Fellow Foolish contributor Rich Duprey was on the right path when he gave a cautionary earnings preview for footwear company Deckers Outdoor
Let's start with the just-completed quarter's good news. Third-quarter sales rose 24% year over year, and diluted earnings per share kicked into high gear -- up 37%, fueled by a 3.5% increase in operating margin. Sales and earnings were at record highs for any third quarter in the company's history.
Pushing sales up was a 54% increase in the Ugg line, which, thanks to greater retail exposure, made up 82.9% of total sales. Teva sales, though, fell 18.4% (and now make up only 14% of total sales), in part because of lower international sales. And the Simple line of casual shoes registered a whopping 54.4% decline because of the discontinued "sheep" line.
Inventories surged 147.1% compared with the year-ago period because the company decided to stock up on Ugg items earlier this year -- a good move after last year's delivery problems. Inventory levels for the Teva and Simple lines, meanwhile, are lower than year-ago levels.
Hurting the stock Friday -- besides two brokerage downgrades -- was the lowering of fiscal 2005 earnings and a lackluster 2006 projection. That made Deckers one of Friday's biggest percentage losers on the Nasdaq. Before June, revenue was expected to fall between $250 million and $260 million. Now, after its second revision, revenue is forecasted to fall between $246 million and $249 million. Earnings, once projected to be $2.50 to $2.60 a share, are now targeted at $2.13 to $2.17.
There won't be a barn-burner in 2006, either. Besides investing heavily in product development and design -- code words for getting the Teva and Simple sales moving upward again and keeping Ugg's moving -- Deckers is also going to increase its spending on marketing and advertising while it also invests in its retail and international infrastructure. In short, expenses are going up. The hope is that the company will be better positioned for the long term and that, maybe, Ugg will once again produce a fashion bonanza -- though, according to the company's revenue guidance, that's not expected for now.
While revenue for 2006 is expected to improve, earnings will fall to between $2.00 and $2.15 a share -- not a good showing. The stock is trading for 8.5 times this year's earnings, and analysts expect the company to compound earnings at a 16% rate for the next five years. And the company's announcement on expected 2006 endeavors hearkens to analysts' concerns: First, it's difficult to build one veritable brand in fashion, let alone three; and second, Ugg has been hugely popular among fashionistas, but based on company revenue projections, that growth has hit a plateau, and it is unclear whether product line extensions will restart sustainable growth. Inconceivable as it seems, growth might stop altogether, or even reverse.
The bottom here is that companies in the business of peddling fashion are sometimes able to define tomorrow's look, but tomorrow is also able to break the company. Deckers' current sales concentration in Ugg makes it appear as though the company's fortune should move in whichever direction Ugg moves.
Do small-cap stocks, and their chance for oversized gains, fit into your portfolio objectives? If so, let Motley Fool co-founder Tom Gardner and his Motley Fool Hidden Gems newsletter team help you find companies like Deckers Outdoor -- which just happens to be a Hidden Gems recommendation. A free, no-risk trial awaits you.