2024-01-07 23:22:57 ET
Summary
- Small caps experienced significant gains in the final 60 days of 2023, but investors are now being more selective.
- Deckers, the parent company of UGG and HOKA, has resiliently performed well due to its strong product lines.
- HOKA's distinctive design and comfort have attracted serious runners, giving DECK a significant market share in the specialty-running retail market.
Small Caps are now under siege after a phenomenal final 60 days in 2023. Are there still ones that can run?
The IWM Small Cap ETF is one of the best barometers of the real economy as much of the U.S. labor market is comprised of small-medium enterprise hiring.
Small Caps made a pronounced upside move in the final 60 days of 2023, sweeping nearly all companies up inside the IWM indiscriminately to experience 10-30% ferocious advances. As 2024 begins, Investors are being more selective about which companies' advances were deserved. For those companies' advances that weren't perceived to be deserved, expect last year's gains to be rotated into stronger and safer ideas.
Deckers Outdoor Corporation (DECK) has so far been resilient against the IWM's 2024 slump as it has several major winning product lines, most notably UGGs and Hokas. While inventory problems have surfaced at other retailers and other firms resorted to intense promotional activity, DECK's popular product line Hokas hasn't done Black Friday sales in the past 2 years due to its strong demand.
While today's share price is elevated, and therefore a Hold, it is a company that has strong potential to be included in our portfolio at the right price and valuation.
This, and more, will be discussed below.
Deck Technical Structure (Trading View)
The Catalysts for DECK and Fundamental Outlook
Deckers focuses on footwear designer brands and is a large apparel distributor where roughly 2/3 of its sales are generated in the U.S. and the other 1/3 internationally. The company's brands include UGG (the most famous of their product line in the mass market), Koolaburra, Teva, Sanuk, and Hoka (an extremely popular product line in their specialty niche). Below is an image that illustrates these brands and their taglines.
- UGG: Sheepskin footwear that is popular among women
- HOKA: Premium running footwear
- Koolaburra: Wool Boots
- Teva: Sports Sandals
- Sanuk: Surf Sandals
Deckers Product Line (Deckers)
In their distribution channels, wholesale contributed roughly 60% of sales while DTC (Direct to Consumer) contributed the remaining 40%. Their UGGs and HOKA product lines have been very strong where they saw 28% and 27% increases in sales from their Q2 results, in the context of a very competitive market for athletic brands.
We believe Decker's HOKA product line is quite important to their future growth prospects. Specifically, we think this product line is quite distinguished from other shoe brands such as Nike and believe it could take market share from Nike over longer term timeframes.
In running communities, runners typically view shoes from two lenses: it is either designed with very thin soles and a low heel-to-toe drop or they have thick midsoles with higher heel-to-toe drops. Runners sometimes refer to this differentiation in design as Minimalist (former) or Maximalist (latter). Some images are shared below to highlight the difference - the Nike pair has thin soles while the HOKA pair has thick soles.
Nike Minimalist Shoes (Nike) Deckers Maximalist Shoes (Deckers)
Hoka's running shoes are traditionally distinguished from Nike's because they are designed to give maximum comfort when running which can reduce stress on joints during long sessions. This specific design -even though it is bulkier and heavier - from Hoka attracts a significant number of serious runners to opt for their shoes due to injury prevention considerations.
Studies of runners have found that running in "maximalist" shoes like Hokas eases pressure from a runner's feet and allows them to go for their routine sessions more comfortably even if they currently have minor foot injuries such as fractures or heel atrophy.
Over time, maximalist running shoes are growing more popular among serious runners and Nike adapted to market demand by releasing their "Zoom Fly" shoes in 2017. Since then, Adidas, New Balance, and Asics have followed this trend to cater to runners.
That being said, the competitive advantage that Hokas has is that they command a significant of the specialty-running retail market as shown below. From the market share graph below, we can see that their product quality has won over consumers' hearts and minds. Yet most people haven't even heard of Hokas, let alone know that the brand is owned by Deckers, which is why Deckers Corporation has gone through such a tremendous stealth rally without most investors paying attention to it.
Hoka is now growing very quickly with runners, outdoor explorers and strength trainers. Celebrities such as Gwyneth Paltrow and Emily Ratajkowski have been spotted wearing Hokas in their everyday routines. The company built a very strong reputation among long-marathon runners who actively select sneakers that they believe will help prevent injuries. Many marathon runners are practical in their shoe selection and care more about running performance than shoe style.
From the chart below, we can see that Hokas is gaining practical market share away from incumbent brands' flagship running shoes.
Dicks Sporting Goods Market Share (YipitData)
We can see from the chart below from sell-side research firm Stifel that Deckers has fewer supply chain problems and inventory issues that plague other specialty retailers. The Hoka brand is so popular among runners that analysts have noted that they have not even run discounting promotions on Black Friday over the past two years, in great contrast to nearly every other retail brand that participates in promotional activity. Because of its significant market positioning, DECK's stock has seen its valuation become relatively expensive in comparison to its history - a key risk to new entries now.
In their past full fiscal year DECK saw net sales increase 15% to $3.627 billion compared to $3.150 billion. Their DTC channel sales increased 38.8% to $331.7M vs. $239.1M in the prior period. Meanwhile, Wholesale Net Sales increased 11.6% to $2.161B compared to $1.9B from the previous year. The company grew sales 13% in the U.S. and 19% internationally, suggesting that their product lines are getting more popular outside of the U.S. DECK was able to see their margins slightly fall to 50.3% from 51% in the prior comparable period.
This financial profile is a double digit compounder and highlights the popular product sales growth that Uggs and Hoka are currently enjoying. The current risk is that the company needs to balance sales growth with company image. In an earnings call in 2023, DECK management discussed that they are "very selective of who we sell Hoka to at wholesale." Because they are not mass-distributing their products to all wholesalers, they do need to see their existing wholesale partners Dicks Sporting Goods, REI, and Foot Locker see strong foot traffic for their wholesale channel sales efforts to continue their growth trajectory.
Adjusted for inflation, DECK's double digits nominal sales growth still sees about high single digits which is impressive given that U.S. retail sales were estimated to grow at about 4-6% in 2023 (before adjusting for inflation). After inflation, U.S. retail sales was most likely flat.
Risks, Thoughts on Entry and Valuation
DECK has a winning product line with their UGGs and Hokas shoes and has gained a very powerful presence in the niches where they operate. And as a result, their valuation reflects this premier positioning.
The valuation of Deck on forward earnings and EV/EBITDA perspective reflects this as its earnings multiples trade similar to that of a tech stock at 28X forward.
In corrective cycles, this will make DECK trade like a high-beta tech stock due to its high valuation.
In order for DECK to keep moving higher from here, they will need to increase their market share further in both their UGG and Hokas product lines. Deckers' management has stated that they believe Hokas can be a $2 billion dollar brand in the coming years. Hoka's growth alone drove Decker's direct to consumer business to 34% of its overall brand revenue which marks a material increase from 29% the prior year.
The best strategy here is likely to wait for a market dislocation to cause a sector-wide corrective cycle that impacts DECK and look for better entry points.
The median enterprise valuation multiple for DECK is around 16X EV/EBITDA (currently below the 19.5X multiple), so if we see about a 10-15% correction in the name that will make the stock include a larger margin of safety with long timeframes if we consider sector multiples. This is because the Consumer Discretionary Sector has traded between 14X-26X from 2020-2022 and given DECK's growth profile, a 16X multiple would place it as equally attractive as the overall sector's prospects yet it has stronger fundamentals than most retailers as the inventory data above shows (based on my opinion).
Sector Valuation Table (Statistica)
Right now, the primary risk for DECK is related to valuation given that it is trading at near the upper bounds of its valuation range. The company has very solid fundamentals, so the primary concern is macro related. If interest rates do not fall as quickly as expected, it's likely that the Buy Side will re-rate valuation multiples of Small and Mid caps a degree lower from here, and DECK may not escape that re-rating due to the high correlation with its index IWM.
If the company's fundamental operating outcomes are strong in the coming quarters, which I believe they may be, any corrective phases will be bought faster and more sustainably than other names within specialty retail. Most important to follow is Deck's continued success with its UGG and Hoka product lines. If those products continue to sell well based on next quarter's outcomes during periods of share price declines back to near the median valuation multiple (which makes DECK cheaper than most names in the Consumer Discretionary sector), the company will eventually recover. For now, I rate the company a Hold.
For further details see:
Deckers Outdoor: Strong Specialty Retail Name To Watch On Sector-Wide Craters