FINAL - Deckers Brands - Final Term Project
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Transcript of FINAL - Deckers Brands - Final Term Project
1 December 17, 2015
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Deckers Brands December 17, 2015
(NYSE: DECK)
Chase W. Lindsey, Analyst
Student Investment Fund
Recommendation: Buy David Eccles School of Business
Current Price (12/16/15): $50.54 1655 Campus Center Drive,
Price Target: $79.04 Salt Lake City, UT 84112
Potential Upside: 56.38%
52-Week Range: $45.14 - $95.82 1-Year Price Performance (DECK vs XRT)
EXECUTIVE SUMMARY
We are initiating coverage on Deckers Brands with a Buy
recommendation and a target price of $79.04 representing a
potential upside of 56.38%. Deckers Brands is headquartered in
Goleta, CA and is engaged in the business of designing,
marketing and distributing footwear, apparel and accessories
through its five brands (UGG Australia, Teva, Sanuk, Hoka One
One and Ahnu). Deckers primarily wholesales its footwear to
large specialty and high-end retailers such as Nordstrom, Neiman Marcus, REI and Zappos and also sells directly to
consumers through its rapidly expanding network of company-owned retail concept stores.
We believe Deckers is currently under appreciated in the market. The street has doubted the future success of
Deckers’ largest brand, UGG Australia for years leading to a current valuation below its peer group. Additionally, we
feel the market has underestimated the growth in Decker’s retail segment going forward. We feel that this is likely to
change in the coming 12-24 months for the following reasons:
The UGG Australia brand is stronger than the market believes it to be. In spite of a decline in its most
popular SKU, the classic UGG boot, the market is underestimating the sales potential of the new UGG
Australia styles and how quickly sales of new styles will surpass that of the declining classic boot.
The other four brands have shown higher than average sales growth and we expect this trend to continue.
Deckers Brands has successfully forward vertically integrated into retail by opening its own retail concept
stores. We believe this retail segment will be a large driver for future growth and will reduce the threat that
wholesale buyers pose to Deckers’ bottom line.
We feel that our valuation takes a conservative but realistic approach to future growth and that future positive
earnings surprises within the next 1-2 years will be the catalyst needed to make the market understand Deckers
Brands’ true value.
Initiating Coverage Deckers Brands (DECK)
2 December 17, 2015
BUSINESS MODEL AND PRODUCT ANALYSIS
Deckers’ Supply Chain
Deckers utilizes its industry experience and talented team of designers to design each product in house. Designers
work with buyers to keep the cost of raw materials in check throughout the entire design process in an effort to
design the best apparel while keeping raw material costs under control. Once designed, Deckers contracts the
manufacturing of its products to independent manufacturers located primarily in Asia. Deckers has established on-
site supervisory offices in these areas to monitor production from beginning to end but maintains no long-term
contracts with its manufacturers. In order to ensure quality, Deckers requires that all manufacturers use raw materials
sourced from suppliers pre-approved by Deckers’ buying office. These raw materials, with the exception of the
sheepskin used in the UGG product line, are all widely available from many sources at competitive prices. Although
Deckers does not manufacture its own products, it is still very effective in keeping control of its supply chain from
beginning to end. This is important as it allows Deckers to avoid the large capital investment required in machinery
and manufacturing while still maintaining a high level of control over the final product.
Once manufacturing is complete, Deckers relies on its internal sales and marketing teams to either wholesale the
products to global and domestic retailers or stock the inventory in its own retail stores located throughout the
United States, Asia and EMEA. Deckers’ recent expansion into the retail segment plays a vital role in its future success
as it increases the amount of control that Deckers
has over its revenues and potentially brings higher
profits by capturing the retail markup.
How Does Deckers Make Money?
As a wholesaler, Deckers’ primary source of
revenue, accounting for 66% of total revenues for
FY 2015, comes from selling its footwear and apparel in bulk to department stores and other retailers in the U.S. and
globally. Though still growing in total dollars, wholesale revenues are quickly becoming a smaller portion of total
sales as growth in Deckers’ retail and e-commerce segments continue to outpace wholesale sales growth. Deckers
generates an increasing portion of its revenues from sales at its own retail locations. Beginning in 2006, Deckers
began forward vertically integrating into the retail segment in what the company calls an “Omni-Channel” strategy.
Through the implementation of this strategy, Deckers opened its own retail stores which have been the primary
drivers of growth in recent years showing an impressive 32.26% CAGR over the last five years. In FY 2015, the retail
segment made up 21.15% of total revenues. Lastly, the company generates an increasing amount of its revenues
from its e-commerce segment. Online sales have shown impressive growth over the last five years and now account
for 12.83% of total revenues as of FY 2015. All three sources of revenue have shown impressive growth and we
expect this trend to continue into the future.
Initiating Coverage Deckers Brands (DECK)
3 December 17, 2015
Industry
Revenues
(Millions)
DECK
Revenues
(Millions)
DECK % of Total
Industry
Revenues
2006 31616.8 304.4 0.963%
2007 33472.7 448.9 1.341%
2008 32439.5 689.4 2.125%
2009 29230.3 813.2 2.782%
2010 31390.3 1001.0 3.189%
2011 32442.2 1377.3 4.245%
2012 33012.8 1414.4 4.284%
2013 34074.5 1556.6 4.568%
2014 35724.0 1587.6 4.444%
CAGR 1.54% 22.93% 21.07%
Footwear Wholesaling Industry Revenues
Cost Structure
When analyzing Deckers’ cost structure, it is important to recognize that there are two different businesses that need
to be examined. When we look at the design, marketing and wholesaling side of the business we see that there are
very few fixed costs. This is a result of outsourcing the manufacturing process as it allows for more flexible
production costs. Low fixed costs result in low operating leverage which is generally safer in tougher times. Since
Deckers has forward vertically integrated into retail, we also have to analyze the costs associated with the retail
segment of the business. Deckers states in its FY 2015 annual report that gross margins are generally higher in the
retail and e-commerce segments. Unfortunately, the company does not specify by how much. These retail stores
have lease obligations which are considered fixed costs. No matter how many shoes Deckers sells, the lease payment
is always due. This increases Deckers’ operating leverage which can be both good and bad. If demand falls and sales
decrease, it will still need to pay the lease on the retail store. This could result in a dramatic drop in operating margin
or even a net operating loss if sales are not sufficient to cover these fixed costs. In good times when sales are up,
this results in an increase in operating margin.
Market Share
Deckers has been tremendously successful in taking market share
over the past several years. The data below and to the right shows
the total industry revenues (source: IBISWorld) and Deckers
Brand’s Revenues (source: Morningstar.com). You can see the total
industry revenue CAGR is significantly smaller than Deckers’
revenue CAGR and Deckers’ share of total industry revenues has
grown from approximately 1% to nearly 4.5% in 8 years
representing a 21.07% CAGR in market share. When looking at the
graphs below we can see that Deckers was able to maintain
revenue growth during the recession when total industry revenues
fell.
4 December 17, 2015
Industry
Revenues
(Millions)
DECK
Revenues
(Millions)
DECK % of
Total Industry
Revenues
2009-2014 4.09% 14.32% 9.82%
2011-2014 3.26% 4.85% 1.54%
Revenue CAGRs Since Recession
The market share data in more recent years does tell a different story however. If we examine revenue growth in the
years since the recession in the chart below, its revenue growth slowed. In the last 5 years, from 2009 – 2014,
Deckers’ revenue CAGR has dropped to 14.23% while the total industry CAGR has increased to 4.09%. This change is
even more dramatic when you look at the last 3 years
from 2011 – 2014. Deckers’ revenue CAGR fell sharply to
just 4.85% while the industry revenue CAGR fell
modestly to 3.26%.
Deckers has been able to steal a significant amount of
market share over the last 8 years but its ability to
continue to steal market share is questionable. From
2006 – 2013, Deckers was able to increase its share of
total industry profits, but in 2014 we saw the first decrease in market share from 4.568% down to 4.444% of total
industry revenues. This is most likely due to a combination of dramatically increasing revenues by the largest
industry player, Nike, as well as the maturing of Deckers’ largest brand, UGG.
Competitive Advantage
Deckers has utilized trademarks on nearly all of its products and has done well to ensure that no major portion of
trademarks expire at or near the same time. Deckers also continues to grow its portfolio of styles and designs by
working with in-house designers as well as through the acquisition of new brands. Deckers utilizes its operating
leverage, outsourced manufacturing, forward vertical integration, design core competencies and trademarks to
maintain its competitive advantage. The question remains, however, whether the company can continue to take
market share from its larger industry competitors. In our view, Deckers will be able to outpace industry growth and
continue to grow its market share due to the continued future success of its five brands and expansion of its retail
and e-commerce segments.
Product Analysis
Deckers Brands is a consumer products wholesaler with a portfolio of several major footwear and apparel brands.
UGG Australia
UGG Australia was founded in 1978 and is Deckers’ largest and most successful
brand making up 82% of total company revenues for FY 2015. The UGG brand
features outdoor footwear and apparel crafted from high quality sheepskin, wool
and other materials. UGG products are sold in high-end retailers and department
stores like Nordstrom, Neiman Marcus, Dillard’s and Bloomingdale’s as well as
specialty and online retailers like Zappos.com. The UGG product most easily
recognized is the traditional sheepskin UGG boot for women, pictured right. The
UGG line for women also includes slippers, sneakers, handbags, outerwear and
other apparel, hats, gloves and many other boot variations and styles. The UGG mens line includes many of the same
items designed for men and a wide variety of leather boots, outerwear, dress shoes and more. Deckers has opened
UGG concept stores across the country to showcase the UGG brand.
5 December 17, 2015
Teva
According to the Teva brand history webpage, “Teva was born in the Grand Canyon back in 1984, when a river guide
rigged two Velcro watchbands to an old pair of flip flops and created a shoe that wouldn’t float away.” This
statement embodies the outdoor, active lifestyle that the Teva
brand represents. The primary product is the Teva sandal, a
simple, comfortable platform with basic nylon straps—pictured
to the right.
Teva is Deckers’ second most successful brand bringing in 7%
of FY 2015 revenues. Deckers wholesales the Teva brand to
outdoor and sporting goods stores such as REI, L.L. Bean,
Dick’s Sporting Goods and The Sports Authority.
Sanuk
The Sanuk brand makes sandals, slip-ons and other casual footwear intended to be comfortable to wear. The shoes
pictured below are the Men’s Chiba (left) and the Women’s Dona Hemp (right), the two bestselling Sanuk shoes.
Sanuk is also known for products like the SIDEWALK SURFERS shoe and the Yoga Mat and Beer Cozy collections.
Sanuk is Deckers’ third most successful brand accounting for 6.3% of 2015 revenues.
6 December 17, 2015
Ahnu & HOKA OneOne
The Ahnu and HOKA OneOne brands both focus on more active footwear for activities like hiking and running. As
the smallest brands, these two combined accounted for a total of 4.5% of 2015 revenues. These shoes are
distributed for sale to specialty and online retailers and are the fastest growing brands within Deckers’ portfolio. The
company reported that the HOKA OneOne brand had revenue growth of 74% during a June 2015 investor
presentation.
The green shoe below is the Men’s HOKA Clifton 2 running shoe. It has been specifically designed for running on
hard surfaces like roads and sidewalks. The red shoe is the Women’s Ahnu Sugarpine hiking shoe. It is lightweight,
breathable and waterproof and has been designed to withstand the rigor of all-day hiking and trail running.
Conclusion
Deckers Brands has built a diversified portfolio of footwear and active apparel. In the most recent Annual Report the
company stated, “Our primary objective is to build our footwear lines into global lifestyle brands with market
leadership positions.” Deckers intends to accomplish this goal by continuing the implementation of its “Omni-
Channel” strategy by opening more retail stores and through the expansion of its online marketing and sales
capabilities. Each of Deckers’ brands has a reputation for quality and functionality in a growing active wear market.
We believe Deckers has the business model and product lines needed to succeed and expect that it can utilize its
many resources and continue its growth both here in the United States and globally.
7 December 17, 2015
INDUSTRY AND MARKET ANALYSIS
Current Operating Conditions
According to IBISWorld, the U.S. footwear wholesaling industry is classified as having very high competition or
rivalry, low concentration, lower than average profits driven down by pressure from retailers, low capital intensity,
and low revenue volatility. Due to the high level of competition, success in this industry is predicated upon efficient
and effective operations on all fronts. IBISWorld provides a list of key success factors that a successful operator in
this industry should have: (a) established brand names, (b) ability to protect intellectual property, (c) supply contracts
in place for key inputs, (d) a cost effective distribution system, (e) ability to control stock on hand, (f) prompt delivery
to market, and (g) strong relationships with major retailers. We feel that Deckers has the core competencies and
operational infrastructure in place to take advantage of each of these success factors.
SWOT Analysis
Strengths
Deckers Brands has been able to create a brand portfolio of easily recognizable and successful brand names. The
UGG brand has been established for years and its primary product has become a fashion staple in a young women’s
winter wardrobe. The brand is capitalizing on its successes and is attempting to mirror that growth in the men’s and
kid’s areas. Deckers has also been able to take advantage of its beneficial supply chain contracts. The company’s
control of its supply chain is impressive given that it does not own its manufacturing process. This tight control
allows the company to manage stock on hand and manage key inputs effectively. Additionally, Deckers has been
able to secure good relationships with many key retailers like Nordstrom. Getting shelf space in these large retailers
is quite difficult and this is something that Deckers has proven effective at. The company can leverage its existing
relationships to help maintain its competitive edge. These relationships also reduce the company’s threat of new
entrants.
Weaknesses
Deckers has struggled in its ability to protect its intellectual property. Though Deckers owns patents for its products,
copy-cat styles run rampant. Bearpaw makes a similar shoe to the classic UGG sheepskin boot and are frequently
referred to as “fake UGGS” or “FUGGS”. In addition, the company has struggled to protect itself from intellectual
property theft internationally. Deckers is taking action to combat this however. On November 23rd
, the company
announced that it had launched new anti-counterfeit social media sites for the UGG brand in an attempt to inform
consumers and to allow for reporting of infringers by consumers themselves. Deckers also took this as an
opportunity to reiterate that it is focused on purchasing fake UGG products to take them off the market and would
be more aggressive in protecting its intellectual property moving forward.
Opportunities
International expansion is the greatest industry-wide opportunity and we feel that Deckers is well-poised to take
advantage of it. Though the U.S. footwear retail market is saturated, this is not the case in many international
markets and it opens the opportunity for real growth. IBISWorld reports that globalization for this industry is
8 December 17, 2015
considered low but increasing. Demand for American products internationally poses a potential great opportunity
that Deckers can capitalize on due to its company-owned retail segment. Other competitors within this industry
must rely on relationships with international retailers to expand internationally whereas Deckers is doing this on its
own already with 91 of its existing 145 retail stores located in non-US markets (see Exhibit 1).
Threats
The most prominent industry-wide threat comes from competition and rivalry. This industry, as mentioned above, is
characteristically highly competitive and is highly fragmented. As such, Deckers must be able to sell more than its
industry competitors and be able to outperform industry-wide growth metrics. IBISWorld reports that annual
revenue growth for the U.S. footwear wholesale industry has been 3.4% over the last five years. Deckers Brands has
shown an impressive 16% revenue CAGR over the same period (see chart on page 2) demonstrating the company’s
ability to outperform industry averages. Competition is a very real threat in this industry but Deckers has historically
been able to place itself among the top performers in its industry and we feel the company will continue this trend
into the future and is expected to continue growing revenues at a greater rate than the industry average projection
of 3.0% through 2020.
9 December 17, 2015
CORPORATE EMPLOYEES AND MANAGEMENT
Summary
Deckers Brands is headquartered in Goleta, CA and has an estimated 3,400 employees. The company has an
extensive internship program and prides itself on the development of talent with an emphasis in the areas of brand
management, product innovation and design, and supply chain core competencies. Deckers has an ISS Corporate
Governance Score of 1 indicating the lowest risk level and has cultivated a management team with extraordinary
talent and industry experience. Additionally, Deckers’ CEO, Angel Martinez, has expressed the importance of a
corporate culture that fosters creative design, innovation and brand leadership development. However, Deckers has
had its fair share of challenges with a high turnover of key top executives in recent months. A business like Deckers
is driven by innovative design and competent brand management that can turn a shoe brand into a lifestyle brand.
Given the recent struggles of Deckers’ largest brand, UGG Australia, the question remains: Can Deckers management
team do what they say and turn all five brands into successful lifestyle brands? We will not recommend this company
as a buy if we do not believe management has what it takes to repair its struggling brand and accelerate the growth
of its others. An in-depth say-do analysis should shed some light.
Corporate Management
Deckers Brands has an impressive management team with brand management talent and collective experience that
is second to none within the footwear and apparel industry. Deckers’ Chairman and CEO, Angel “Anjo” R. Martinez
has been at the helm for nearly 11 years and has cultivated a team of managers capable of making Deckers an
industry leader. His current team has worked for companies and brands like Nike, New Balance, Tommy Hilfiger,
Reebok, Converse, Timberland, Keen, Puma, Gap, Oakley, Luxotica and others. A detailed bio of each manager has
been included in Exhibit 2. This success has not come without its challenges however. Within the last 18 months,
Deckers has seen a change in seven major upper-management positions including the departure of Constance
Rishwain, President of the UGG brand, earlier this year. There is question as to whether Deckers can turn around its
stagnant UGG brand without the leadership of Ms. Rishwain. Current leadership consists of the following individuals.
Deckers Brands Management Team:
Chairman & Chief Executive Officer: Angel R. Martinez
President of Deckers Brands: David Powers
Chief Financial Officer: Thomas A. George
Chief Operating Officer: David E. Lafitte, J.D.
President of UGG Australia: Constance Rishwain (recently announced departure – consultant now)
President of Hoka One One & Ahnu Brands: Jim Van Dine (recently changed, no replacement yet)
President of Teva Brand: Wendy Yang (recently appointed)
President of Sanuk Bramd: Jake Brandman
President of Omni-Channel: Stefano Caroti (started on November 2, 2015)
Senior VP of Innovation & Product Development: Stuart Jenkins
Senior VP of Omni-Channel Operations & E-Commerce: John A. Kalinich
President, Asia Pacific: Peter K. Worley
10 December 17, 2015
Management Compensation
All executive management with public compensation information is compensated with a mixture of both cash and
equity compensation. This is generally intended to align the interests of management with that of the shareholders.
Exhibit 3 is from Deckers most recent proxy filing with the SEC and shows the total compensation for the publicly
reported executives broken down by cash and equity based compensation over the past several years.
Corporate Culture
Deckers Brands prides itself on being an unconventional company to work for. The corporate office is casual dress
every day and benefits include things like car washes, free shoes, dry cleaning, massage therapy, a fresh produce
truck and coffee service. They also have a fleet of bicycles that are available for all employees to grab and head
down to the beach (located just one mile from the corporate headquarters). Glassdoor.com reviews consistently
show “employee-friendly environment” as a pro. The compensation seems fair and the benefits include pretty good
medical, dental, vision, life and disability insurance coverage as well as a 401k plan with positive reviews, maternity
and paternity leave, paid holidays, vacation and sick days, as well as employee discounts, tuition assistance and a
newly introduced employee stock repurchase plan. According to 53 reviews on Glassdoor.com, 74% would
recommend the company to a friend and 89% approve of the CEO (see image below from glassdoor.com).
11 December 17, 2015
Say-Do Analysis
When looking at management effectiveness for a company facing headwinds like Deckers, it is important to look at
how good the management team is at setting realistic goals and accomplishing those goals. The management team
is naturally more informed on the market within which their company operates and can therefore give good
estimates for future growth and performance. We performed a simple Say-Do Analysis on Deckers by looking back
at earnings releases to see how actual results compared to guidance. In the areas of revenue, EPS and net income
over the last 10 years, the company has a consistent record of beating estimates. Our research presented no serious
concerns in this regard except one. Deckers has seen unusually high upper-management turnover in recent months.
This poses some problems when performing a Say-Do analysis for the simple reason that we are no longer analyzing
the same management team. We therefore cannot conclude that the Say-Do analysis would generally apply to a
mostly new management team. Although we have no reason to suspect otherwise, we cannot confidently say that
we expect this management team to perform as well as the last without seeing a longer history with the new team in
place.
Insider Transactions
Over the last several months, insiders have been accumulating shares of Deckers Brands. The chart below was pulled
from Capital IQ and shows the number of
insiders and number of shares transacted by
insiders in recent months.
Insider buying can be an indicator that
management believes future prospects of the
company are positive. The one sell position
listed on this chart was a sell transaction
placed by Constance Rishwain and appeared to
be around the time she announced her
departure from the company.
Conclusion
Deckers Brands has an exceptional management team. They are making changes at the top that will position the
company for future growth and have recently vacated several positions that will be in need of replacing soon.
Management is accumulating shares and the corporate culture appears to be conducive to a productive creative
environment. We believe that Deckers Brands is well poised to take advantage of its new and changing management
team and will continue to perform as expected and honestly represent to shareholders their reasonable and
achievable goals.
12 December 17, 2015
Alm
ost
Cer
tain
Negative exposre to
foreign exchange risk
from international
business operations
Like
ly
Failure to acurately
estimate purchases
resulting in high/low
inventories
Mo
der
ate
New management
fails to deliver
Retail stores
underperform
Un
likel
y Increase in cost of
sheepskin and other
raw materials
Weather negatively
impacts sales of
largest brands
Failure to anticipate
or adapt to new
fashion trends
Rar
e
Insignificant Minor Moderate Major Catastrophic
Like
liho
od
Impact
Investment Risk Matrix
INVESTMENT RISKS AND GROWTH STRATEGY
Like all investments, purchasing equity in Deckers Brands is subject to many risks, both positive and negative which
vary in likelihood and potential impact. We looked at many risks stated within the company’s 10-K as well as other
macro risks and determined the most likely and highest impact. We then analyzed these in more detail. A graphical
representation of these risks in the form of a risk matrix is provided herein with an accompanying detailed analysis
for each risk.
Potential Downside Risk
Downside risk, or the risk of earnings underperforming to some degree, may stem from events specific to the
company, industry, or geography as well as macroeconomic or systematic events. We determined the most likely or
highest impact risks were the following, in no particular order.
1. New management fails to deliver
2. International operations cause negative foreign exchange exposure
3. Deckers fails to accurately estimate purchases leading to excess or shortage of inventories
4. An increase in the cost of raw materials decreases margins
5. A mild winter decreases UGG sales which have sensitivity to weather
6. Deckers new retail stores underperform
7. Deckers fails to anticipate or adapt to new styles and fashions leading to reduced sales
The investment risk matrix below shows where we place each of the above risks in terms of both likelihood and
impact.
New Management Fails to Deliver
Deckers has experienced high
upper-management turnover in
recent months with some key
executive positions seeing
significant changes. In April,
Constance Rishwain, the long-
time President of the UGG brand
resigned unexpectedly. The
announcement came shortly after
the company announced that
David Powers would be its new
President overseeing each of the
major Brand Presidents. There is some speculation that Ms. Rishwain’s sudden departure could be a result of this
new appointment. In addition to Ms. Rishwain’s departure, seven other upper-management positions have recently
changed including the appointment of David Lafitte, former general counsel, to the COO position. Mr. Lafitte, a
13 December 17, 2015
securities lawyer by trade, taking over as the Chief Operating Officer definitely raises some questions given his
limited operational experience.
The remaining management changes have led to appointments of internal and external candidates who all have
extensive experience in the footwear and apparel industry ranging from successful Nike brand managers to former
Timberland executives and more. There is no question that this group has the experience on paper to create great
success at Deckers Brands but only time will tell if they can work well with one another and produce positive results
for shareholders. This uncertainty creates a certain amount of risk which we have classified as moderate in both
likelihood and impact.
Negative Foreign Exchange Exposure from International Operations Hurts Bottom Line
As of the end of September, Deckers has 145 total stores globally, 91 of which are located outside of the United
States. According to the company’s annual report, these stores conduct business in the local currency which creates
a foreign exchange risk when repatriating cash. Given the recent strength of the dollar and the high likelihood of a
rate hike from the Federal Reserve, among other global macroeconomic factors, we anticipate that the dollar will
continue to strengthen resulting in a negative impact on Deckers financial performance. It is important to note
however that Deckers does engage in hedging activities through derivatives in order to mitigate this risk. The risk
cannot be entirely eliminated however as it is impossible to predict exact sales figures in foreign markets potentially
leaving some gap in the revenues hedged. For these reasons, we have determined the likelihood of a negative
impact from foreign exchange to be almost certain with a minor impact due to the hedging activities intended to
mitigate this risk.
Deckers Fails to Accurately Estimate Demand Resulting in an Excess or Shortage of Purchases and Inventories
It is extremely unlikely that Deckers will estimate the exact demand for each SKU accurately. Because of this, there
will likely be some shortage or surplus in inventories. In addition to the standard error, retailers in this most recent
quarter have posted significantly higher than average inventories. The Journal of Commerce reported on November
16 that US Retailers saw a 5.1 % year-over-year increase in inventories while Macy’s and JC Penny saw 4.6% and
9.3% increases respectively as a result of slower sales. These figures resulted in dramatic downward price movements
for both Macy’s and JC Penny following earnings. We estimate that the likelihood of a significant miscalculation of
inventories is likely in the months to come for Deckers and therefore rate this risk as likely. This will likely affect
Deckers’ own stores negatively and hurt its retail business but the impact will mostly be felt by the major retailers
like Nordstrom who hold most inventories for Deckers’ products. Therefore we feel the impact will be moderate as
opposed to major or catastrophic.
Cost of Raw Materials Increases Resulting in Decreased Margins
Deckers contracts for the purchase of its raw materials from a select few suppliers who meet its high quality
standards. It is entirely possible to see fluctuations in the price of raw materials like the sheepskin used in producing
the iconic UGG boot. The company has seen slight variations in the price of this input specifically within the past
several years and has taken steps to mitigate the risk of a cost increase through the use of long term purchasing
contracts with its few suppliers. We have no reason to believe that the price of any major input will rise significantly
in the near term and therefore we consider this event to be unlikely to occur. Thanks to the contracts with its
14 December 17, 2015
suppliers, we also believe that a cost increase would have little impact for Deckers in the near term and therefore
believe the impact would be minor.
A Mild Winter Adversely Affects UGG Sales
Deckers’ largest and most successful brand, UGG Australia, is known for its iconic UGG sheepskin boot. Its tough
construction and warm wool interior lining make it a hot item during the winter months. Deckers has indicated in its
annual report that the UGG brand is sensitive to the weather showing higher sales in harsher winters than in milder
ones. A mild winter can have a negative impact on Deckers top and bottom line as well as result in an increase in
inventories mentioned above. Therefore we consider this a risk with a major potential impact.
To determine the likelihood of this event we looked at weather forecasts for this upcoming winter across the United
States. This revealed several telling things, most importantly that this is a very strong El Niňo year. El Niňo is a
weather phenomenon that has various effects on North American winters but generally leads to a drier and mild
winter in the northern half of the country and a wetter, harsher winter with increased snowfall in the southern half,
according to the Weather Channel (see exhibit 4). Our key takeaway was that some areas of the country will see a
decrease in snowfall and likely a milder winter but that key population areas of the country including parts of the
Northeast, California and the Southeast will all see in increase in snowfall and a harsher winter. Therefore, we believe
the likelihood of a milder winter that negatively affects UGG sales is unlikely.
Deckers’ New Retail Stores Underperform
Deckers has made a significant investment in its vertical integration strategy opening nearly 150 of its own retail
stores around the world. These stores have been the largest contribution to the company’s growth, according to the
most recent annual report, but if not executed correctly, this growth strategy could backfire. Deckers has traditionally
been a wholesale footwear and apparel company exclusively selling its products to other retailers. Its recent
expansion into retail of its own has increased fixed costs and accordingly, operating leverage. If these retail locations
fail to produce returns we will see a decrease in sales as well as profitability due to the inability to cut large fixed
costs (like building leases) during tough times. Vertical integration has its benefits and seems to be working well so
far for Deckers but the risk associated with this capital intensive growth strategy should be monitored carefully. For
these reasons, we consider this risk to have a moderate likelihood but a major impact if it was to happen.
Deckers Fails to Adapt to New Trends and Styles
As an apparel company, Deckers is subject to rapid changes in consumer tastes. This is evidenced by the slowing
sales growth of its largest brand, UGG Australia. One of the greatest potential risks that Deckers faces is that they are
unable to design and produce a fashionable product. It is entirely possible that Deckers’ designers are unable to
come up with something that sells or that Deckers brands have run their course. (Crocs, anyone?) We find the
likelihood if this event to be low with a rating of unlikely primarily because of the resilience of each of Deckers’ five
brands. Additionally, as one of the larger players within the footwear industry, Deckers can and has mitigated this
risk by creating a diversified portfolio of footwear brands through acquisition. That does not change the fact that
were this event to occur, the impact would be catastrophic. Sales would plummet and the brands would become
“uncool” making it harder to bring them back. For these reasons we consider this an unlikely risk with a catastrophic
impact.
15 December 17, 2015
Key Risk Takeaways
It is always important to consider the potential downside risk of any investment carefully and we feel that Deckers is
no exception. But it is also important to think about the potential upside risk for an investment as well. We are
recommending this investment as a buy for several reasons but not the least of which is the potential for upside risk
factors. While we consider the possibility that the retail stores may underperform or that the company may not
produce anything fashionable or trendy, we must also consider the possibility that the opposite may be true.
Deckers’ retail stores may prove to be the greatest investment they’ve ever made returning outsized gains and
providing a more profitable way to sell to the customer. It is also entirely possible that the designers working with
the UGG brand create the most successful shoe ever made or that the company acquires a new brand that performs
remarkably well for years to come. These considerations are taken into account by examining Deckers’ growth
strategy and critically analyzing it to determine its likelihood of success.
Growth Strategy
Deckers Brands needs to address growth in two distinct categories. First, the company needs to focus brand-specific
growth. This means working to create a lifestyle brand out of each of its five brands. Additionally, Deckers needs to
work on growing each of its revenue segments (wholesale, retail and e-commerce). These two categories are the key
drivers of Deckers’ business and growing each of them will require different perspectives and strategies.
Brand-Specific Growth Strategy
Deckers has developed a highly detailed brand-specific growth strategy aimed at growing each of its five brands.
The company outlined its highly detailed growth strategy in its latest investor presentation on October 29, 2015. The
company presented a plan for growing the UGG, Teva, HOKA OneOne and Sanuk brands. Slides from the
presentation summarizing each plan can be found below in Exhibits 5-8.
Growing the UGG Australia brand is vital to the continued success of Deckers Brands and to our investment thesis.
UGG represents 82% of total revenues meaning there is no room for declining sales. As goes UGG Australia, so goes
Deckers Brands. The UGG brand has already shown success in its women’s line and specifically the classic sheep skin
UGG boot. Since demand for the classic boot is waning, the brand needs to continue to innovate and expand in
order to continue its growth. Deckers outlined how it intended to do keep up the continued growth in its most
recent October 2015 investor presentation. Continued success of UGG Australia is going to be driven by:
Evolving the classic UGG franchise with new designs and styles,
Growing the UGG men and UGG kids lines,
Expanding UGG casuals and UGG weather product lines, and
Expanding UGG’s non-footwear categories.
Evolving the classic UGG franchise has already begun. Deckers has enlisted the help of fashion designer Rachel Zoe
to redesign the classic UGG boot from the ground up adding a new slimmer profile, more durable construction and
a new contoured, raised heel for added comfort. New designs for men and kids have already begun and the men’s
line now has New England Patriots Quarterback, Tom Brady as its celebrity sponsor. New casual and weather designs
16 December 17, 2015
have hit the market and the company is offering many non-footwear UGG branded products with more expected to
come.
Continued growth of the other four brands is dependent upon applying the core competencies and successful
strategies used in developing the UGG brand to the other four. The slides shown in Exhibits 5-8 explain in more
detail how Deckers plans on growing the other brands.
Segment-Specific Growth Strategy
Deckers collects revenues from three distinct sources: wholesale, retail and e-commerce. As we discussed above,
although wholesale is still the largest contributor to total revenues, its share is shrinking. This is not necessarily a
problem and conforms to Deckers’ growth strategy of shifting toward higher margin business segments like retail
and e-commerce. Additionally, the company is still actively growing its retail segment which has been its fastest
growing revenue segment over the last five years. Reducing its dependency on the traditional wholesale model will
allow Deckers to capture that full retail margin and also provide it with better market intelligence, a higher degree of
control and should simultaneously reduce the threat that buyers place on margins which should give Deckers a
competitive advantage.
We believe that Deckers possesses the core competencies and key personnel and talent needed to continue the
success of the UGG brand in spite of Ms. Rishwain’s recent departure. When combined with the continued growth of
the other four brands and a focus on growing non-wholesale revenue segments, we feel that Deckers has the ability
to remain a major industry player for the foreseeable future.
17 December 17, 2015
VALUATION
When determining the value of Deckers Brands, we used a weighted average of four different valuation methods
and projected a worst, base and best case in order to come up with our final figure. Worst, base and best case
assumptions were made primarily on the basis of revenue projections which we broke down by segment. These are
shown in detail in Exhibit 9. We ultimately
determined that the base case provided the most
reasonable expectations of future financial
performance and accordingly used the base case
figures to arrive at our final price target of $79.04.
Valuation Methods
EBITDA Exit Multiple
The first valuation method we used was an EBITDA exit multiple whereby the income statement was projected out 5
years to come up with free cash flows and EBITDA. The income statement projection can be found in Exhibit 10. We
multiplied the year 5 EBITDA figure by an exit multiple of 8.4x which we sourced from Bloomberg consensus to
arrive at our terminal value. We then discounted this figure back 5 years
using the company’s WACC of 8.40% which we also sourced from
Bloomberg’s WACC calculator. We then calculated the present value of the
projected free cash flows and added this to the present terminal value to
arrive at a total enterprise value. After taking out debt and adding back
cash and marketable securities (net debt), we arrived at an equity value
which we divided by total shares outstanding. Because this method
involves a significant amount of detail and careful consideration of the
income statement, we assigned this valuation method a 40% weight in our
final total value calculation.
Free Cash Flow Perpetuity Growth
The second valuation method we used was a free cash flow
perpetuity growth method. We started by finding a terminal
value by taking year 5 free cash flow and dividing it by
WACC less our projected perpetuity growth rate of 3.10%.
We took this perpetuity growth rate from Bloomberg
consensus. We then discounted the terminal value and
added it to the discounted sum of total cash flows from
years 1-5. After taking out net debt, we arrived at an equity
value that we divided by the total number of shares
outstanding. We also assigned this method 40% of our final
weighted average.
18 December 17, 2015
Forward P/E Multiple
This method involved using comparable companies to determine a fair
forward P/E ratio. We pulled a list of comparables from Capital IQ (see
Exhibit 11) in order to find the appropriate multiple. Once found, we
multiplied that forward P/E by projected EPS for the next year to arrive at a
value. Because this method does not take into account actual cash or
projections of earnings any further than one year, this was only assigned 5%
to our total weighted average in the final value calculation.
EV/EBITDA Multiple
This method, like the forward P/E multiple method, involves the use of comparable companies to arrive at fair
multiple. The same comparables found in Exhibit 11 to calculate the
forward P/E multiple were used to find the EV/EBITDA multiple. We
then used the projected income statement (Exhibit 10) to arrive at a
projected EBITDA figure for the next year. Once these figures were
determined, we calculated enterprise value by adding market cap and
total debt then subtracting total cash and marketable securities. We
had to hold the debt figures and cash and short term borrowings
constant so we could determine what market cap figure would get us to
the fair EV/EBITDA multiple. We found this figure using a goal-seek
function in excel which we then divided by total shares outstanding. We
determined that this method would be assigned the remaining 15% of
our weighted average final valuation.
Revenue Growth Assumptions
Projecting revenues out five years meant understanding the specific growth drivers for each revenue segment
(wholesale, retail and e-commerce). We broke revenues out by each segment and examined how they grew over the
last five years in order to give us a better understanding of estimated future growth. The chart below shows there
results.
We can see by examining this chart that the greatest portion of total revenues is made up by the wholesale segment
but that this trend is slowing. Over the last five years, this segment has grown in real dollar terms but has ultimately
declined in terms of percentage of total revenues from 78.28% down to 66.02%. This resulted from outpaced growth
19 December 17, 2015
in the retail and e-commerce segments. We feel that the continued expansion of Decker’s retail segment is a vital
earnings driver moving into the future and that the company is well positioned to keep this segment growing into
the future. We ultimately modeled revenue growth in the retail segment at a steady 15% over the next five years.
Wholesale revenue growth is expected to slow in the short term due to a slowdown in consumption over the past
several months. As such, we slowed the historical growth rate from wholesale down to 4% in the coming FY 2016
and held this steady at 5% growth from FY 2017 through FY 2021. We estimate the e-commerce revenues will also
continue growing but at a conservative 10% annually over the next five years. The chart below details how our
revenue growth was broken down by segment in our base case revenue assumptions. The percentage figures in blue
at the bottom show what total revenues are expected to grow as a result of the growth rates projected in each
segment.
We feel comfortable with these growth assumptions and feel that they accurately account for the risk of slowing
future sales since all of these growth rates are less than the previous year CAGR figures per segment. Ultimately, this
amounts to an 8.07% revenue CAGR which we feel is a fair and reasonable expectation of future sales growth.
20 December 17, 2015
CONCLUSION
It is our belief that Deckers Brands
has the management team, product
lines, core competencies, supply chain
and strategic relations to continue
growth into the future. Retail will continue to be the largest contributor to growing future revenues and we expect
that the company will continue to expand its retail footprint both domestically and internationally as it has been in
recent years. Wholesale and e-commerce will continue to show growth as well with e-commerce posting better
growth that wholesale over the next five years.
We also feel confident that the recent redesign in the UGG brand will allow it to post better than expected gains.
This has been a major sticking point for investors in recent years but we feel that this is where the market has it
wrong. We also believe that the market underestimates the affect the other four brands have on the company
overall and that the other four brands will continue outsized growth into the future over the next five years.
We expect positive earnings surprises within the next 24 months to be the catalyst that propels the stock price
upward understanding that earnings within the nearer term may not immediately outperform. Pressures from
wholesale customers in the near term may drive down wholesale sales but over the longer term, it is our belief that
this trend will reverse.
As with every investment, a position in Deckers Brands does pose certain risk. We understand that a relatively
undiversified revenue stream as a result of a majority of sales coming from the UGG brand does present risk but our
belief is that the continued success of the UGG brand can be reasonably expected as a result of design
competencies and a focus on retail sales in company-owned stores allowing Deckers to capture the entire retail
markup.
Ultimately, we are initiating coverage on Deckers Brands with a buy recommendation and a $79.04 price target
representing a potential upside of 56.38%.
21 December 17, 2015
Exhibits
22 December 17, 2015
EXHIBIT 1
(Source: October 29, 2015 DECK Investor Presentation)
23 December 17, 2015
EXHIBIT 2
Management Bios (Sourced from Capital IQ)
Angel R. Martinez: C.E.O. & Chairman of the Board
Mr. Angel R. Martinez has been Chief Executive Officer of Deckers Outdoor Corp., since April 11, 2005 and served as its President. Mr. Martinez has extensive
experience in brand building, where he has been instrumental in the development and success of many brands throughout his 26 years in the footwear industry.
He was an Independent Consultant since June 2001. He served as the Chairman of the Board, Chief Executive Officer and President of Keen LLC since April 2003,
which he co-founded and launched in April 2003. From 1980 to 2001, he held numerous senior level positions at Reebok International Ltd. He served as an
Executive Vice President and Chief Marketing Officer of Reebok International Ltd., from October 1998 to June 2001. Prior thereto, he served as President and Chief
Executive Officer of The Rockport Company, a subsidiary of Reebok, since 1994. He served as Vice President of Global Marketing for the Reebok brand and was
responsible for the worldwide advertising, corporate communications and promotions for the brand. He has been the Chairman of Deckers Outdoor Corp. since
May 2008. He has been a Director of Deckers Outdoor Corp., since September 16, 2005 and Tupperware Brands Corporation since 1998. He also championed
Reebok's Human Rights programs and serves on the Board of Advisors of the Human Rights Award. He's credited with significantly diversifying its product
offerings by introducing Reebok aerobic shoes, tennis shoes, walking shoes, and basketball shoes, as well as creating the Reebok "Classic" line of footwear and
apparel and the Reebok "Step" program. Mr. Martinez was honored for his work in 1997 with the Man of Year award from Footwear News, a leading trade
publication in the footwear industry. (CAPITAL IQ)
David Powers: President of Deckers Brands
Mr. David Powers, also known as Dave, has been the President of Deckers Brands at Deckers Outdoor Corp. since March 2015. Mr. Powers served as the President
of Omni-Channel at Deckers Outdoor Corp. since January 28, 2014. He served as the President of Direct to Consumer at Deckers Outdoor Corp. until January 28,
2014. Mr. Powers joins Deckers from Converse, a division of Nike, Inc., where he served as Vice President of Global Direct to Consumer and Licensed Retail since
2008, during which time he successfully guided the expansion of the Converse brand into Europe, the Middle East, Africa, Latin America and Asia and developed
relationships with key license partners resulting in over 1900 partner stores. He also served on the Nike Senior Leadership team and as a member of the Converse
Executive Leadership team. He has over 20 years of experience in the retail business and has developed merchandising, product, and store concepts at some of the
industry's top retailers. Previously, Mr. Powers held several leadership roles at Timberland including Worldwide General Merchandise Manager where he was
responsible for global merchandising and oversaw brand merchandising and strategy. Mr. Powers spent 10 years at Gap Inc. [NYSE: GPS], where he was Divisional
Merchandise Manager for men's and kids businesses.
David Lafitte, J.D.: Chief Operating Officer
Mr. David E. Lafitte, J.D. is a Share Holder of Stradling Yocca Carlson & Rauth, P.C. Mr. Lafitte has been the Chief Operating Officer of Deckers Outdoor Corp. since
February 1, 2015. He served as Secretary and General Counsel of Deckers Outdoor Corp. until February 2, 2015. Mr. Lafitte's areas of practice include corporate and
securities and life sciences. He has experience in transactions in the field of venture capital financings, IPO, and other public offerings, public and private mergers
and acquisitions, and technology licensing. He represents clients involved in a diverse range of businesses including high technology, medical device, and
healthcare services, consumer product companies, and other emerging growth companies. Mr. Lafitte is admitted to practice at the State Bar of California and
American Bar Association. He serves as a Director at Stradling Yocca Carlson & Rauth, P.C. He is a member of the U.S. Supreme Court Society. Mr. Lafitte is also a
member of the Board of Directors of the Center for Entrepreneurship & Engineering Management, College of Engineering, University of California, Santa Barbara.
He received a J.D., cum laude, from the Tulane University Law School, New Orleans, LA and a B.A. in Economics from the University of Colorado, Boulder, CO.
Thomas A. George: C.F.O. & Principal Accounting Officer
Mr. Thomas A. George, also known as Tom, has been the Chief Financial Officer of Deckers Outdoor Corp. September 11, 2009 and serves as its Principal
Accounting Officer. Mr. George has over thirty years of experience in corporate finance and accounting, having served in a number of senior level positions with
both public and private companies. He joined Deckers Outdoor Corporation from Ophthonix, Inc., where he served as Chief Financial Officer since February 2005.
He served for 7 years as Chief Financial Officer for publicly held Oakley, Inc., where he led all aspects of its financial operations and was instrumental in establishing
a global infrastructure to support international expansion. Mr. George held positions at Loral Corporation, International Totalizator Systems, Remec Corporation
and Coopers and Lybrand. He joined Oakley Inc. in October 1997 and served as its Principal Accounting Officer. He served as Senior Vice President of Finance and
Chief Financial Officer at REMEC, a designer and manufacturer of microwave wireless electronics since 1990. He has more than 25 years experience in finance and is
also a certified public accountant. He has been Director of Nemus Bioscience Inc. since January 2015. Mr. George received a Bachelor of Science in Business
Administration from the University of Southern California.
24 December 17, 2015
Stefano Caroti: President of Omni-Channel
Mr. Stefano Caroti has been President of Omni-Channel - Deckers Brands at Deckers Outdoor Corp. since November 2, 2015. Mr. Caroti served as Chief Commercial
Officer of PUMA SE from August 1, 2008 to December 31, 2014 and served as its Managing Director of Sales since July 25, 2011. Mr. Caroti served as Managing
Director of PUMA SE until December 31, 2014. He was responsible for PUMA’s wholesale and retail functions. He served as a Member of the Board of Management
at PUMA SE from August 1, 2008 to July 24, 2011. He held a number of senior executive positions at Nike in Sales, Product, Marketing and General Management.
He served as Vice President of EMEA Commerce at Nike Inc. since 2005 and was responsible for the entire wholesale and retail business in the EMEA region. He
served as the Vice President of EMEA Footwear at NIKE Inc. since December 2002. He joined Nike in March 1985 as a Footwear Demand-planning Manager in
Germany. He served for eight years at Nike Italy and also served for three years at Nike Germany. He also served at EMEA Footwear as General Manager since 2000.
Mr. Caroti holds a BA in History and German from Middlebury College in 1984.
Stuart Jenkins: Senior VP of Innovation & Product Development
Mr. Stuart Jenkins serves as Senior Vice President of Innovation and Product Development at Deckers Outdoor Corp. Mr. Jenkins has over 20 years experience in
athletic and sporting goods technology marketing and licensing. Mr. Jenkins provides strong strategic planning and marketing skills. Mr. Jenkins has been
instrumental in getting several technologies to market from inception to multi-million dollars in sales in the sporting goods industry, including Energaire, lights for
children’s shoes, and graphite for athletic footwear. Mr. Jenkins served as President and Chief Executive Officer of SKYDEX Technologies, Inc. He served as Chief
Executive Officer of The Principia. Mr. Jenkins was the first person to successfully license the same footwear technology to both the high-end performance footwear
market and the lower tier market. He serves as board of directors of several private companies, including Energaire (shoe cushioning system), SOAP shoes, Botex
materials, and is on the Board of Trustees at his alma mater, Principia College.
John A. Kalinich: Senior VP of Omni-Channel Operations and E-Commerce
Mr. John A. Kalinich has been Senior Vice President of Omni-Channel Operations and E-Commerce - DTC of Deckers Outdoor Corp. since April 09, 2014. Mr.
Kalinich served as Director of Retail and Licensing of Deckers Outdoor Corporation since November 2002, and served as its Vice President of Consumer Direct from
November 2002 to April 09, 2014. Mr. Kalinich served as a Director of Deckers Outdoor Corporation since November 2002 to May 2004. He was previously an
employee of Deckers Outdoor Corporation’s former Teva Licensor, Teva Sport Sandals. He is responsible for the protection of Deckers Outdoor Corporation’s
worldwide intellectual property and the operation of the e-commerce web sites for Teva, Simple and Ugg. Prior to joining Deckers Outdoor Corporation, Mr.
Kalinich was the Chief Operations Officer for Teva Sport Sandals Inc., from January 1995 to November 2002. Previously, Mr. Kalinich was employed as an audit
Senior Associate by Coopers & Lybrand from July 1991 to January 1995. Mr. Kalinich is a Certified Public Accountant.
Wendy Yang: President of Teva Brand
Ms. Wendy Yang has been the President of Teva Brand at Deckers Outdoor Corp. since May 1, 2015. Ms. Yang joined Deckers from New Balance, where she served
as General Manager of Women's Training, Lifestyle, Walking since 2012. From 2009 to 2012, she held the position of General Manager of Wellness at New Balance.
Previous footwear experience includes senior leadership roles with Stride Rite Corporation, Timberland, Tommy Hilfiger Footwear, and Reebok. Ms. Yang earned a
Bachelor of Arts in Managerial Studies from Rice University and a Master of Business Administration from the Kellogg School of Management at Northwestern
University.
25 December 17, 2015
EXHIBIT 3
26 December 17, 2015
EXHIBIT 4
27 December 17, 2015
EXHIBITS 5-8
28 December 17, 2015
EXHIBITS 5-8
29 December 17, 2015
EXHIBIT 9
30 December 17, 2015
EXHIBIT 10
31 December 17, 2015
EXHIBIT 11
32 December 17, 2015
EXHIBIT 12 – INCOME STATEMENT FOR YEAR ENDED MARCH 31, 2015
33 December 17, 2015
EXHIBIT 13 – BALANCE SHEET AS OF MARCH 31, 2015
34 December 17, 2015
EXHIBIT 14 – STATEMENT OF CASH FLOWS FOR YEAR ENDED MARCH 31, 2015