Can UGG and HOKA Continue To Propel Decker's?

Today's Green Screen stock review focuses on yet another consumer goods name that most, if not all, of you are familiar with. You might not recognize the company name: Decker's Outdoor (DECK). But I bet you recognize at least one of its two primary brands: UGG and HOKA.

Decker's has defied the odds for 2 decades in becoming one of those rare mainstream fashion names that has been able to maintain its brand advantages and deliver excellent returns to investors at the same time. When you consider some once-hot footwear and apparel brands that have fallen hard over that period - names like Reebok or Under Armour - that's a pretty impressive thing to do.

But is this stock worthy of a "green dot" and a spot on our Watch List? Let's find out.

The Business

One thing I like about consumer brand stocks is that they are very easy to understand. Decker's mainly sells premium priced footwear under the UGG, HOKA, Teva, Sanuk, and Koolaburra brand names. For the purposes of simplification, investors really only need to consider the UGG and HOKA brands, which account for over 93% of sales and are management's focus (Koolaburra is an extension of UGG priced under $100).

Most folks own a pair or at least have seen and heard of UGGs. These are primarily cold-weather, comfort-based sheepskin footwear, known especially for the low-rise boot style (although UGG offers many styles for sale). The brand has a history of celebrity supporters including Oprah Winfrey, Paris Hilton, Beyonce, and Tom Brady, just to name a few.

Decker's was built on the UGG brand, and even today it accounts for 53% of total sales.

Decker's other major brand, and the one that has propelled its stock over the last 2-3 years, is HOKA. HOKA is more of a traditional performance footwear brand, with its hallmark being maximum cushioning combined with minimal weight. It is especially popular with runners, with HOKA models consistently rating highly on running websites. Decker's has seized on this popularity to extend the brand line into trail running, hiking, general fitness, and even lifestyle use cases.

HOKA accounted for 39% of company sales in 2023, and is by far the fastest growing brand in the portfolio (more on this later).

Decker's sells its products through both wholesale and direct-to-consumer (DTC). The wholesaling business accounts for 66% (2/3rds) of total sales, with wide distribution at retail outlets such as Foot Locker, Amazon, Zappos, REI, Dick's Sporting Goods, Nordstrom, and many others. The DTC channel is 34% of sales and consists of direct sales to consumers through Decker's various websites (notably UGG.com and HOKA.com) and company-owned stores.

Decker's is a global company, with sales to over 80 countries worldwide. International sales outside the U.S. accounted for 32% of total revenue in 2023.

Growth Potential

Decker's has a 3 year compound annual revenue growth rate of over 19% - pretty impressive when you consider UGG's heyday was about 15 years ago!

The story recently has been the explosive growth of the HOKA brand. Acquired in 2012 for peanuts ($1.1 million), Decker's has grown the brand from $3 million in sales to over $1.4 billion in 2023. That was an incredible 53% increase over 2022! More recent quarters are seeing moderated but still strong 20%+ year-over-year growth from HOKA.

Running shoes are a relatively large market at $15 billion and growing about 4% annually. The bigger play is in athletic footwear at large, which is a huge $127 billion market worldwide. There is a boatload of competition in this space, however, which limits how much market share any single company can realistically grab. We have to be careful extrapolating recent results for HOKA, because brands rise and fall in this space frequently.

HOKA will be the primary driver of growth here. UGG at this point can safely be considered a stalwart brand, but it isn't a rapidly growing one anymore. UGG sales were down about 3% in 2023, and have only produced about a 6% CAGR in sales since 2015.

I feel a 5% expectation for UGG going forward is reasonable given long-term trends. HOKA still has momentum at present - I believe it can generate a 20%+ growth rate for fiscal (March) 2024, after which I think Decker's will face more challenges maintaining 10%+ growth in the brand. Even decades-old, established footwear brands like New Balance are "only" doing $5 billion in annual revenue. Given this, it seems reasonable to assume 10-12% sales growth for Decker's over the next few years, followed by more muted 7-9% growth after that.

I do think there is some additional profitability upside as Decker's shifts more of its sales to higher-margin direct-to-consumer channels. These grew 21% in 2023, vs. 12% growth in the wholesale channel.

Finally, I don't consider footwear to be recurring revenue. Sure, shoes wear out and we have to buy new pairs, but there is little guarantee that a "new pair" is going to come from the same company. Specialty footwear like UGGs can last for years. There is nothing structural that keeps customers paying month after month or year after year.

Is There A Moat?

We've said it many times, but the primary source of economic moats in the consumer goods space are strong BRANDS.

Brand moats are characterized by two factors: the ability to sell similar products at higher price points than competitors, and/or eliminating search costs for consumers by becoming the "default brand" in any given category.

With Deckers, there is kind of a "split decision".

It is reasonable to argue that the UGG brand has carved out a narrow brand moat for itself. It has maintained significant popularity over a 20+ year period, not easy to do in fashion. It created its own category, and while a lot of competition has entered the space (Sorel, Columbia, even Sketchers just to name a few), UGG is still the "default choice" for low-cut, sheepskin-based, fur lined, cold weather, low rise boots. A pretty specific category, to be sure, but still a category killer. I don't see this advantage going away any time soon. This is a staple brand.

HOKA, on the other hand, hasn't earned any kind of brand moat - yet. Despite explosive growth recently, this is a brand that was barely known just 5 years ago. A number of similar running-focused brands come to mind - Saucony, Brooks, ASICS - as well as the cushioned lightweight competition from the big boys like Nike, Adidas, and New Balance. Running shoes have a history of faddish booms and busts (Nike Flyknit? Adidas Boost?). I'd have to see sustained strength from HOKA for a lot longer than 18 months before considering any kind of brand moat for it.

Management and Finances

Decker's is led by CEO Dave Powers, who has been at the helm since 2016, and with the company since 2012. He has a background in the footwear industry, earlier working his way up to leadership positions at Nike and Timberland.

There isn't much to complain about under Powers' leadership. Under his watch, the company has nurtured HOKA from nothing into one of the top up-and-coming running shoe brands in the world. He has also done a good job of protecting and even growing the stalwart UGG brand.

Decker's excellent management also shows up in its financial metrics. The firm is entirely debt-free. It generates free cash margins averaging about 14%, an excellent mark in a space where 10% is more the norm. Cash returns on invested capital have averaged over 40%, which is just remarkable. Goodwill and intangibles are minimal - Deckers is a firm that has relied on organic growth. The company has bought back over 2% of shares annually since 2018, and currently has a huge $1.3 billion buyback authorization (almost 10% of market cap). It is little surprise, then, that the stock has outperformed the market by 4x and the peer apparel space by an incredible 10x since 2018.

Not much else to say here - this is unquestionably an extremely well run and financially healthy company.

Risks

Decker's would fall on the "medium-high" spectrum for risk. The primary risk is simply fashion risk around the HOKA brand. Is it a fad that will quickly run out of growth steam? Or is it the next big running brand? We've seen both happen in the past with other brands. That uncertainty is the single biggest risk with an investment in the stock.

Compounding that risk is the tremendous amount of competent competition, particularly around HOKA. There are other running-focused brands, stalwart multi-national full-line athletic sportswear giants, and even specialty shops. That's a lot of options for consumers to consider, making it critical to execute design, operations, and marketing effectively to stay ahead. That's a tall order over the long-term.

Conclusion

Decker's has been an expertly run company throughout most of its history. Not surprisingly, it has also been an excellent investment. However, despite this success, management acumen is never a long-term competitive advantage. There are a number of business aspects that concern me with a potential investment in Deckers. There are no reliably recurring revenues, the brand moat around HOKA (the main growth engine) is uncertain, how big HOKA can actually get is unclear, etc. That makes it difficult to make assumptions with any degree of confidence.

If I was to take a shot at a valuation, I'd assume about 10% annual growth, a 14% free cash margin, a 2.5% annual share buyback, and a somewhat high 11.5% discount rate. That gives me a fair value at $542, which represents about 10% upside form current stock prices. If you like Decker's, or are a big fan of UGG or HOKA, you could do a lot worse than this. However, it doesn't quite make the cut as a "Green Dot" stock.