2023-04-20 05:53:57 ET
Summary
- NAPA has shown impressive resilience in revenue despite challenging market conditions.
- Management has increased FY23 guidance, but it still relies heavily on 4Q23 performance, which is a risk.
- I am concerned about the effects of the ensuing "deflationary" period. Therefore, until there is proof that volume growth is stabilizing, I prefer to play it safe and wait on.
Description
Previously , I valued Duckhorn Portfolio ( NAPA ) at $16.56 per share, suggesting there was little upside to the stock. I hold the same hold rating now as well following the 2Q23 earnings. To begin with the positive aspects, NAPA has shown an impressive level of resilience in terms of their revenue despite the challenging conditions in the consumer goods market due to inflation and declining category trends. The $38.8 million in adjusted EBITDAS that NAPA reported was significantly higher than the $36.2 million predicted by consensus. An increase in gross margin more than made up for an increase in selling, general, and administrative expenses. The headline certainly grabs attention, but in my opinion the true metrics are even more compelling. The 4.8% increase in top-line revenue was leaning towards the upper end of management's internal expectations for low- to mid-single-digit growth%, as outlined on the 1Q23 conference call. Positive momentum, in my opinion, is being felt by management. In particular, there have been no warning signs of a slowdown in trade, Decoy Limited's expansion has far exceeded projections, and the demand for the latest Kosta Browne album has far outstripped supply. My guess is that this is why management has increased FY23 forecasts. Despite the more difficult macro, NAPA has continued to outperform. However, once inflation slows, I am concerned about the effects of the ensuing "deflationary" period. Revenue increases, I should note, were primarily the result of price increases. Therefore, until there is proof that volume growth is stabilizing, I prefer to play it safe and wait on the sidelines. While the FY23 guidance appears conservative after a strong first half, it still relies heavily on 4Q23 performance, which is a risk in my view.
Results and guidance
I applaud management for their savvy execution, as NAPA has consistently outperformed street estimates for multiple quarters running, most recently posting a small top-line beat in 2Q23 following a strong beat in 1Q23. It is remarkable that the top line has shown such strength in the face of the current high inflation rate. I would pay attention to management commentary and tone regarding guidance as well. Management decided to increase their FY23 top-line guidance by only $4 million despite encouraging data regarding the stability of their affluent customer base, the sell-out of Kosta Browne, promising spring wine club bookings, a depletion rate that outpaced shipments, and strong performance indicators across channels. My belief is that management might be too conservative on their guidance.
Also, despite the fact that the release of the Kosta Browne appellation in 4Q23 is crucial to the management guided to increase in revenue for FY23. I believe there is a good chance for NAPA to grow as guided given the continued strong sell-out of new releases and extensive backlog. On the other hand, management remains positive that the year-over-year trends are stabilizing and foresees a return to the usual high-single-digit percentage algorithm in the future, even though the Wholesale channels experienced a slowdown over a three-year period in the quarter.
Margin
Management attributed the 318 bps increase in gross margins to favorable changes in channel mix and the ongoing flow-through of pricing actions. Seeing as how gross margins have grown by about 160 basis points year-to-date, management has once again increased their gross margin guidance for FY23 from flat to -50 basis points to -100 basis points. Despite the apparent improvement in gross margin, I feel compelled to point out that, based on 1H23 performance, the revised FY23 gross margin guidance almost certainly implies that 2H23 gross margins will have to be lower than in the prior year. There are two ways I see this:
- Management is attempting to be conservative here because NAPA still has the pricing lever to ensure that gross margins can be sustained. In addition, the business should see positive channel mix (e.g., higher margin DTC channel from Kosta Browne release) in 2H23.
- Management is indirectly informing the market about the impact on gross margins if there are no additional pricing benefits (i.e. in a deflationary environment)
The latter does not seem to mesh well with the other tone and positive guidance trajectory, so I think the former is more likely and management is just being conservative on guidance. However, I also point out that while channel mix is beneficial to gross margin, it may act as a drag on operating expenses if the company must pay a disproportionate share of those costs to the Wholesale and Distributors channels. Therefore, I believe it is probably wise for an investor to gain more insight into how the bottom line will be before jumping on board.
Summary
Despite the challenging market conditions, NAPA has shown resilience and posted impressive financial results in 2Q23. Despite the strong performance, I have concerns about the effects of the ensuing "deflationary" period once inflation slows. Even though management has increased its FY23 guidance, it still relies heavily on 4Q23 performance, which is a risk in my opinion. It remains to be seen whether NAPA can achieve the guidance as management has been conservative in the past. The increase in gross margins is attributed to favorable changes in channel mix and ongoing pricing actions. However, channel mix may act as a drag on operating expenses, so it is important to gain more insight into how the bottom line will be before investing.
For further details see:
Duckhorn Portfolio: Reiterating My Hold Rating For Now