2023-11-24 22:27:45 ET
Summary
- Deckers Outdoor Corporation is a strong business due to its diverse brand portfolio, high margins, and positive medium-term outlook through its Hoka brand.
- DECK's share price has significantly outperformed the wider market in the last decade, and is primed to achieve similar growth in the coming years.
- Financially and commercially, DECK looks to be one of the best footwear businesses. Its Hoka brand is primed to take the place of UGG as its main growth driver.
- Despite near-term risks, DECK remains an attractive business long-term, owing to its impressive ability to market its products, as well as several strong brands.
- The near-term valuation premium of DECK does imply it could trade sideways in the coming quarters.
Investment thesis
Our current investment thesis is:
- DECK is an attractive business, owing to its portfolio of brands, high margins, impressive brand development / marketing ability, and positive medium-term outlook.
- The business continues to outperform expectations, although the UGG brand is experiencing a slowdown. Hoka is offsetting this impact thus far but we remain hesitant.
- When compared to other footwear peers, DECK performs extremely well, growing at a strong level while boasting substantially better margins.
- DECK is trading at a substantial premium to its peers and historical average, pricing in the improvement thus far and the forecast growth ahead.
Company description
Deckers Outdoor Corporation ( DECK ) is a renowned American footwear and apparel company that designs, manufactures, and markets a diverse range of outdoor and lifestyle products.
The company's portfolio includes popular brands such as UGG, HOKA ONE ONE, Teva, and Koolaburra.
Share price
DECK's share price has performed incredibly well in the last decade, significantly outperforming the wider market. This has been driven by a rapid improvement in financial performance, alongside underlying commercial development.
Financial analysis
Deckers financials (Capital IQ)
Presented above is DECK's financial performance.
Revenue & Commercial Factors
DECK's revenue has grown at a CAGR of 11% during the last 7 years, with only a single year of negative growth and a significant improvement in recent years. This is a reflection of the company's upward trajectory.
Business Model
DECK operates as a consolidator of several brands, a brief description of each is below.
- UGG : Iconic brand known for premium footwear, apparel, and accessories. Global appeal, strong consumer loyalty.
- HOKA : Authentic, high-performance footwear and apparel. Gained popularity among athletes and outdoor enthusiasts.
- Teva : Trusted outdoor companion, focuses on sport sandals, sustainability, and category expansion.
- Sanuk : Lifestyle brand with relaxed, comfortable shoes and sandals, playful branding.
- Other Brands : Includes Koolaburra, which targets value-oriented consumers to complement the UGG brand.
DECK benefits heavily from selling a wide variety of brands, as it gains diversification benefits. The fashion industry is notoriously unattractive due to ever-changing consumer trends, making it difficult to find long-term winners. With a wide variety of brands targeting a range of segments, the business is able to hedge its exposure across the wider industry. Further, from an operational perspective, the business can benefit from shared competencies and resources, generating scale economies.
Management's focus has been on building distinct brands with a strong emotional connection to customers. This has been achieved through direct marketing to its core demographic, seeking to create a relationship with its customers. This is critical as the ability to withstand changing trends is having a brand strong enough to keep customers interested regardless. UGG is the perfect example of this, initially exploding in popularity but has subsequently become a staple in the industry, even if it is no longer at its peak popularity years later.
The success of Management's marketing effort is reflected below, with a significant increase in searches for the Hoka brand. The brand focus to grow this business is impressive. In FY23, sales for the brand grew 58.5%.
Although UGG has performed well, there is a risk that the business is facing greater weakness, potentially due to a change in focus. Sales from this brand declined (2.7)% in FY23, primarily from the wholesale channel. We believe this should be monitored further, as it would quickly lead to reliance on Hoka.
DECK utilizes a multi-channel distribution strategy, including retail stores, e-commerce, and wholesale partnerships. The business has focused heavily on wholesale historically, which is logical given the focus on expanding brands and directly competing with peers. Once brands reach maturity and national awareness, the focus should rapidly switch to increasing direct-to-consumer sales. The reason for this is improved economics from each sale and reduced reliance on wholesalers. This strategy has been successful thus far, with 20.8% growth from DTC vs. 11.6% from Wholesale in FY23.
In conjunction with quality marketing, the business emphasizes continuous product development. This has contributed to its brand's ability to stay relevant in an ever-changing consumer market. UGG has successfully expanded beyond boots to selling well in apparel and its non-women segments.
Competitive Positioning
We believe DECK possesses the following competitive advantages.
- Strong Brand Portfolio . The company has a diverse brand portfolio that caters to a wide range of consumers and lifestyles, allowing it to diversify revenue and exploit growth opportunities.
- Culture . The business clearly has a strong culture, focused on both driving growth and innovation as a means of achieving a positive long-term trajectory. HOKA ONE ONE, for example, is known for its innovative footwear technology.
- Capabilities . The business has shown an ability to operate several brands concurrently, illustrating deep expertise in the industry, across footwear and the wider apparel industry.
Footwear and Apparel Industry
Deckers compete with notable players in the footwear and apparel industry, including Nike ( NKE ), adidas ( ADDYY ), Wolverine ( WWW ), Puma ( PMMAF ), Crocs ( CROX ), and Steven Madden ( SHOO ).
A key industry trend that Hoka is leaning into is Athleisure. Athleisure is a combination of athletic wear and leisure wear. Its growth is due to people increasingly looking for comfortable and stylish footwear (and clothing) that they can wear both for working out and for everyday activities. We expect this trend to continue in the coming years, as the general attitude toward this trend is positive. Hoka and Teva in particular could see a continuation of their current trajectory as a result of this (Teva up 12.5% in FY23).
Given the business has shown an ability to manage a portfolio of brands successfully, we believe M&A could represent a potential growth avenue for the business if a good opportunity presents itself. This has the potential to enhance its organic growth trajectory, which will inevitably normalize at the long-term GDP rate.
Finally, growth will continue to be driven by new store locations, both nationally in the US and Globally. We consider the expansion of Hoka, and the expansion into emerging markets to be quality opportunities in particular. With strong brands and a history of innovation, we see no reason why its success cannot be exported.
Economic & External Consideration
High inflation and elevated interest rates are impacting the company in the following ways:
- Consumer Spending . Elevated rates and high inflation are contributing to softening consumer spending on discretionary items, as finances come under attack. In July , retail spending came in above analyst forecasts (+0.3ppts), although on an absolute basis is fairly disappointing (0.7%). This is primarily price driven, as well as higher-than-expected social spending during the summer months.
- Input Costs. Inflationary pressures are causing upward pressure on both production and operational costs. Thus far, the business has performed exceptionally well to limit the impact on margins, with a reduction in S&A spending offsetting the impact on GPM. We expect a gradual easing of pressures, creating the scope for medium-term improvement (which is being seen in the LTM).
Margins
DECK has incredibly impressive margins, with an EBITDA-M of 21% and a NIM of 16%.
The strong margins are a financial reflection of its strong brands, allowing the business to price aggressively. Further, the business has benefited from scale economies and share competencies, allowing it to minimize operational and production costs.
Balance sheet & Cash Flows
DECK is conservatively financed, with only lease liabilities representing material long-term obligations. This further supports the ability to fund future expansion with debt once rates decline.
Inventory turnover has declined below pre-pandemic levels, implying the business has been unable to wholly unwinding stock, contributing to near-term concerns that demand is slowing beyond expected. This has yet to impact FCF and so should be monitored in the coming quarters.
Outlook
Presented above is Wall Street's consensus view on the coming years.
DECK is forecast to continue its strong growth trajectory, with analysts forecasting an 8% rate. This likely assumes a continuation of the Hoka brand's trajectory, as well as improvement in UGG.
Further, margin improvement is also forecast. This reflects the underlying brand strength, allowing the business to maintain its margins despite the high competition. Sufficient demand should limit discounting, allowing for appreciation.
Industry analysis
Presented above is a comparison of DECK's growth and profitability to the average of its industry, as defined by Seeking Alpha (8 companies).
DECK's recent growth is slightly below the industry average, primarily due to the impressive performance of both Crocs ( CROX ) and On Holdings ( ONON ). When excluding these two, DECK overperforms. Nevertheless, on a 5Y basis, and on a forward basis, the company is performing exceptionally. While other businesses rely on the continued development of sole brands, DECK benefits from diversification.
DECK's profitability is where the business stands out, with significantly higher returns and cash flows. On an EBITDA-M basis, only Crocs performs better. This is a reflection of its market position, quality marketing, and strong brands, allowing the business to price aggressively.
Valuation
DECK is currently trading at 18x LTM EBITDA and 18x NTM EBITDA. This is a premium to its historical average.
A premium is undoubtedly warranted, given the company's impressive margin improvement, the continued strength of UGG, and the growth trajectory of Hoka. A 35-40% premium is fairly rich we believe, given that the fashion industry is inherently risky due to changing consumer trends. DECK offsets this somewhat via diversification but remains somewhat concerning.
Relative to its peers, we believe a premium is justified. DECK benefits from diversification relative to the group, has significantly higher margins, and is growing at a slightly higher rate. Our view would be that a 20-25% premium is justifiable on the top end, implying a continuation of strong growth and defensible margins. This suggests the company could be slightly undervalued on an LTM EBITDA and NTM P/E basis.
Based on this, we do not see a clear route to attractive gains while investors experience short-term risk with macroeconomic conditions and the potential for slowing UGG growth.
Final thoughts
DECK is a highly attractive business. The company has a strong portfolio of brands, high margins, a good growth trajectory, and a positive medium-term outlook through the Hoka brand. When compared to peers, this advantage holds up. Given the near-term risks faced by the business, we do not see an attractive risk-adjusted return profile based on its current valuation.
For further details see:
Deckers Outdoor: Strategy For Growth