Deck the Halls With Deckers

 | Dec 27, 2011 | 7:15 AM EST  | Comments
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I know I'm not supposed to give gifts after Christmas, but consider this stock idea your holiday bonus -- Deckers Outdoors (DECK). Yes, Deckers -- the makers of those ugly UGG boots that women love. (Why? Don't ask me.)

Now, understand that this pick is not without controversy. There are two schools of thought on the stock, and the first argues the mania has cooled. These folks say the boots aren't selling like they used to. They say warm weather and higher prices are contributing to the slowdown, and that retailers have wised up -- they are not stocking company's products for fear of being stuck with tons of furry boots they can't sell.

These investors argue Deckers will report a deceleration in the wholesale business, which would lead to serious multiple compression. This thesis has received the most investor attention, and it has pushed the stock down over the last few weeks.

The second school of thought says, "No way." The disappearance of Deckers inventory from stores during the holidays is intentional, say these bulls, and the company will report a huge blowout quarter. This school of thought argues the company is playing mind games with the girls. By limiting in-store inventory, Deckers is able to avoid sharp markdowns -- and, by making the product more difficult to find, the brand's exclusivity is enhanced.  This game is custom-made for women who love the thrill of the hunt (and don't mind paying full price).

In sum, bullish investors believe the company is carefully regulating inventory, and that the wholesale business isn't decelerating -- it's just being cleverly managed. In fact, these investors have monitored inventory across many retail outlets and report a consistent, deliberate drawdown in availability across the entire product line.

For some reason, in both cases, the analysts get to the same exact earnings-per-share number for the fiscal fourth quarter: $3.21. The optimistic investors believe the company will be able to overcome a 40% increase in the price of sheepskin (used to make the boots) and post-operating income of $182 million on $571 million in sales.

The pessimists, meanwhile, believe revenue will come in light, at $550 million to 560 million, and that Deckers will only manage to achieve operating income of $179 million. They also believe gross margins are about to take a hit and come in a 53.5%, while the optimists see a full percentage point higher at 54.5%. Last year, gross margin for the fourth quarter was 54.2%. 

Whatever the case, when fourth-quarter results are reported in February, investors will be carefully digesting the company's forward outlook. To me, the "controversy" over who is right and who is wrong isn't what is interesting. It's the direction, and it's the volatility. Right now, I have no idea if the bulls or bears are going to be right. I just know that Deckers will either be a $70 stock or a $125 stock. I would consider playing both sides. In a flat market, volatility -- in either direction -- would be a great Christmas bonus.

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