Zumiez: A Reasonable Valuation, But Tough Comps Ahead

Summary

• Zumiez released its Q3 results in December, reporting revenue of $289.5 million, a 7% increase year-over-year and a 10% increase on a two-year basis.
• The strong results were driven by more stores being opened and a more normal back-to-school season, and margins benefited from occupancy leverage and higher profit margins.
• However, with Zumiez lapping government stimulus, a surge in demand from last year's re-opening, and an elevated proportion of full-priced selling in retail, it has tough comps ahead in Q1.
• While I believe some of these risks are priced into the stock at ~11x FY2022 earnings estimates, I don't see enough of a margin of safety to buy the stock here above $48.30.

Aksonov/E+ via Getty Images

It was an outstanding year in 2021 for the Retail Sector (XRT), with the index up 40% for the year, easily outperforming the S&P-500. Two of the stronger performers in the small-cap space were Zumiez (NASDAQ:ZUMZ) and Tilly's (TLYS), which were up 30% and 97%, respectively. However, while Zumiez is on track to post strong growth in annual EPS in FY2021, the company is up against difficult comps in FY2022, and it's possible we'll see some mean reversion to less full-priced selling across the retail space. While I believe some of these risks are priced into the stock at ~11x FY2022 earnings estimates, I don't see enough of a margin of safety to buy the stock here above $48.30.

(Source: Company Website)

Zumiez released its Q3 results in December, reporting revenue of $289.5 million, a 7% increase year-over-year and a 10% increase on a two-year basis. This was helped by a higher store count, fewer store closures (99% operating hours in the period), and full-priced selling due to pent-up demand and a more normal back-to-school season. Combined with meaningful margin expansion in the period, Zumiez's quarterly earnings per share soared to $1.25, with year-to-date EPS already at record levels ($3.22). Let's take a closer look at the results below:

(Source: Company Website)

For those unfamiliar, Zumiez is a small-cap retailer with over 700 stores globally, with most of its store base in the United States. The company sells apparel, footwear, skateboards, skateboard/snowboard-related accessories, and other accessories (hats, backpacks, belts, watches, jewelry). The company had an impressive 2020, with annual EPS soaring more than 13% vs. pre-COVID-19 levels, and FY2021 is expected to be another solid year helped by increased operating hours, single-digit store growth, and improved margins.

(Source: Company Filings, Author's Chart)

As shown in the chart above, Zumiez has seen meaningful sales growth vs. pre-COVID-19 levels, evidenced by revenue coming in at $289.5 million in Q3, up from $264 million in Q3 2019. This was despite slight headwinds on a two-year basis due to only 99% operating hours vs. full operating hours before the pandemic. Zumiez noted that the strong sales performance was helped by the men's category and footwear &accessories, offset by a decline in hard goods sales, which isn't surprising given that there was a surge in demand to keep busy during the lockdowns.

(Source: Austria COVID-19 Cases, Worldometers.info)

Looking ahead to Q4, the momentum appears to be keeping up, with sales up 8.6% in the first month of Q4 vs. 2019 levels. This is despite a temporary headwind related to store closures in Austria, with the country going into a full lockdown due to surging COVID-19 cases in November. With the emergence of the new Omicron variant, the country has extended lockdowns for the unvaccinated until January 10th, and this affects more than 20% of Zumiez's store base in Europe.

Fortunately, while Austria is remained partially locked down, Australia has ruled out lockdowns for the time being despite a surge in cases related to Omicron, which is partially balancing the traffic headwinds in Austria. As it stands, Australia and Europe make up roughly ~11% of Zumiez's store base, so while the Austria lockdowns certainly won't help Q4 sales, but they won't cripple them either. The good news is that despite the difficult environment, Zumiez is confident it is gaining market share in Australia and Europe.

Moving over to inventory and staffing, Zumiez shared that it is content with its inventory position heading into the holidays, which is encouraging given the supply chain headwinds globally. Meanwhile, the company also noted that it believes it's more adept than many competitors relative to labor, helped by the fact that it has a loyal customer base and it essentially hires its customers. So, this shouldn't have been a headwind in the holiday season unless there ends up being a significant increase in team member exclusions related to positive COVID-19 cases and or COVID-19 exposure to those that have tested positive.

So, was there any negative news?

In the case of Zumiez, the only real negative was that FY2021 has been so strong, helped by a much less promotional environment for retailers sector-wide. This was partially related to re-opening demand with consumers anxious to refresh their wardrobes and tightness in some inventory, which helped with an increased level of full-priced selling. This boost in product margins and occupancy leverage helped Zumiez report a nearly 400 basis point increase in gross margins (Q3 2021: 39.6%).

However, this has created tough comps year-over-year in Q1 and the last month of fiscal Q4. This is because Zumiez is now coming up against the benefit of government stimulus and a surge in demand due to the wardrobe refresh. It's unclear how this will play out, but it could lead to a slightly more promotional environment, as well as a slight dip in demand. So, while Zumiez is set to report a significant increase in annual EPS this year, with estimates sitting at $4.92 (FY2020: $3.00), we will likely see some giveback in FY2022.

(Source: YCharts.com, Author's Chart)

Looking at Zumiez's earnings trend above, we can see that the stock has seen steady growth in annual earnings per share since FY2014, with annual EPS increasing from $1.73 to estimates of $4.92 FY2021. This translates to a compound annual EPS growth rate of ~16%, a very respectable figure. However, with the potential for a medium-term peak in annual EPS in FY2021, we will see some deceleration in this annual EPS growth rate, which will slide to ~11.5% in FY2023, assuming Zumiez isn't able to beat estimates of $4.59. This may explain why the stock is trading at a discount to its historical multiple currently. Let's take a look at the valuation below:

Valuation & Technical Picture

As shown in the chart below, Zumiez has traded at ~16.6x earnings since and has traded at closer to ~13x earnings over the past few years. However, the best time to buy Zumiez has been below 10x earnings, evidenced by the troughs in Q4 2018, Q2 2019, and Q3 2020. Based on this historical low-risk buy zone, and FY2022 estimates of $4.42, the ideal place to buy the stock would be closer to ~$40.00, or near 9x FY2022 earnings estimates. As it stands, Zumiez trades at nearly 11x FY2022 earnings estimates at a share price of $48.30.

I believe it's best to be conservative and not pay the historical multiple because when we see peak earnings, we often see some multiple compression short-term until there's a clear sight to a new high in annual EPS. This appears to be the case for Zumiez when comparing the FY2021 results to FY2022 and FY2023 estimates. So, Zumiez looks very reasonably valued at a 15% plus discount to its more recent average earnings multiple (13 PE); the risk is that we see some compression in this earnings multiple next year.

(Source: FASTGraphs.com)

Moving to Zumiez's technical picture, we can see that the stock has strong support at 39.70, but it's run into strong selling pressure over the past six months in the $51.00 - $52.00 region. Based on a current share price of $48.30, this translates to $8.60 in downside to support and $3.70 in upside to resistance. This translates to a reward/risk ratio of 0.43 to 1.0, or closer to 0.37 to 1.0 if we use the mid-point of the $51.00 - $52.00 resistance area. Generally, I prefer at least a 4 to 1 reward/risk ratio when it comes to small-cap stocks, and Zumiez doesn't even come close to meeting this criterion currently.

This doesn't mean that the stock can't go higher, given that even overvalued stocks are seeing a relentless bid under them in the ebullient market environment we're in currently. However, I do not see this as a low-risk buy point from a trading standpoint, even if the valuation is reasonable. The silver lining, though, is that the $39.00 - $40.00 level should provide rock-solid support, with Zumiez opportunistically buying back a significant amount of shares, with ~2.2 million shares repurchased in Q3 alone (over 8% of float) at a share price of $41.00.

(Source: TC2000.com)

(Source: Multpl.com, Author's Chart)

Zumiez has had a very solid year, but with tough comps ahead, it's more difficult to argue for paying ~11x next year's earnings. Some of the worries about the possibility of peak earnings in FY2021 appear to be priced into the stock, with Zumiez trading at 11x FY2022 earnings estimates. Having said that, with Zumiez in the upper portion of its trading range against a general market backdrop that is higher-risk, I don't see any way to justify paying above $48.00 for the stock. This is because the S&P-500 currently trades at 3.25x price-to-sales, a figure that is nearly 25% above Dotcom Bubble levels (2.65).

To summarize, I think Zumiez is a name to keep a close eye on for a bottoming setup if we see it return to the $40.00 level. However, I think there are currently more attractive bets elsewhere in the market. One name that looks more attractive is SSR Mining (SSRM), with ~35% operating margins and trading at 9.5x FY2022 earnings estimates with an improving earnings trend. Another name that looks very attractive is Kinross Gold (KGC), trading at 7x FY2023 annual EPS and also sporting 35%+ operating margins.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of GLD either through stock ownership, options, or other derivatives. 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.

Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.