DECKERS BRANDS
We start with Deckers Brands, which designs, markets and distributes footwear, apparel and accessories, and owns the UGG and Hoka footwear brands, among others. Both these key brands have seen excellent growth in customer awareness and enthusiasm over the past few years, but what has caught our eye is Deckers’ dramatic near-sevenfold increase in earnings over the past decade. While we view UGG as a mature brand, Hoka is young and has wide scope to grow share in a huge market. Management has a history of beating both its own guidance and market estimates.
What we also like about Deckers is the simplicity of the business. The group ticks a number of quality metrics, with high returns on equity, high margins, no debt, excellent conversion of accounting profit into cash, and a tax rate that makes sense.
Unfortunately, the share price has already baked in the quality and simplicity of this business, as evidenced by the 28 times forward price-earnings (P/E) multiple. While such a valuation is almost justifiable, it doesn’t take into account that fashion can be fickle, and the consequent risk to long-term estimates. While great money can be made in this space, it can also be lost, as evidenced by Under Armour, which went up 15 times from 2010 to 2015 but has since fallen over 85%.
ARISTA NETWORKS
A business in a very different industry, but with an even more impressive growth history, is Arista Networks, which provides cloud networking solutions for data centres, mostly through switching and routing products, with a small services component.
Arista has grown its earnings per share by 35 times over the past decade thanks to data centre expansion, with a kicker in recent years from the growth of artificial intelligence (AI). The venture capital industry likes businesses that satisfy the ‘rule of 40’, where the expected revenue growth plus the earnings before interest, taxes, depreciation and amortisation (EBITDA) margin in the next two to three years delivers a number greater than 40. Arista makes a mockery of this, with revenue growth in the high teens and mid-40s margins for a combined score of around 60. This business has one of the best conversion rates of revenue to free cash flow we’ve ever seen, at ~37%.
Again, unfortunately the price already reflects the growth expectations for this business via a 40 times forward P/E multiple, while our valuation points to a multiple of 30 to 34 times being more appropriate.
DEERE & CO
The third business we’ve had on our radar is agricultural equipment maker Deere & Company. While many will be under the impression that Deere is just a tractor company, the reality is that this business has evolved as farming has become increasingly scientific. Deere’s precision agriculture offering includes products such as near-self-driving tractors, variable-rate seed and fertiliser application, and telematics for irrigation management, which all help large-scale farmers improve productivity.
Unlike the case with most manufacturing businesses, we see China as far less of a threat to Deere’s business given the very different agricultural practices in that country compared to the US. Chinese farms are typically a small fraction of the size of those in Deere’s primary North American market and are thus far less mechanised.
This tech focus has helped drive the company’s 11% annualised earnings growth over the past two decades and has driven the return on equity from averaging below 20% in the late 1990s and early 2000s to a new, sustainable level of more than 30%.
We see Deere & Co as a top-quality business within the cyclical space, which means there are bound to be opportunities to buy its shares at attractive prices in future, even if we don’t think we’re currently at that point.
The above three businesses provide a small window into the broader universe of companies we assess and then either consider or reject for our client portfolios in our ongoing search to populate the portfolios with the best businesses at attractive prices.
