Yeti: Holding Out For A Rebound

About: Yeti Holdings (YETI)
by: Gary Alexander

Shares of Yeti have slumped approximately 20% after releasing Q3 results, the company's first time reporting earnings since going public in October at $18 per share.

After rising briefly in November while other stocks were sinking, Yeti shares are now down relative to the IPO price.

Revenue growth appears to have slowed down materially to 7% y/y this quarter, but the timing of inventory dispositions colored these results.

Overall, remain focused on the company's expansion to both new geographic areas as well as new demographics. In particular, Yeti has been gaining traction with women.

Yeti Holdings (YETI) suffered a massive shock after reporting third-quarter results, the company's first time reporting earnings since going public in October. The perception of weak revenue growth - thanks to the discontinuation of a popular line of coolers in the prior-year compare - threw off investors who were hoping for much more. Immediately after posting the results, Yeti shares sank to $16 (-25%), and though it's recovered somewhat since, the stock has now given up all of its post-IPO gains and remains well below the IPO price.

Chart YETI data by YCharts

I've been bullish on Yeti since its IPO. I've compared this stock to Canada Goose (GOOS) - a fast-growing brand that's popular with millennials and has tremendous success in selling, to be completely honest, overpriced products. Like Canada Goose, Yeti Holdings is a well-covered brand across social media channels and has a young, "mass affluent" demographic of customers that are relatively price-insensitive. Yeti customers seem to not bat an eye at dropping hundreds (sometimes thousands) of dollars on its heavy-duty coolers.

The company has also done a good job at extending its brand into tertiary products. Drinkwares now make up a substantial portion of its revenues, and Yeti remains poised to continue taking market share away from existing outdoor brands.

In my view, we shouldn't let a single quarter's results distract us from the longer-term thesis, especially when the prior-year compare is so ambiguous. With shares of Yeti now back down to buyable levels, let's review the bullish thesis for this stock.

Why Q3 earnings weren't that terrible

Investors had a knee-jerk reaction to Yeti's first earnings release. The first time a company reports earnings is an important milestone that often dictates near-term trading momentum, and Yeti certainly failed this test - but the reality of its situation is actually a lot better than appearances.

Here's a look at the quarterly results below:

Figure 1. Yeti 3Q18 results

Source: Yeti earnings release

The key point here: revenues grew just 7% y/y to $196.1 million. This is a huge disappointment because when Yeti filed for its IPO, its first-half FY18 revenues showed a 34% y/y growth rate. A quick glance suggests that this company may have dolled up its financials for the IPO, while pulling demand in from future quarters.

This wasn't exactly the case, however. Here is CFO Paul Carbone's explanation of the revenue trends, taken from the Q3 earnings call transcript:

While 7% is lower than our long-term guidance, this was due to a one-time bulk sale last year during the third quarter as we transitioned into our second generation of soft coolers. Given our desire to get this new innovation associated with the second generation coolers into the market as soon as possible, we decided to clear through our first generation product, which was actually purchased back in 2016. In the future, we do not expect to see the same level of excess prior gen inventory when we launch new products as we have revamped our demand planning and inventory management processes."

It would have been fantastic to see how much of last year's revenues were derived from this "one-time bulk sale," but regardless, the clear takeaway is that the product timeline colored this quarter's results. It's worth noting as well that for the most part, this revenue "deceleration" was expected. Yeti's revenues came in just a hair over Wall Street's consensus revenue estimates of $196.0 million.

Note also that direct-to-consumer revenues jumped 23% y/y. Direct revenues strip out the noise related to last year's bulk dispositions, so this is a better gauge of end-customer demand for Yeti's products. The company's direct channel sales mix is now also up to 34%, up from just 8% in 2015, highlighting its growing popularity and recognition as a consumer brand.

Equally important to recognize is the fact that Yeti still managed to grow operating income by 14% y/y to $28.1 million, representing a 14.3% operating margin, up 80bps from 13.5% in the year-ago quarter. The company's pro forma EPS of $0.24 also showed a 14% upside surprise against Wall Street's consensus of $0.21.

Focus on future growth drivers

Q3 is over and done, so let's focus on what can drive the company's business going forward. There are a couple of important factors that can propel Yeti in FY19 and beyond.

First and foremost is its logical extension into drinkware. Note that these aren't your typical plastic products - here's an example of a Yeti bottle that's "on sale" at $40:

Figure 2. Yeti Rambler bottle

Source: Company website

CEO Matt Reintjes also noted that "slightly more than 50%" of Yeti's sales are now derived from drinkware products. As the company begins to innovate further into outdoor accessories to support its flagship line of coolers, it can continue to generate tremendous sales growth.

The second piece of the company's growth story is an expansion of its target market, both geographically and demographically. Yeti has traditionally been a strong player in what it calls its "heritage markets" of Texas, the Gulf Coast and Florida, but now, the lion's share of revenues comes from new markets where the brand is just ramping up. Reintjes' commented on the Q3 earnings call, saying:

Today, more than 50% of our consumer demand is generated in our newer, non-heritage markets. We believe we still have a large, untapped opportunity in our heritage and our non-heritage markets for our current portfolio and new product innovation."

This aggressive geographical expansion includes international markets as well. The company launched in Japan over the past quarter and noted "strong growth" in two markets launched last year: Canada and Australia. The majority of Europe and Asia are still untapped markets, and Yeti has a large opportunity to tap into young, affluent customers there.

Another important market extension is its growing popularity with women. The company reported that 34% of its sales are now deriving from women, up from just 8% in 2015. Yeti has frequently been associated as a masculine brand (its coolers are popular with fraternities), so its heightened appeal with women presents another large growth opportunity.

Shoring up the balance sheet

We also want to highlight the fact that Yeti is taking steps to deleverage its balance sheet and grow its tremendous cash flow potential. In the nine months through October 2018, it has generated $105.5 million of free cash flow ($118.8 million of operating cash flows less $13.3 million of capex), representing a respectable 20% FCF margin. Additionally, the company has multiplied its FCF relative to the prior year's nine-month FCF of $30.6 million.

Figure 3. Yeti free cash flows

Source: Yeti earnings release

Yeti has also noted that it's using a portion of its IPO proceeds to retire a $50 million term loan. At present, it has $387.8 million of net on its balance sheet. Its perception as a leveraged company has at times dampened enthusiasm for this stock, but with the company planning to de-leverage, it will be able to reduce its interest payments and drive further EPS growth.

Key takeaways

In my view, the long-term bullish thesis for Yeti remains unchanged, so the chance to purchase the stock at a ~20% discount from recent peaks is compelling. It is an immensely popular brand that still has plenty of untapped markets, both domestic and international, in which to grow. The strong growth in direct-channel revenues is a reflection of Yeti's growing reputation as a pop-culture brand, and the high prices on its product afford the company a high gross margin and the potential to dramatically expand its earnings base.

Despite the pessimism on Yeti, stay long on this stock.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in YETI over the next 72 hours. 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.