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Deckers Upgraded to Neutral

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We recently upgraded our recommendation on Deckers Outdoor Corporation (DECK - Free Report) to Neutral with a price target of $36.00, following its third-quarter 2012 bottom-line performance. Earlier, we had an Underperform rating on the stock.

Deckers’ quarterly earnings of $1.18 per share came ahead of the Zacks Consensus Estimate of $1.02 per share. However, it declined 25.8% year over year due to muted top-line performance but fared better than the projected decline of 31% in the bottom line due to effective cost management coupled with the share repurchase program.

Total net sales of $376.4 million fell short of the Zacks Consensus Estimate of $412 million, and declined 9.2% from the prior-year quarter, as the price hiked to mitigate an 80% rise in sheepskin and raw material costs boomeranged. Warm weather condition also had an adverse impact on the demand of UGG brand with the ongoing European crisis playing spoil sport. The company had earlier forecasted top-line growth of 1%.

To counter this, Deckers decided to make retrospective adjustment in prices of selected Classic styles that were shipped since July 1, 2012. Moreover, in order to safeguard against rising sheepskin costs and other raw materials, Deckers has undertaken certain long-term programs, which includes increasing the mix of non-sheepskin merchandises, new casual footwear materials less prone to weather, and innovative production technologies.

The company is eyeing other profitable markets, and remains focused on product introductions, store augmentation, along with geographic expansion. Management intends to focus on China, where the company has increased its store count to 20 by opening 7 new stores during the quarter. In the year-ago quarter, Deckers had 8 outlets.

Deckers has been grappling with inflated inventories and sluggish demand on account of increase in prices. Consequently, amidst waning demand for its UGG product lines, the company trimmed its fourth quarter and fiscal 2012 outlook.

Management now projects total revenue growth of 5% for fiscal 2012, down from the prior guidance of a 14% increase. Earnings per share are expected to decline 33% compared with a 9% to 10% decrease forecasted earlier. The company now foresees a 6% jump in total revenue and a 14% decrease in earnings per share for the fourth quarter. Earlier, management had guided growth of 19% in total revenue and a 22% jump in earnings per share.

Despite a dismal outlook, the stock suggests enough upside potential as it trades at a discount to its peers based on our forward earnings estimates. Deckers currently trades at a forward P/E of 9.17x, reflecting a 43.8% discount to the peer group average of 16.32x.

Consequently, given the pros and cons, we adopt a Neutral stance on the stock. However, Deckers, which competes with Nike Inc. (NKE - Free Report) and Wolverine World Wide Inc. (WWW - Free Report) , holds a Zacks #5 Rank that translates into a short-term Strong Sell rating, and defines the company’s sluggish top-line performance and trimmed outlook.

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