Are Uggs the new Crocs?

Deckers Outdoor has been soaring. But with Ugg boots making up 87% of sales, could changing consumer tastes wipe out shares?

By InvestorPlace Apr 5, 2010 11:51AM

crocs crox deckers outdoor deck stockOutdoor clothing and footwear manufacturer Deckers Outdoor (DECK) has been a standout among beleaguered retail stocks. Shares are up nearly 250% since the March 2009 lows with no sign of slowing down.

 

The secret to Deckers’ success are trendy and durable Ugg brand boots that account for 87% of the company’s revenue -- and consequently, the company’s rapidly growing bottom line. But is this over-reliance on a footwear fad risky for the company? The 2007 collapse of Crocs (CROX) showed all too well that when it comes to cashing in on fashion, tastes change overnight.

So are Uggs the new Crocs? And if they are, is that such a bad thing?

 

There’s no denying the power of the Uggs brand when it comes to sales. After a strong fourth-quarter earnings report, shares of DECK jumped 35% in between Feb. 24 and March 24 alone. Investors’ reason for enthusiasm was obvious -- in the fourth quarter, Deckers’ profit climbed 29% and sales grew 15% from a year earlier. It was the 12th consecutive quarter that earnings topped Wall Street expectations.

But that’s eerily reminiscent of the surge before the slide that we saw in CROX shares. In 2007 after a blowout earnings report in May, Crocs jumped 20% in one day alone. That was part of a rapid race to the top, where the footwear company climbed from $20 at the start of the year to $70 in late 2007.

 

Then the bottom fell out, and CROX plummeted to a mere $1 a share in early 2009.

 

The two companies have more in common than just the movement in share prices. Both are small-cap apparel companies. Crocs currently has a market cap of about $700 million, though at its peak it was probably closer to Deckers’ current market size of $1.8 billion. Also, both are heavily reliant on fashion trends. These companies are not selling a service or a product that does something. They are simply selling a look -- something far less tangible than chip speed in a laptop or cable television subscribers. That means projections are slippery.

So if DECK and CROX are so alike, how can Deckers Outdoor avoid Crocs’ fate? Well, the key is to manage growth plans. The fundamental problem with Crocs was that the company banked on the eternal popularity of what was essentially a fad, and ramped up production too fast right before consumer tastes changed. This pitfall is not unique to fashion companies -- Krispy Kreme (KKD) grew too fast at a time that carbs were becoming the enemy of dieters everywhere. Another poster child of growing too fast is Starbucks (SBUX), which  recently announced plans to actually close 300 stores and lay off 7,000 employees after trying place a store on nearly every corner in America during its boom times.

No investor wants a company that isn’t growing, but investing in a stock that’s growing beyond its realistic reach is also a recipe for disaster. For now, the growth in Ugg sales is impressive -- but it’s unrealistic for investors to expect 20% sales growth every quarter for eternity. Anyone who expects a record like that in this retail environment just isn’t paying attention to consumer spending habits.

 

The most important lesson to be learned from Crocs isn’t its fall in 2008, but the long road to recovery the company has faced since. Crocs is struggling to even turn a profit, and shares have traded between $6 and $8 since August 2009. The company posted a loss of 13 cents a share in its Q4 report, though CROX significantly raised its guidance and actually expects to break even when it offers up Q1 numbers. But if Crocs is in the red again, the company will be awfully close to folding altogether.

 

DECK investors obviously are enjoying the ride right now. But with Uggs accounting for almost 90% of the company’s sales, investors need to realize that fortunes can change quickly if the brand falls out of favor with consumers.

 

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