Shares of footwear-marketer DeckersOutdoor (Nasdaq: DECK ) , a Motley Fool Hidden Gems recommendation, have gone through the roof since the beginning of 2003, thanks largely to the popularity of its UGG boots. How key will UGGs be to the company's future fortunes?
Deckers reported comfortable second-quarter earnings last week. Sales rose 3.4%, though earnings were flat year over year. Still, results beat analyst expectations, causing the stock to jump about 16% the day following the release and continue toward a 52-week high as investors also applauded Deckers' increased full-year earnings guidance.
Management attributed strong trends to profitable sales across its three major brands: Teva sandals, UGG boots, and Simple casual footwear. Simple grew the most, up 40% for the quarter, while UGG grew a strong 20%, though Teva sales fell 8%.
Based on forward guidance of $2.39-$2.45 per share in earnings, Deckers trades at a forward P/E between 17-18. That's a decent multiple for a stock that has grown sales at about 18% annually over the past five years, and earnings at slightly more 27% annually in the same time frame. In addition, operating cash flow tends to run in line with net income, and free cash flow is consistently positive, due to relatively low levels of annual capital-expenditure needs. How does Deckers achieve this?
The company's operating model is similar to Nike's (NYSE: NKE ) , in that it is primarily a designer and marketer of its shoe brands, depending on outsourcing for the more capital-intensive manufacturing of its shoes. Additionally, net profit margins beat those of traditional retailers, who get weighed down by the fixed costs of opening and running stores. For example, Timberland (NYSE: TBL ) is mostly a footwear marketer, but it runs some of its own outlet stores; Bakers Footwear (Nasdaq: BKRS ) and Payless Shoesource (NYSE: PSS ) are primarily peddlers of other firms' shoes at their respective stores.
Its profitability is impressive, but my key concern with Deckers overall is the sustainability of the UGG boots brand. Sales growth has been impressive, but the brand appears overly susceptible to fickle consumer tastes, especially considering its rapid increase in popularity. The company's most recent 10-K filing said it well when it stated that "over the past few years UGG has benefited from significant media attention and celebrity endorsement . further raising the profile of UGG as a luxury comfort brand."
As one might expect, when star-struck fashionistas start seeing their favorite actor wearing a particular product, sales can jump quickly, as happened with UGG. Its sales skyrocketed from $35 million to $150 million in only two years (through 2005), now accounting for more than half of Deckers' total sales. That trend is impressive, but also worrisome; consumers could just as easily switch to a competing product.
Other than that, Deckers' Teva brand sales have increased relatively smoothly over the past five years, accounting for about 30% of sales in 2005. Simple brand sales have decreased over that time frame, but they only accounted for a tiny percentage of last year's sales. It will be important to track trends at these brands to see whether they might be able to offset any potential volatility in the UGG franchise.
Overall, if you think the UGG fad is just beginning, the shares may be worth a further look. Personally, I'm sticking with a more proven brand in Nike, with its stellar track record and lower earnings multiple. There's also K-Swiss (Nasdaq: KSWS ) to consider in the footwear marketing space; it's trading at a lower multiple, with an equally impressive history.
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Fool contributor Ryan Fuhrmann is long shares of Nike but has no financial interest in any other company mentioned. The Fool has an ironclad disclosure policy. Feel free to email Ryan with feedback or to discuss any companies mentioned further.
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