Susquehanna Financial Group on Monday lowered its rating on Deckers Outdoor to “negative” due to ongoing challenges at the Ugg flagship brand and doubts that a turnaround plan from activist investor, Marcato Capital Management, will pay off.

“Marcato’s plan to drive shareholder value at DECK is either overly optimistic or completely unrealistic,” wrote Susquehanna analyst Sam Poser in a note. “We lean towards the latter.”

Poser also believes the likelihood that a sale of “either all or some of DECK’s brands occurs is low, particularly at Marcato’s valuation levels.”

On October 5, Marcato Capital, which owns about 6 percent of Deckers’ shares, filed a plan with the Securities & Exchange Commission as part of its proxy seeking to replace all 10 Deckers Outdoors’ directors with its own slate. The annual meeting will take place on December 14, 2017.

The plan calls for increasing Deckers EPS from $3.82 in FY17 to $12.68 by FY 2021 through the sale of non-core Ugg brands, store rationalization, additional cost-reduction initiatives, and aggressive stock buybacks

Poser believes Ugg’s brand will “need to be much smaller” to achieve the target margins in Marcato’s plan. He said Ugg brand “is weaker today: as compared to FY12, when Deckers last posted EBIT of approximately 19 percent. Total Ugg revenue in FY12 was $1.2 billion while Marcato is assuming FY19 Ugg revenue of $1.5 billion. Poser said potential strategic buyers of Ugg have told Susquehanna that the “optimum annual revenue” of Ugg  was closer to $1billion and he likewise agrees that Ugg will have to shrink to improve profitability.

Said Poser, “We believe that investors should be wary of the assumptions within Marcato’s plan, and, at the same time be wary of the ability of DECK’s current management to impact positive change.”

He noted that Ugg has been most successful as an “accessible luxury brand” but the brand’s expansion into moderate channels has hurt its luxury positioning and “will hurt sales and margins over time.”

The move to moderate channels was due to a “lack of innovation and compelling product” that led to lower sales and then the search for other growth avenues.

Opening up distribution to Macy’s and Amazon in particular has “caused a mutiny of sorts” from better retailers such as Nordstrom, Dillard’s and Zappos, who are all planning their business with Ugg down. Presenting risks to Ugg margins is the tendency by Macy’s to quickly turn promotional if sales underperform while Amazon doesn’t honor MAP policies. He adds, “If recent history is any indication, DECK is likely to continue to chase sales and increase distribution at moderate retailers.”

Another risk for Ugg is a predicted warm winter.

Regarding the sales value of Teva, Sanuk, and Hoka, Poser writes that the valuations in the Marcato plan are “rich, and unrealistic in our view,” and that the brands “would have already been sold” at those prices.

He also believes that for Sanuk and Teva, the share of DECK’s corporate overhead were not properly reflected in the valuation that Marcato assigned.

Hoka’s valuation is based on two-time’s this year’s sales. Poser said that while retail checks show the brand is gaining traction, there’s some oversupply in the marketplace. Poser wrote, “Despite the fact that we believe that Hoka makes very compelling running shoes, DECK may be pushing too much inventory into the marketplace in order to drive short term results.”

Susquehanna lowered its rating on the stock from Neutral to Negative, reducing its price target from $57 to $55. The stock closed Monday at$64.65, down, $1.18, on the New York Stock Exchange. Its EPS estimates was maintained at $3.91 in FY18 and $4.33 in FY19.

Poser concluded, “We again believe that whether or not Marcato gets its slate elected and installed as DECK’s Board of Directors, the likelihood of selling assets, and improving the position and improving Ugg sales and margins are limited at best.”

Photo courtesy Ugg