There’s a lot wrong with DECK right now, but we don’t think it’s terminal. Revenues were weak and they missed. Bad news. We get it. We’re not trying to gloss over the issues. But 24% of the float is short, and it still is giving up $650mm in market cap today – or about a quarter of equity value and 32% of Enterprise Value? Seems pretty steep.
The question with UGG (over 90% of cash flow) is always ‘is the brand dead?’ And yes, this is always the (seasonally weak) time of year people ask it. No doubt, with inventories up an average of 100% over the past 2 quarters, there’s clearly more weight to the question today than in past years. But consider the following…
1) Do these stories ALWAYS have to be binary? Why do people view them as either the greatest thing since Nike, or dead in the reincarnation of Heely’s? Can there be something in between where good brands can exist for a long time? Yes. Especially those that have already proven that they can successfully grow beyond US borders.
2) As it relates to inventory, we need to account for about an incremental $100mmm yy.
- $10mm for new stores. Keep in mind that inventory will naturally accelerate as UGG grows its consumer direct model.
- $20mm to grow its new European business. Inventories will be heavier up front.
- $10mm in cold weather product that has been sold for delivery in later quarters.
- $40mm in higher sheepskin costs. UGG is likely to recoup at least some of this in pricing.
- $20mm in spring inventory – supporting new product rollouts (i.e. some of which are using alternative materials).
3) Let’s put this in perspective. In looking at retailers for the better part of 15-years, if there’s one thing I’ve learned is to rarely beleive a management team’s reasons as to why they have too much inventory. It’s an easy (and unverifiable) spot to make excuses. But as it relates to leftover inventory from this (aberrational) winter, as well as higher product costs – I am willing to give them a pass right there on over half of the inventory growth.
4) They’re 95% done with pre-orders – especially strong in men’s and kids (ie less dependent on the sheepskin-laden classic) and are introducing more alternative fabrics without (reportedly) shifting away from identity.
5) When all is said and done, let’s say that you squarely believe that the UGG brand IS on a decline. We’d challenge you to talk to any wholesaler, and find someone tell you that they’re comfortable not placing reorders on UGGs for this fall and winter. If the brand is still in demand, and a wholesale buyer does not have the goods, then they’re probably out there looking for a job.
We’re coming out at $4.85, $6.05 and $7.10 for 2012, ’13, and ’14, respectively. With $6.80 in cash on hand, we’re looking at 9.4x, 7.5x and 6.4x earnings over those durations. Valuation is by no means a catalyst. But sentiment is low (24% of the short is float), seasonality is out of favor, and you have to wait to fall in order to get a reacceleration in the business. But keep in mind that the ‘there’s no catalyst for 2-3 quarters’ argument is the top bear case I hear. From a risk management perspective, we’ll rarely be early on a name like this. But for someone that wants to stomach near-term noise and look out a year, this looks like a good risk/reward. Sometimes, herd mentality that there is no catalyst is, in itself, a catalyst.
Brian P. McGough
Managing Director
(F12 Outlook post Q4)
Full-Year 2012 Outlook
- Based upon current visibility, the Company expects full year revenues to increase approximately 15% over 2011 levels. (now +14%)
- The Company expects full year diluted earnings per share to be approximately flat with 2011 levels (now down 9%-10%) due primarily to the increase in sheepskin costs in 2012 compared to 2011, which the Company projects to adversely impact profitability by approximately $1.40 per diluted share. This guidance assumes a gross profit margin decline of 200 basis points (now -250bps) from 2011 levels due to an increase in costs of goods sold, partially offset by selective price increases, an increased contribution from retail sales, and the addition of the Sanuk brand for the full year. This guidance also assumes SG&A as a percentage of sales of approximately 29%.
- Fiscal 2012 guidance assumes approximately $13 million, or $0.23 per diluted share, associated with the amortization and accretion expenses related to the Sanuk acquisition.
- Fiscal 2012 guidance also assumes that the Company’s effective tax rate will be approximately 31%.
- UGG up +10% (was 11%)
- Teva +low-to-mid single-digit (was +10%)
- Other down -15%
- Sanuk still expected to be ~$90mm
Highlights:
- Sanuk continues to outperform - strong sell-in of the spring line equally strong in March/April
- Brand making progress building distro with retailers incl JWN, Zappos, Journeys, & DDS
- UGG spring styles were up meaningfully yy
- Cold-weather boot sales the big offset
- Sheepskin up 40% in 2012 yy, but coming down from highs
- Spring styles up 20% in domestic wholesale channel
- Fall close to closing pre-book, pleased with level of commitment from domestic wholesale
- Open to buy dollar pool has contracted, but based on conversations with retailers, mgmt believes UGG maintaining share
- Consumers will see new fall collection as early as June/July (new sneakers, casuals and boots)
- Closing some accounts that can't display full offering, increased net independent door counts in 2011
- Int'l sales of UGG in Europe lower than expected - UK DECK's biggest int'l mkt
- Still ramping marketing spend in Europe to build awareness and expand product line
- Goal to develop slippers, cold weather, casuals, men's and kids like in the U.S.
- Benelux (2nd biggest mkt) had very good Q1 - difference to UK is more mature distributor partners that can offer broader assortment
- Asia UGG business grew at a fairly rapid pace in Q1 - wholesale cont. to rebound in Japan vs. tsumani yy
- Have recently taken minority interest in JV to capitalize on China opportunity
- Total store comps flat vs. Domestic comp up HSD in Q1 offset by down Int'l comps
- US regional comps: Northeast hit hardest
- e-commerce down -7.5%: Teva up strong offset by HSD decline in UGG
- Teva posted strong domestic wholesale growth + dom. e-com. Offset by Int'l down
- Closed-toe product up 38%
- Due to over-inventoried position at retail, not seeing orders in near-term impacting fall demand = taking down projections for the year.
"UGG Brand's primary selling season at retail typically doesn't get underway until later in the year, hitting peak velocity in November and December."
Sheepskin:
- Will not know what 2013 prices look like until they lock in prices for fall '13 line in October
- Skeepskin is a by-product of the meat industry
- Sourced primarily from Australia with some from the UK and US
- Decline in herd sizes driving up price
- Drought in Australia also a factor
- Fx also a headwind
- Are seeing prices starting to decline
- Believe other companies have shifted to other materials (out of the market)
- Published price of skins not only factor in DECK's cost:
- Use higher grade skins
- Tanneries in China another factor that carry additional costs
- Trying to offset this to some extent with non-sheepskin product
GM: -403bps
- ~300bps due to higher product costs
- ~200bps due to markdowns, closeouts, discounts and DTC mix
- Offset in part by Sanuk and increased pricing
- Increased closeouts attributable to discontinued Spring/Fall styles
- Teva and Other brands and UGG closeouts cause for results below expectations (~-200bps)
- Sanuk brand margins came in ahead of expectations
SG&A: +36% ($35mm)
- +$8.7 related to Sanuk acquisition
- +$4.7mm in marketing (UGG men's and classic campaigns)
- Addition of 19 new stores LTM
Store Growth:
- Expect to have 70 at year end vs 46 now
- 27 stores in comp (18 in US, 4 in UK, 4 in China, 1 in Japan)
- Of 19 non-comp stores many in Asia and are 1/3 smaller with lower sales/store
- In addition to infrastructure investments behind store rollouts, this is why store productivity appears to be declinnings
- Sales/sq.ft. comparable in Asia
- Additions: 24 store opening left in 2012; 4 in U.S. and 10 each in Eur and Asia
Inventory:
- Up +95% yy to $209mm due to:
- Primarily fall UGG product ($90mm), product costs, and addition of Sanuk brand ($12mm)
- Of $90mm increase in UGG inventory:
- $65mm fall inventory ($50mm in classics and slippers) have orders for this at full price
- $10mm in cold weather product that has been sold for delivery in later quarters
- Can also look at by:
- $40mm in inventory product cost increases
- $20mm in European inv to support direct business
- $20mm spring inventory
- $10mm new store inventory
BS:
- Cash position $228.6mm
Outlook:
FY12:
- Lower projections for Int'l wholesale and Teva domestic sales
- Total revs now +14% (was +15%)
- UGG up +10% (was 11%)
- Teva +low-to-mid single-digit (was +10%)
- Other down -15%
- Sanuk still expected to be ~$90mm
- GM: -250bps (was -200bps) - lower int'l sales and increasing Q1 closeouts
- SG&A: ~30% of sales (was 29%)
- Tax rate: ~31%
- CapEx: ~$80mm (was ~$90mm) - $32mm to new HQs, $26mm new stores, $10mm IT & maintenance, $4mm retail operating systems, $8mm corp infrastructure
Q2:
- Revs +8% - added pressure from European business
- GM: ~43%
- SG&A 63% as % of sales
- EPS: -$0.60
Q&A:
UGG Inventory Levels:
- Most inventory on-hand has been committed for fall - mostly classic product no fashion element
Biggest Changes since last Qtr:
- Seasonality, weather has profoundly impacted how retailers are buying cold weather product - from one extreme to the other
- Kid's and men's has done very well, really seasonal product weakness
Gross Margins:
- Closeout impact fairly equally split between Teva & Other brands and UGGs
- Channel mix also impacted margin
Order Book:
- ~95% done with prebook
- Especially strong in men's and kids - less dependence on traditional classic
- Have done a good job mitigating sheepskin impact with alternate designs - shifting to more fashion
- Has allowed DECK to offer lower price points, retailers receptive
- RED FLAG: no longer offering Fall/Winter backlog (was up +15% last qtr), now just reporting full-year due to addition of Sanuk
- ASPs up slightly in order book
International Business Outlook:
- "Feel really strong where we're headed with our retail business and where that's going to end up for the year"
- Int'l expectations have come down from up over 20% and 33% of sales - now more like +15% (Domestic expectations up)
- China is all direct, no wholesale.
- Seeing improvement in Japanese business
- Have good visibility now with most of European orders pre-booked. Reduced expectations to a level believe achievable.
Spring Product:
- Typical split between carryover product vs. spring product roughly 40/60 (ballpark)
- Spring up close to +20%
Outlook:
- More growth expected in Q4 than Q3
- European distributor disruptions lowering expectations in Q3
Cost of Skins:
- Not fully locked in for 2013 yet, waiting for killing season in Q3
Sanuk:
- ~60% of business in 1H
- Expect good growth in Sanuk in Q2
