2023-05-09 05:17:55 ET
Summary
- Canada Goose Holdings Inc. is a company that designs, produces, and sells luxury performance apparel worldwide.
- Revenue has declined by 3% in the LTM period, which is a reflection of a weak few years for the business.
- Margins have declined since FY17-FY20, with the company investing in reinvigorating growth.
- We are not sold on the execution of Management's strategy.
- GOOS's valuation does not imply upside.
Investment thesis
Our current investment thesis is:
- Canada Goose produces fantastic outerwear, but its other clothing is less compelling.
- The company is a victim of its own success, with growth driven by hype rather than function or design superiority.
- Growth has slowed and margins have declined.
- A 20x EBITDA multiple implies better prospects.
Company description
Canada Goose Holdings Inc. ( GOOS ) is a company that designs, produces, and sells luxury performance apparel for different age groups worldwide.
The company operates through three segments: Direct-to-Consumer, Wholesale, and Other. Its product line includes parkas, jackets, rainwear, knitwear, footwear, and accessories for fall, winter, and spring seasons.
Share price
GOOS's share price has had a wild ride. Initially, we observe substantial gains, driven by improving interest in the brand but as with all things based on changing consumer tastes, we saw this come crashing down as sentiment changed.
Financial analysis
Presented above is GOOS's financial performance for the last decade.
Revenue
GOOS has achieved an impressive revenue growth rate, with a CAGR of 20%. This is well above its IPO forecasts and what many had predicted, driven by an explosion in popularity for the brand.
Management's current strategy is to:
- Accelerate consumer-focused growth
- Build its DTC network
- Create new and expand existing categories, rapidly.
Our view is that these are the correct next steps for the business in the coming years, although execution risk continues to be prevalent. We will breakdown the company's current commercial profile now, touching on these factors overarchingly.
One of the key factors driving the rise of GOOS is the development of its brand. Consumers are willing to pay a premium for products from well-established brands, who are known for their quality. This is especially the case for the segment that GOOS targets, where production quality is key to its utility. This has contributed to the consistency of growth, but a large improvement has come from social media. Canada Goose Jackets are highly fashionable, with many young people sporting the brand. This has developed through celebrities wearing the products and cultures embracing the brand. This is less about utility and more about style; it might rain regularly in London but it's not cold enough that all rappers require a Canada Goose Parka. The concern here is that consumer trends change and fashion adapts. For every Burberry ( BURBY ) Trench coat or Barbour Jacket, which have been popular for decades, there are hundreds of outwear apparel that history has forgotten. We cannot predict the future but GOOS is of a size that this continues to be a risk.
The luxury apparel industry has become increasingly global, with demand shifting away from its traditional core markets in North America and Europe to Asia. China is now the largest retail market in the world, with ravenous demand for Western products. GOOS has targeted the region as a growth area, now representing the second-largest contributor to revenue.
The athleisure trend, where athletic apparel is worn for non-sporting activities, has been growing in popularity in recent years. Consumers are seeking versatile clothing which can be used in a range of activities without looking out of place. GOOS is positioned perfectly for this, as although its products are made specifically to be weather-durable, they are also stylish and can be worn in a range of settings. Although anecdotal, it feels like the majority of the bankers and PE individuals I know own either a Canada Goose Gillet or Parka.
The acceleration of growth in the brand has been driven by a change in consumer interests and industry dynamics, supported by effective marketing by Management. Having seen the rise of the brand in real-time, it is difficult to say what is attributable to Management and what was driven by the culture of fashion. Our view is that the execution of (1) above is likely dependent on (3), as their current offering alone is too reliant on the hype around the brand.
Management's eagerness to develop its DTC offering further is due to the superior economics it comes with. Retailers take a cut of earnings when selling products, and have greater control over discounting. Moving this demand in-house allows GOOS to increase revenue and margins. This does not come for free, however, as it requires building the infrastructure necessary to support the DTC. E-commerce is an easier avenue, as it requires marketing spend alone. However, GOOS will also need to increase its physical footprint, which will involve investment in physical locations. We like the former, but not the latter, although accept that this is required.
What is working in GOOS's favor here is that the company's demand is sticky. A large number of customers are repeat purchases and those who do spend significantly more. This is a testament to what are clearly high quality products at a compelling price point. These consumers will be quick to transfer across to DTC if given half a reason.
Finally comes the third block in GOOS's strategy, and by far the most important. The expansion of its existing categories. Although the Canada Goose brand has exploded, consumers are primarily buying coats, those being heavyweight and lightweight downs. This is an issue as the products are highly cyclical, which reduces earnings potential, and leaves the business susceptible to a change in trends (as we have already touched on). Therefore, product diversification is imperative to the long-term health of the business.
GOOS has created a range of traditional clothing products in a similar vein to its outwear. Further, GOOS is targeting both women and Gen Z, building on its hype to enter the most lucrative segments of the luxury industry.
Regarding the clothing, we do not buy it. Having looked through what they have to offer, the products are generic and boring, with the impression that quality was chosen over design. This is where outerwear differs from clothing. Outerwear is function over fashion (even if the hype is driven by fashion), whereas clothing is the opposite. Luxury fashion houses are judged on their designs, with quality expected as a minimum.
Targeting women and Gen Z is a logical decision on paper, why would you not enter the market with the largest TAM. The problem is that these segments are also the most competitive and demand the most differentiation from the brands operating within them. Our view is that GOOS offers a compelling outerwear product, which should sell well, but we are less positive beyond this.
Overall, we are disappointed with the strategic direction of (3). The products do not look compelling and will make targeting the women's segment more difficult. Although my opinions are just that, if you filter for Bestsellers on the Canada Goose website (as of the time of writing), what you will see is that all 32 products are outerwear.
Economic considerations
Current economic conditions pose a risk for GOOS. Consumers are experiencing a tightening of finances as inflationary pressures and heightened rates contribute to a rise in living costs. This deters discretionary spending, which could lead to reduced demand for its products.
Margin
GOOS has seen margin dilution since FY18-FY20, with EBITDA-M declining from c.26% to 15%, and is potentially falling further.
Inflation is partially the reason for this, although GPM has continued to increase on the back of scale benefits.
The reason in our view is the rapid increase in S&A expenses, which is now 56% of revenue compared to 36% in FY19. This is likely a strategic decision by Management to support growth, which has weakened in the last 4 years. Note, this is in large part due to Covid-19. However, the FY20 results (Mar20 y/e) saw the lowest level of growth in the period we have covered, which indicates the problem pre-dates the pandemic.
With demand declining in the LTM period, we suspect margins will tick down further in the coming year.
Q3 results
GOOS experienced a decline in revenue during the last quarter, at a time when luxury houses such as LVMHF are posting continued double-digit growth.
Management state shipments are a potential driver of this but if peers are still growing, we would expect far better than a decline.
China has been disrupted following the end of its zero-covid policy, which could mean a boost in Q4 as demand improves following the end of the pandemic.
Balance sheet
GOOS is conservatively financed, with a ND/EBITDA ratio of 1.8x. This gives the company funding flexibility should it choose to engage in M&A or organic growth.
Valuation
GOOS is currently trading at 20x EBITDA and 43x earnings. Our view is that earnings will decline in the full-year given the Q3 weakness, which pushes these multiples up.
At 20-30x, our expectation would be for the business to generate low double-digit growth, alongside good margins. GOOS currently has neither. Investors could buy LVMH and get both for 20x. Should growth return, we would suggest the business would be close to fair value at 20x, as margins can be improved at a later date.
Key risks with our thesis
The risks to our current thesis are:
- Demand from China could drive a short-term rally in the share price as the company gives the perception it is outperforming.
- Product development improves or hype is strong enough to allow for non-outerwear to grow.
Final thoughts
GOOS creates some fantastic products and we are a fan of their outerwear. The issue is that its products beyond this do not offer anything unique, and the data suggests consumers see this. Further, this is a hype brand, being worn more for the style than function, which creates uncertainty as to sustainability.
GOOS's valuation multiple has declined in recent years as investor sentiment changes. At 20x, this might look attractive compared to historical trading but is still overvalued on an absolute basis. The return to sustainable double-digit growth is not certain and margin dilution looks possible.
Although Management's strategy is correct, we do not buy the execution.
For further details see:
Canada Goose: Growth Strategy Looks Questionable