's almost certain that the company's margin and earnings will take a hit as the company works through this excess and has to mark prices down to get it sold.

Worry #4 – Weaker Balance Sheet:

In the past, one thing that I liked about Deckers was its relatively clean balance sheet, and lack of debt. However, on a year-over-year basis, the company's cash is now down $200 million, and short-term borrowings increased from virtually nothing to $275 million. It's not as though the company is in eminent financial danger, but it certainly doesn't help that Deckers reported negative free cash flow in the current quarter. Combined with all of the other challenges, a weaker balance sheet is yet another red flag for investors.

Worry #5 – Decreased Guidance:

Previously, investors could hold onto management's expectations for improved performance going into the end of the year, but no more. In fact, management's outlook was downright depressing. Sales are expected to increase just 5%, and diluted EPS guidance was even worse. The company now expects a decline of over 30% versus prior guidance of a decline of 10%. What should be no surprise is management also guided that the dominant UGG brand is now expected to see flat sales versus a 10% increase in their prior guidance.

Conclusion:


The bottom line is, Deckers has some huge challenges in front of it. Analysts have also come to this realization, and have decreased their growth expectations by more than half over the last year. In the past, investors saw a stock selling at 8 to 10 times forward estimates and expected to grow in the high teens. Today, analysts are calling for less than 8% growth, and with the stock selling for eight times earnings this doesn't appear to be a spectacular value. Given the company's inventory issues and declining sales, I would suggest investors stay away until these problems are resolved.


MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of SKECHERS USA and Under Armour. Motley Fool newsletter services recommend Under Armour. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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