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).


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.


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


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


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.


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


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.


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.


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


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.


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%.


Exhibits


EXHIBIT 1

(Source: October 29, 2015 DECK Investor Presentation)


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.


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.


EXHIBIT 3


EXHIBIT 4


EXHIBITS 5-8


EXHIBITS 5-8


EXHIBIT 9


EXHIBIT 10


EXHIBIT 11


EXHIBIT 12 – INCOME STATEMENT FOR YEAR ENDED MARCH 31, 2015


EXHIBIT 13 – BALANCE SHEET AS OF MARCH 31, 2015


EXHIBIT 14 – STATEMENT OF CASH FLOWS FOR YEAR ENDED MARCH 31, 2015

FINAL - Deckers Brands - Final Term Project

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