Canada Goose: 70% Upside Over 3 Years

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About: Canada Goose Holdings (GOOS)
by: Tim Moore, CFA

Summary

Channel mix shift from wholesale to direct-to-consumer will improve operating margins by 600 bps over the next few years.

Very early stages of new store openings with only two stores now.

Website growth will also help margins.

Canada Goose (GOOS CN/GOOS, $23.70 CAD/$19.13 USD) 9/25/17

This is a designer, manufacturer, distributor, and retailer of premium luxury outerwear, hats, scarves, gloves, and knitwear. Its bestselling product is its ultra-down technical parkas for $800-1,200. It also sells coats, shells, and jackets. The company sells 100 styles of parkas/jackets in 37 countries. This month, it introduced knitwear (sweaters, vests, hoodies) for $300-500, which has initial good traction based on a few wholesale stores that I spoke with.

The company is based in Toronto and was founded in 1957 to cater to Canadian Rangers and arctic explorers. The company had only $5 million of revenues in 2001 but should exceed $500 million in March 2018. Bain took a stake in 2013 and rapidly increased its manufacturing and marketing capabilities. Management wisely focused on high-end stores (Saks, Bloomingdales, Nordstrom, Neiman Marcus) and protected distribution to prevent discounting.

IPO was in March at $17 CAD (range was $14-16). The stock price closed up 26% that day and briefly shot up to $33 CAD in early June after reporting an upbeat first set of results as a public company. The stock drifted down over the summer with other retailers, and I bought shares in my personal account three weeks ago. The $100 million of IPO proceeds were used for debt repayment and to fund new store openings and two manufacturing facilities in Canada.

In terms of pattern recognition, this reminded me of my analysis on Lululemon Athletica (NASDAQ:LULU) in 2007, which created a new space and carving out a niche for six years before being copied well enough by others. Canada Goose's brand has successfully evolved into a combination of cold weather protection/comfort and fashion. Similar to what Lululemon achieved with its high-quality fashionable yoga pants. Exclusive and not mainstream mass volume. Not just functionable fashion but also a status symbol aspect. Outer fashion with authenticity is a driver of Canada Goose's success. Premium outerwear is becoming a part of the wardrobe for consumers living in cold climates or who enjoy ski trips. Similar to how many men did not have a sports coat two decades ago, but most have at least one nowadays. Its target market is wide with anywhere from affluent college students to professionals in their 40s.

Its upscale product is not mainstream and only started getting attention in 2015. I also like how it is starting from a very low store count base of only two stores today and plans to open only four to five each year through 2020. This will help not dilute the brand too much but will cause margins to rise as the sales channel mix shifts away from wholesale to direct-to-consumer. This is quickly becoming a global brand and creating the luxury outwear category.

My wife is a retail buyer and also expects the adoption and penetration rate to continue for many years. We visited the upcoming location for its fourth store at the Prudential Center mall in Boston. It has a terrific spot near Under Armour (NYSE:UAA) and Lululemon. Lastly, this is not a fully loved stock. Barron's has published three negative articles on it in the past six months, and I like how a third of the sellside analysts do not have a buy rating yet.

Geographic Sales (June 2017): 38% Canada; 33% US; 29% Rest of World

Segment Sales: 72% Wholesale and 28% Direct-to-Consumer; 70% Heavyweight Parkas/Jackets and 30% Lightweight

Competitive Advantages

  • First-mover advantage in North America for luxury outerwear. It has a heritage of being a function-first parka or jacket, then fashion. It is trying to market itself as the Land Rover of clothing.
  • Its parkas are easily identified by their two-inch round patch on upper left sleeve. Some of the flagship parkas also have a fur trim hood, which prevents face frostbite and differentiates the product. These act as a symbol or a pseudo-bragging right or fashion statement like Swatch, Apple white cellphones, and Lululemon logos or bags did for many years. They also come in three different body fits (slim, regular, relaxed), which peers do not do.
  • Production is done in Canada. Not Asia. It has terrific quality control assurance teams in place (six sites). It has some production flexibility with the third-party sub-contractors (32 of them) for two-thirds of its output. Proudly made in Canada awareness. It believes its craftspeople set it apart drastically abroad.
  • It does not rely on expensive advertising or marketing events. Similar to Lululemon, it relies on word of mouth, brand ambassadors that travel around, and storytelling (coffee table book, feature films, celebrities placement).
  • Minimizes inventory risk and continues its supply scarcity model by keeping distribution limited at full prices.

Thesis and Catalysts

I believe its revenues can grow at an average +20% rate over the next four years. Wholesale growth might be only +8-10% growth, but its own retail stores and website will generate most of the overall growth.

  1. Penetration into this growing addressable market of luxury outwear. This category has been growing at +12% the past two years. Brand awareness is now above 25% in the Northeast US and 46% in New York and Boston. China is barely tapped and has large potential later.
  2. Store openings to be methodical and disciplined to avoid over-saturation. Its first retail store only opened in October 2016. Toronto and New York were the first stores. Management expects to open 4-5 new stores each year from a base of only two today. Boston, Chicago, Tokyo, London, and Calgary open this fall. More of the Midwest, Denver, and San Francisco are targeted for 2018. At a cost of $3-5m per store, the payback is expected to be 12-18 months for most stores. Toronto and New York achieved payback in less than 12 months. By not being aggressive in store openings, there will not be a drain on the working capital or financial structure. Five stores will cost $20-25m, and I forecast that the company can generate $60-70m operating cash flow in each of the next two years. Management seems prudent on not saturating the brand and continues to state that it wants only 20 stores in 2020. It seems obsessed about not letting CapEx get beyond 6-8% of sales. While it has not disclosed yet its sales expectation per new store, I estimate it could average $5-6 million. $7-8m for its initial eight openings at the most brand aware and population density cities.
  3. Under-appreciation by investors and sell-side about the power potential of the brand. The company just launched knitwear this month, which does not seem to be in sell-side estimates. There could be a halo effect from this pulling in mid-tier customers to get hooked on the brand with a $400-500 item and then upgrade to a $900 parka next year. Furthermore, the company started to notice a lot of repeat customers in the past two years. Instead of buying one $1,000 parka and keeping it as your solo one for many years, some customers are coming back the following season to add either a different weight jacket or the latest style or a different color. This is not noticed by investors yet and should help sales growth. Lastly, its innovation team is rolling out products for more than just winter. It is tapping into fall and spring in the new order book being mailed out this quarter. Fleeces could be a new launch in two years, and the recent knitwear launch should do well.
  4. Margin improvement from a sales channel mix shift as more retail stores are opened and its website sales grow. Gross margins for direct-to-consumer (retail stores and online) are twice that of wholesalers (Saks Fifth Avenue, Bloomingdales, Neiman Marcus, Barneys, Intermix, and high-end sporting goods shops). 75% versus 35-40%. While rent expense dampens retail store margins, the EBITDA contribution is still much higher than at wholesale. Every 5 pts of sales mix shift from wholesale to direct-to-consumer is 150 bps of operating margin expansion.
  5. One-third of total production is done in its own Canadian plants, which should become half done in-house during 2018 from its newer Quebec and Ontario facilities. In-sourcing should help gross margins improve.
  6. Management believes it can take 5-10% more pricing on its parkas collection as it adds features and benefits.
  7. E-commerce is only 13% of sales ($48m or so recently), but it began only two years ago in the US and Canada. UK and European e-commerce only began in 2016. It could go from reaching four countries now with websites to 15 in 2019. E-commerce is its highest margin channel despite free shipping (75% margin) and should grow 25%, which will help margins.
  8. Lease-adjusted ROIC could reach 25% in 2021.
  9. Interest expense could decline from $14 million to nothing by 2021. That would be a $0.10 EPS lift.
  10. Most retailers are not posting SSS growth and will be challenged going forward. Investors might flock to Canada Goose as the rare growth story and pay up for on a multiple for it to get the exposure.

Company IPO Prospectus March 2017

Earnings Power and Valuation at $24 CAD/$19 USD

  • $1.40 EPS and $225m EBITDA for calendarized 2021 might be possible if it successfully opens 4-5 stores annually.
  • If achieved, the stock would be 17x P/E 2021 and 12x EV/EBITDA 2021. PEG appears to be 1.0x.
  • 30% average annual EPS growth over the next four years could occur. From $0.40 to $1.40.
  • Revenues could reach $850m for calendarized 2021 with $140m of the $340m growth coming from new stores.
  • EBITDA margin could reach 26% compared to 18% for March 2017. Driven by the channel shift to higher margin stores and less wholesale mix, website contribution and SG&A scale savings.
  • Valuation is very expensive and sticker-shock on the next 24 months, but reasonable after that for its prospects.

Peers

Moncler (OTCPK:MONRF) and Yves Salomon (mostly fur) are the most similar peers selling $500-2,400 parkas/puffers. Burberry (OTCPK:BURBY) has only a couple items and is not competing. North Face, Patagonia, and L.L.Bean are lower-end substitutes ($200-300).

Moncler (MONC IM; €24.97, €6.4b) trades at 26x 2017 P/E and 23x 2018. 16x EV/EBITDA 2017 and 14x 2018.

Compared to GOOS at 37x calendarized 2018 P/E and 22x calendarized 2018 EV/EBITDA.

Moncler is growing sales at +14% in 2017 versus Canada Goose at +26%. Moncler EBITDA margin is 34% and slightly contracting versus Canada Goose at 20% March 2018, but expanding.

Key Risks and Concerns

  • If not enough full assortment or planning in place for new store openings that are October/November loaded.
  • Highly seasonal business with 100% of profits and 80% of revenues from its September and December quarters.
  • A warm winter or low snowfall would dampen sales. Past two winters were mild or a late start, but neither had a material effect on revenues. Inventory is slow turning, though, at 220 days (1.7x the retail apparel average).
  • Fad risk or over-saturation risk if too many celebrities or neighbors or friends start showcasing the parkas.
  • Canada sales to slow to only +10-12% sales growth due to maturing market, but easily offset by other countries.
  • If North Face, Patagonia, L.L.Bean or others successfully copy the down parkas.
  • Fashion risk is less of a concern because of its customer emphasis on functionality and how the company does not launch bold colors or do one to two-year color trends chasing. 50% of sales are from its top 10 SKUs.
  • Recession risk would impact this stock. A minor recession might be possible in 2018, but not severe. I think the high-end customers would continue to buy, but maybe sales growth decelerates by 5-8%.
  • PETA and animal rights activists. This has been an ongoing issue for four years, but has not stalled the company. Down is sourced from a byproduct of the poultry industry and not from live-plucked or force-fed birds.
  • Its largest single customers are 20% of Canada's sales and 21% of US sales, but these are sustainable retailers and will naturally decrease as percentage of sales as retail stores are opened and the website grows.
  • Foreign currency can add noise, but should be less of a concern as sales are less dependent on Canada and become more dependent on the US and Europe.
  • Bain Capital divesting its 70% stake over the next three to four years.
  • Net Debt/EBITDA is 2.0x March 2018 forecasts, but should decrease as free cash flow occurs. Its revolver requires a fixed charge coverage of 1.0x.

Management Overview

CEO (Dani Reiss) has been in that role since 2001 and worked in most other roles in the four years prior to that.

CFO (John Black) has been in that role for four years and seems sensible. He was at Trimark Sportswear prior.

SVP of Wholesale (Pat Sherlock) been in role for five years and was national sales manager at New Balance Canada.

SVP of E-commerce & Stores (Scott Cameron): joined one year ago and was a partner at McKinsey prior for retail.

BUY. This is one of the few publicly listed retailers that has structural tailwinds and is likely to generate like-for-like sales growth well above 5% for the next several years. While it is an expensive stock near-term, EPS could become $1.40. Upside could be +70% to $41 CAD. Downside could be -30% to $17 CAD if it mis-executes on store openings, has a bad winter, or a mild recession occurs. In terms of weather, it is not as dependent on cold or snowy winters like ski resorts are. A warm winter in the US and Europe could cause a temporary multiple compression.

Disclosure: I am/we are long GOOS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I purchased shares between $17.50-$19.40 for the US ticker (GOOS).