Deckers Outdoor (DECK): Excessive Investor Optimism Can Trigger A Selloff As Growth Slows

Introduction & Investment Thesis

Deckers Outdoor (NYSE:DECK) is a casual lifestyle and performance-driven footwear, apparel, and accessories company that operates across its five proprietary brands that include UGG, HOKA, Teva, Sanuk, and Koolaburra. The company has massively outperformed the S&P 500 and Nasdaq 100 YTD. I initiated a “hold” rating on the stock on April 14th, and my thesis was predicated on my belief that although Deckers Outdoor has a long-term growth story given its culture of product innovation and building memorable brand moments and experiences to engage its users, its valuation did not provide any upside. Since the time of my writing, the stock has climbed 31%, outperforming the S&P 500, which is up just 4%.

The company reported its Q4 FY24 earnings, where revenue and earnings grew 18% and 42% YoY, respectively, for the whole year. This was driven by strength in both its HOKA and UGG brands, where it continued to drive product innovation across targeted consumer segments while successfully acquiring and retaining its customers through unique brand moments, leading to exceptional levels of full-price selling.

For FY25, the company is expected to grow at a slower rate of 10% YoY to $4.7B, while its operating margins are expected to contract to 19.5% as it expects margin pressures from lower full-price selling and higher freight costs.

Although the company has operated exceptionally well in an uncertain macroeconomic environment thus far, I believe that the stock price has likely reached peak investor optimism given the projected growth rate of its revenue and earnings in FY25 and beyond, making it prone to a sizable pullback should investor sentiment turn lower as consumer spending deteriorates from its current levels, affecting the company’s top and bottom lines. Assessing both the “good” and the “bad,” I believe that there is more downside than upside at current levels, and therefore I will rate it a “sell” at the moment.

The good: Strong revenue growth in HOKA and UGG led by expanding DTC Sales, robust product innovation coupled with margin expansion from full-price selling.

Deckers Outdoor reported its Q4 FY24 earnings where revenue grew 18% YoY to $4.3B for the full year, driven by continued success of its HOKA and UGG brands that grew 27.9% and 16.1% YoY, respectively, contributing 94.3% of total revenue for the full year, as the company continues to win and retain consumers through a robust and innovative productive pipeline while expanding its Direct to Consumer (“DTC”) channel and advancing market share in its international markets through targeted investments.

Starting with its HOKA brand, revenue grew 27.9% YoY, driven by an increase in brand awareness, coupled with a 40% YoY increase in DTC sales channel and gaining market share with key global wholesale partners as it continues to build innovative updates and introductions across its diverse assortment of broad and niche footwear. In terms of its success with driving brand awareness, HOKA’s growth is strongest among the 18- to 34-year-olds, which comprises Gen Z and the millennial generation, who, I believe, are experiencing an increase in purchasing power as they enter the workforce or progress in their careers by earning higher salaries. I believe this is benefiting HOKA as it builds on its product pipeline by releasing Mach 6, which has become a top five style across all Deckers since its launch, as well as Skyward X, which is designed for everyday runs, among other upgrades, thus allowing the company to invest in customer segmentation efforts to capture incremental market share in the US and internationally. At the same time, the company is also driving brand affinity among its target audience by creating key marketing moments and experiences such as the FLY HUMAN FLY marketing campaign, as well as sponsoring globally recognized and local running events such as UTMB and building community activities like the HOKA Run Club, which, I believe, is successfully engaging their users, resulting in full price selling and a higher number of repeat orders.

In terms of sales channels, the company saw a larger shift of its HOKA sales coming from DTC channels YoY up from 34% in FY23 to 37% in FY24, which was driven by strength in both customer acquisition and retention that grew 32% and 44% YoY, respectively, indicating the success of the brand in driving deeper adoption through its go-to-market strategy and product innovation. For example, it recently opened its second European retail store in Paris, which the management believes will play a key role in driving traffic during the Summer Olympics.

Turning our attention to its UGG segment, revenue grew 16% YoY to $2.2B, driven by an expansion in its DTC channel to account for 50% of all UGG revenue, compared to 47% in the previous year, coupled with expansion in its international markets, where it successfully developed on-brand content and collaborated with local and international artists, influencers, retailers, and others to deepen consumer connections. Meanwhile, the UGG product team continues to drive product innovation in their franchises, such as its Golden Collection which includes its GoldenGlow Sandal and GoldenGlow Clogs, as well as developing new products in the slip-on shoe and sneaker category, which includes Lowmel and Venture Daze, which continue to sell out as soon as new inventory comes into the marketplace, thus showcasing the strong brand affinity that UGG can continue to capitalize on over the coming years.

Shifting gears to profitability, the company saw its gross margins improve 556 basis points to 55.6%, which was driven by full-price selling across both its HOKA and UGG brands given strong brand affinity in the US and international markets, growing momentum in the DTC channel, and superior inventory management, along with freight savings. Meanwhile, the company generated $927.5M in operating income on a GAAP basis, which grew 42% YoY with a margin of 21.6%. While SG&A expenses as a percentage of revenue slightly grew on a YoY basis to support key functions within the organization, including higher performance compensation, marketing spend, and strategic spend to build awareness of HOKA in international markets, the company still managed to expand its profitability from the improvement in its gross margins.

The bad: Revenue expected to slow down in FY25, especially in the UGG brand, coupled with softer margins.

Although Deckers Outdoor has navigated an uncertain macroeconomic environment very well, where it has been able to grow its revenue and expand its margins, its FY25 guidance points to a slowdown in revenue growth across its HOKA and UGG brands. For the full year FY25, the management is projecting to grow 10% to $4.7B, slower than the 18.2% growth it experienced in FY24. Even though HOKA will continue to be the main growth driver, the management expects its growth rate to slow to 20% YoY, while UGG is expected to grow in the mid-single digits, compared to the 16.1% growth rate in FY24.

Although the management is bullish on expanding sales through its DTC channel as well as in international markets, as it continues to acquire customers and drive adoption of its products through innovative brand moments and robust product innovation, the slowdown in revenue growth estimates, particularly in its UGG brand segment, could be a reflection of weakening of customer spending, especially in the US, where interest rates continue to remain higher for longer, thus increasing customers’ dependency on credit cards and “buy now, pay later” providers to fund their purchases. Meanwhile, as per the latest labor report, job openings continue to decline down 3.5% MoM and 18.6% YoY, indicating that the labor market may further weaken, which will put downward pressure on wages and hurt consumer discretionary spending.

At the same time, the management has also guided for gross margins to decline 210 basis points YoY to 53.5% as it expects lower full-price selling than FY24 levels coupled with higher freight costs, along with operating margins that are also expected to decline slightly to 19.5%, with SG&A cost anchored at 34% of total expected revenue. Although the management continues to demonstrate their financial discipline, the nature of the business requires it to continue spending in its marketing efforts to acquire and engage users in order to capture market share. Therefore, should we see broader macroeconomic pressures, it will dampen average transaction values per customer, forcing the company to mark down their products, which will inherently hurt margins at the same time.

Revisiting my valuation: Downgrading to a “Sell”

Assuming that Deckers Outdoor achieves its FY25 revenue target of $4.7B and then continues to grow at the same rate in FY26 followed a slowdown in the high single-digit range in FY27, as it continues to drive product innovation across customer segments and drive customer acquisition and retention through targeted brand campaigns while expanding internationally at the same time, it should be able to produce at least $5.58B of revenue.

In terms of profitability, assuming that the company is able to expand its margins from the projected 19.5% in FY25 to 22% in FY27, as it gets better at managing its marketplace and inventory levels, while expanding its DTC channel to drive full-price selling and benefiting from higher sales and transaction volumes from new and existing customers, it should be able to generate $1.2B in operating income. This will be equivalent to a present value of $1.01B when discounted at 10%.

Taking the S&P 500 as a proxy, where its companies grow their earnings on average by 8% over a 10-year period with a price-to-earnings ratio of 15-18, I believe that Deckers Outdoor should trade at 1.25x the multiple given the growth rate of its earnings. This will translate to a PE ratio of 22 or a price target of $864, which represents a downside of 20%.

Currently, the stock is trading at a forward PE ratio of 35 based on its FY25 earnings expectation, which is significantly higher than the multiple of S&P 500 at close to 22, while some of its competitors, such as Crocs (NASDAQ:CROX), NIKE (NYSE:NKE), and Skechers (NYSE:SKX), are trading at significantly lower PE ratios. One of the reasons for the elevated level of investor optimism could be tied to the company’s record of beating its earnings guidance over the last four quarters on average by 40%. Although strong past performance does not guarantee future outperformance of similar magnitudes, it can certainly shape short-term investor sentiment in bidding up the price of the stock, which I believe is the case with Deckers Outdoor stock.

I believe that the management will likely not be able to deliver such magnitudes of earnings surprises moving forward in FY25, especially as consumer health comes under pressure from weakening labor markets, depleted pandemic-related savings, and record credit card debt. Given that its near-term PE ratio is elevated, I believe it is more vulnerable to a price correction should there be any shift in investor sentiment or a pullback in the broader index. As a result, I believe that in the near term, the stock has more downside compared to upside, making it a “sell” at its current levels.

Conclusion

Although Deckers Outdoor has done an exceptional job so far in driving growth in its HOKA and UGG brands by leveraging its robust product portfolio and marketing efforts to acquire and retain customers by growing its DTC channel, while expanding internationally, as it continued to benefit from full-price selling through superior marketplace and inventory management, I believe there is excessive investor optimism baked into the company’s valuation. I believe in the short term, investor sentiment is prone to turn negative as consumer spending deteriorates, putting pressure on Deckers Outdoor’s top and bottom lines. This will likely lead to the company performing at expectations, as opposed to the large-scale earnings surprises it delivered in the last four quarters, making it a “sell” at the moment.