ATZAF - Aritzia: Undervalued Retail Fashion Powerhouse

2023-03-07 04:39:48 ET

Summary

• Exclusive brands build client loyalty.
• A vertically integrated supply chain reduces costs and ensures high quality.
• Relatively cheaper compared to peers.
• Inventory concern is mounting.

You may have noticed that Aritzia (ATZ:CA) boutique stores have been steadily showing up in your or your significant other's favourite shopping destinations with fashionable interior design. Aritzia boutique stores seem to be drawing traffic from both fast fashion go-to places such as Zara and H&M or luxury go-to places like Nordstrom (JWN).

You are correct. Established in 1984, Aritzia quietly went from 1 store only in Vancouver to 113 stores as of November 2022 both in Canada and the United States. Aritzia expanded into the U.S. since 2008. Aritzia has grown into a global fashion powerhouse with annual revenue north of $600 million and market capitalization of over $4.5 billion.

So, who is Aritzia? Aritzia is a vertically integrated design house with a global platform and an extensive portfolio of exclusive brands for every function and individual aesthetic known as Everyday Luxury. Aritzia sells mainly women clothing, but that is about to change.

What are some of the strategies that have helped Aritzia come this far?

Exclusive brands

95% of Aritzia's net revenue comes from its exclusive brands. Below is a snapshot of Aritzia's exclusive brands.

Aritzia curated a portfolio of brands to provide high-quality products that meet different needs from its clients. For example, Wilfred features creative design while Babaton gives a modern feel and TNA provides an innately cool feeling. This branding strategy has several advantages such as:

1. Clients can't buy products from these brands anywhere else, which creates loyalty toward these brands and Aritzia itself;
2. As its clients grow in age, they can always find a brand that fit their style, which helps maintain that client loyalty;
3. Having a diversified portfolio of brands, Aritzia doesn't depend on a single brand/category/style to succeed.

Vertical integration

Aritzia fully controls its supply chain from design, sourcing of raw materials, selection of manufacturers, operation of distribution centers, marketing, operation of boutique stores. This strategy serves several advantages such as:

1. Aritzia can quickly analyze sales data and latest trend to provide feedback for design to stay on top of the fashion trend; Aritzia's boutique stores always carry proven sellers with new seasonal items to create excitement;
2. Aritzia's integrated control of supply chain provides it with flexibility and agility. For example, from the selection process of manufacturers, flexibility is critical for Aritzia. As such, Aritzia always has a handful of manufacturers from various countries that can be flexible in purchase order size. For any new seasonal item, Aritzia can order a small quantity to launch in select boutique stores to assess demand. Within days/weeks, Aritzia can gather sales data and submit a larger purchase order with its manufacturers to maximum the potential revenue from this new item.
3. By controlling the source of raw materials, Aritzia not only maintains its high standard in quality, Aritzia also reduces its costs by removing the mark-up on raw materials from manufacturers and leveraging volume discount through Aritzia network;
4. Aritzia has 3 distribution centers in North America with 2 in Canada and 1 in the United States. Aritzia is about to open another distribution center (552,300 square feet) in Vaughan, Ontario, which is about to be the largest distribution center for Aritzia to date, which help achieve further economics of scale;
5. Aritzia is very selective in boutique store location. In its history, Aritzia has never closed a store. From time to time, before opening a permanent store, Aritzia may open a pop-up store to assess viability before converting it into a permanent store;
6. Aritzia's boutique stores also act as eCommerce distribution centers that help boost eCommerce sales. Clients can check inventory for any item at any of Aritzia's boutique stores and decide whether to pick up at that store in person or have that store ship the product.

With its vertical integration, Aritzia has created a virtuous flying wheel. Its aspirational boutique stores, high-quality products, exclusive brands and personalized service attract new clients. New clients love the experience and the products and become an influencer (Aritzia also engages directly with influencers to introduce new items and create excitement) to attract more new clients. With higher revenue and profits, Aritzia invests back to provide more variety of products, more boutique stores, and better services.

With this profitable supply chain, it is only a matter of time until Aritzia brings men's clothing into its portfolio. At the end of the day, when the girlfriend/wife/daughter/mothers are shopping at Aritzia, it wouldn't be a surprise that they pick up some men's wear for their significant others.

In June 2021, Aritzia acquired 75% of CYC Design Corporation ("CYC"), a leading designer and manufacturer of premium athletic wear, Reigning Champ, to accelerate Aritzia's expansion into men's wear.

In 2022, Aritzia announced its 2027 strategic plan featuring levers:

• Geographic expansion
• eCommerce acceleration
• Increased brand awareness

Aritzia already is doing a fantastic job in these 3 areas laid out above. Through 2027, it is great to see that Aritzia plans to stay focused on that it does best.

Key Performance Metrics

Aritzia is still growing at a rapid pace. Net revenue in Q3 2023 grew 37.8% from Q3 2022 to $624.6 million.

As part of total net revenue, eCommerce revenue grew 36.1% from Q3 2022 to $201.4 million.

Total net revenue and eCommerce revenue growth can be driven by simply opening new boutique stores. However, one can also see that comparable net revenue growth % is also impressive. Q3 2023's comparable net revenue grew by 22.8%. This means that Aritzia's revenue would still grow organically by 22.8% if no new boutique store is opened or no existing store is expanded or renovated.

Aritzia's revenue contributed from the United States has grown significantly as well. From first entry into the United States in 2008, in recent quarters, the revenue from the U.S. made up about 50% of Aritzia's total revenue.

Valuation Compared to Other Notable Retailors

Lululemon and Canada Goose are notable Canada based retailors. How does Aritzia look in terms of valuation compared to its peers?

To simplify the comparison, I am just going to use the data from the 4 most recent quarters and use the market capitalization as of March 4, 2023 .

One can see that these three companies' net income % is relatively similar when not removing any extraordinary items that may have taken place in the specific quarters.

Aritzia is growing at a relatively higher rate compared to Lululemon and Canada Goose. However, Aritzia has a relatively cheaper valuation compared to Lululemon and Canada Goose.

In addition, in January 2022, Aritzia's management has implemented a share repurchase plan to repurchase and cancel up to 3,732,725 shares representing about 3.2% of weighted average number of shares outstanding on a fully diluted basis. Implementing a share repurchase plan typically means that management views its shares as undervalued.

Risk and Concern

Although Aritzia looks like a solid business that is growing at a rapid pace with a relatively cheap valuation, I want to point out several concerns.

On Nov 30, 2022, Founder and Executive Chairman of Aritzia, Brian Hill, sold 1,500,000 shares at $51.6 per shares lowering ownership to 18.5%. Such sale sends a conflicting signal to investors that the Founder and Executive Chairman is selling stake in the business while Aritzia is buying back shares. In addition, given that this is a secondary offering meaning that the 1,500,000 shares were sold from Brian Hill to other investors and that Aritzia didn't receive any proceeds, I am not quite sure why Aritzia would pay $0.5 million of expenses for this secondary offering.

In recent quarters, Aritzia has built up its inventory more than usual. As shown below, the number of days that it takes Aritzia to move its inventory has increased from 81.4 days in Q2 2022 to 123.9 days in Q3 2023. This may be due to over-estimation on sales velocity in certain categories. In fashion business, inventory can become obsolete quickly.

Aritzia's network may be able to absorb the excess inventory without any significant inventory write-off. We will need to observe the coming quarters closely.

Conclusion

Aritzia stands as a solid fashion business with a virtuous flying wheel built on its fully integrated supply chain. It is valued relatively cheaper compared to other well-known names such as Lululemon and Canada Goose. The payment by Aritzia for a secondary offering is questionable and inventory built-up is fairly concerning if not addressed in the coming quarters.

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