Summary
- The company struggled over the past 3 years as Covid-related issues hurt the profitability of the business.
- The relaxation of Covid restrictions in China will help volume and margin growth for its luxury product range.
- The company’s current valuation is in line with the second tier of global luxury goods businesses.
- The stock price is down a long way from its previous highs but there is significant upside potential should management deliver concrete evidence of progress toward its ambitious 5-year growth targets.
[Please note that all currency references are to Canadian dollar except if indicated otherwise.]
Canada Goose $28.61 (Toronto and Nasdaq symbol [[GOOS]]; Apparel and Accessories; Shares outstanding: 105.3 million; Market cap: $2.7 billion; www. Investor.canadagoose.com ) is a manufacturer and distributor of high-end outerwear and apparel. The company’s registered head office is in Ontario, Canada.
Canada Goose has a long history of entrepreneurial endeavors, which accelerated under the current CEO and with the involvement of the private equity firm Bain Capital. The past 3 years presented major challenges for the company as Covid lockdowns and disruptions played havoc with growth aspirations. However, with the re-opening of the Chinese market, the worst of the pandemic business disruptions is hopefully now in the past and the company can resume its growth path. The valuation is reasonable compared to its peers but there is significant upside potential if management starts to make progress toward its 5-year growth targets.
Entrepreneurial roots
The inception of the business dates back to 1957 when Sam Tick started a clothing manufacturing business in Canada under the name of Metro Sportswear. He was later joined by his son-in-law, David Reiss, the father of the current CEO, Dani Reiss.
After significant growth over the past two decades, the company’s products are now sold in 64 countries generating revenues of over $1 billion. The company generates its revenues globally with the largest revenue contributions from the U.S. (30%), Europe, the Middle East, Africa, and Latin America (24%), Asia Pacific (26%), and Canada (20%). Distribution takes place either directly to consumers through its retail stores and e-commerce platforms (67% of sales) while the wholesale channel brings in the balance. Canada Goose manufactures its products in company-owned or contracted facilities located mainly in Canada but also in the U.S. and Europe. Materials are sourced globally from 18 key suppliers and another 50 secondary suppliers. The primary drivers of operating expenses are the materials used in the manufacturing process, labor costs, and transport.
A large addressable market
Industry estimates indicate that the global sales of the top 100 luxury personal goods companies was $305 billion in 2021 reflecting 22% growth on a depressed 2020 and ahead of the 2019 record level. Industry sales are expected to grow between 6%-8% per year until 2025, in line with the pre-Covid growth rates.
The Americas and Asia (including China) each account for 31% of global personal luxury goods sales, Japan 7%, and Europe 25%.
Industry consultants identify the following as current macro trends in this industry:
- a shift to online purchases of luxury goods, which accelerated during the peak Covid period; this now makes up 22% of global luxury sales – almost double the 2019 level
- significant growth in purchases of luxury goods by younger buyers (born after 1980); this group is expected to make up 70% of luxury goods sales by 2025
- strong growth in the market for previously owned goods through web platforms such as Farfetch. The consultancy Bain & Company estimates that the second-hand market in luxury goods traded was 33 billion euro worth of goods in 2021 - 65% more than in 2017
- the large presence and considerable growth of Chinese and other Asian luxury goods shoppers – this group is estimated to grow to 38%-42% of the global market by 2025
- a growing trend of brands selling directly to customers rather than through wholesalers
- a move towards sustainable production and reducing the pressure on the environment.
The industry is dominated by the large companies
The luxury goods industry is dominated by large companies – in 2021 the top 10 were responsible for 56% of total sales and 85% of the total profits of the 100 companies.
Based on sales, Canada Goose was ranked number 61 in the Deloitte Global Powers of Luxury Report in 2020 but in the top 10 based on the growth in sales between 2018-21.
Here is a comparison of Canada Goose with some of the major listed luxury companies. The global luxury leaders indicated in the table, including LVMH (LVMHF), Hermes, Richemont (CFRHF), and Kering (PPRUF) are all very profitable. Still, Canada Goose is not far behind although the company’s performance has deteriorated in the recent past.
Growth – an aggressive five-year plan
Canada Goose has grown its revenue from $2 million to $1.1 billion since Mr. Dani Reiss became the CEO in 2001. That is 33% per year. Also, at the time of the IPO in 2017, the company provided a range of 3-year financial and operational projections, which were handsomely exceeded.
However, the last three financial years were challenging for the company as the Covid-related disruptions resulted in a decline in most measures of profitability (see the section below). We also note that forecasts made by management since mid-2019 were well below the actual results. Still, the Covid disruptions provide some cover for management’s below-par forecasting performance.
At its recent investor day, management laid out its growth plans for the next 5 years. Key objectives are to treble the revenues to $3 billion, double the EBIT margin to 30%, and grow the EBIT almost fivefold to $900 million.
To get from a $1.1 billion revenue to $3 billion, the company aims to grow significantly across all regions although China, Korea, and Japan stand out as markets where the company has large ambitions.
Management hopes to achieve these aggressive targets by capturing a larger part of the total addressable outerwear market . The company estimates that an increase in market penetration levels in key markets such as the U.S. and China to half of the Canadian market penetration level would increase product demand in fall and winter categories by three times.
Other aspects of the growth plan include the expansion and improvement in the e-commerce offering and a doubling of the retail outlets. The direct-to-consumer business is expected to grow to 80% of the total revenues by 2028, up from 67% in 2023. This focus on getting products directly to the end client through retail or e-commerce outlets should boost sales and profit margins.
There is also the intention to expand the product categories to include all-season apparel, footwear, and accessories. This could be particularly useful as Canada Goose currently makes most of its sales and profits in only six months of the year.
The doubling of the EBIT margin from the 2022 level seems particularly optimistic but has to be considered in the context of an EBIT margin that was already at 25% in 2019 before it dropped sharply over the peak Covid years. Management feels that direct-to-consumer expansion, improving store productivity, and operating leverage are key factors that will drive the improvement in margins.
The corporation is controlled by Bain Capital
In 2013, private equity firm Bain Capital acquired a controlling stake in Canada Goose valuing the business at $250 million. Canada Goose was listed on the Toronto and New York stock exchanges in March 2017.
As of June 2022, Bain held 60.5% of the multiple voting shares (that is 54.7% of the combined votes of all share classes and an economic interest of 29.3%). The Chairman of the Canada Goose board is Dani Reiss. He is also the CEO of the business and recently owned 39.5% of the multiple voting shares and a small percentage of the subordinate voting shares.
Balance sheet in good order and positive free cash flow
The company had shareholders' equity of $484 million by the end of 2022, total debt of $763 million, and cash of $344 million. About $400 million of the debt is a voluntary repayable term loan facility, which carries an interest rate of LIBOR plus 3.5% (currently 8.2%). Net debt to adjusted EBITDA totaled 1.6 times and the debt to capital ratio was 0.60.
Cash flow from operations amounted to $87 million over the 12 months to the end of 2022 while capital expenditure was $36 million leaving a free cash flow balance of $51 million. Free cash flow has consistently been positive over the past 5 years although the level varies significantly.
The company does not pay a dividend but occasionally buys its shares in the market – this amounted to $82 million over the past 12 months. Regulatory approval has been received to buy up to 5.4 million (approximately 10%) of the company’s subordinate voting shares over 12 months starting 22 November 2022.
Covid continues to impact the results
The profitability of the company has deteriorated significantly over the past 3 years as demonstrated in the table below. Profit margins have declined, cash flow generation is down and earnings per share has collapsed. It is no surprise that the share price is also down by almost 50% since the end of 2019. This compares to 3-year forecasts issued by management in mid-2019 when revenues, margins, and profits were expected to grow substantially over the forecast period.
The bad news continued in the 2023 financial year - in the first nine months (to the end of December 2022), revenues increased by 5.5% while operating income declined by 24.1% as expenses increased sharply. Diluted earnings per share declined by 23.4%.
During the first 9 months, sales increased in all regions except Asia Pacific where Covid related lockdowns affected sales. Costs related to the opening of new stores, investments in technology, higher staff costs, and additional marketing expenses pushed operating costs 19.6% higher and depressed operating profit margins.
For the full financial year to the end of March 2023, the management expects the company to generate sales of $1.19 billion, an EBIT margin of 14.7%, and diluted adjusted earnings per share of $0.97 per share (all midpoint estimates). This guidance was well below the estimates issued as recently as November 2022.
Fair valuation but with upside potential – if management can deliver
Given GOOS stock’s current price and consensus estimates for the next 12 months, the company is valued on a price-to-earnings ratio of 18.8 times, an EV/EBITDA ratio of 9.9 times, and a price-to-cash flow ratio of 8.4 times. This represents a discount to the average multiples of its main peers although the luxury majors command valuation premiums. The valuation ascribed to Canada Goose is closer to the second-tier average.
However, there are more options for valuation considerations: First, if management delivers results anywhere close to its 5-year forecasts, the share price has significant upside potential. Under this scenario where the revenues reach $3 billion by 2028 and the EBIT $900 million, the stock price could see a three-to-fourfold increase – and that is by keeping the valuation multiple unchanged from current levels.
Management’s forecasting credibility has taken a hit over the past 3 years as Covid related issues constantly resulted in targets being missed. So, most investors will want to see positive progress and delivery on these targets before the stock will gain traction.
Last, we also want to consider a potential acquisition of Canada Goose by one of the major luxury goods companies. The behemoths of the luxury goods world have significant geographical distribution reach, supply chain control, online presence, and pricing power. Canada Goose with its high-quality and unique products could fit in well with one of the industry leaders. The controlling shareholder, private equity firm Bain Capital, may also be a willing seller after having held on to the stock for a considerable time.
Bottom line …management must deliver
Canada Goose shareholders have suffered over the past 3 years, but the company management is holding out substantial growth potential over the next 5 years. Many investors will want to see delivery on these lofty promises.
By Deon Vernooy, CFA, for TSI Wealth Network
For further details see:
Canada Goose: Worth A Punt