2023-07-05 14:17:20 ET
Summary
- Shares of Duckhorn Portfolio have dropped 21% YTD despite stable operating and financial performance; the company's shares are under pressure due to potential business growth issues as inflation slows in 2023.
- The company's 3Q23 revenue beat investors' expectations on a 3.5% YoY increase in volumes, while prices fell 3.9% YoY.
- I don't see catalysts for stock price growth in the coming quarters due to potential pressure on both top line growth and operating margins.
Introduction
Shares of Duckhorn Portfolio (NAPA) have fallen 21% YTD. Despite the fact that the company's operating and financial performance looks very stable in terms of macro headwinds, the dynamics of the company's shares continues to be under pressure.
Investment thesis
I believe now is not the best time to go long as we may see pressure on business growth as inflation slows in the second half of 2023, while rising prices are one of the main drivers of revenue growth. In addition, despite the fact that the company has confirmed and increased guidance for 2023 (fiscal), I believe that the increase in guidance is modest, reflecting management's expectations about the impact of inflation on sales. Also, the valuation of shares according to multiples does not look cheap, as the shares are traded at or above the sector median. As such, I don't see any catalysts for stock growth in the coming quarters.
Company overview
The company is engaged in the production and sale of wine in the premier luxury segment. Duckhorn Portfolio products are sold in more than 50 countries. The main sales channels are Wholesale and DTC. The company was founded in 1976.
3Q 2023 (fiscal) earnings review
The company reported better than investors expected. The company's revenue decreased by 0.4% YoY . The biggest contributor to revenue growth was a 3.5% YoY increase in sales volumes, while prices declined by 3.9% YoY.
In terms of sales channels, the Wholesale segment made the largest contribution, where revenue grew by 10.3% YoY, the share of the segment (% of revenue) increased from 62% in Q3 2022 (fiscal) to 68.6% in Q3 2023 year (fiscal), while revenue in the DTC segment decreased by 35.2% YoY, and the share of the DTC segment (% of revenue) decreased from 21.4% in Q3 2022 (fiscal) to 13.9% in Q3 2023 (fiscal).
Gross profit margin increased from 48% in Q3 2022 (fiscal) to 55.4% in Q3 2023 (fiscal) thanks to a favorable brand mix and higher prices. SGA spending (% of revenue) increased from 25.3% in Q3 2022 (fiscal) to 26.3% in Q3 2023 (fiscal). Thus, operating margin increased from 22.8% in Q3 2022 (fiscal) to 29.1% in Q3 2023 (fiscal).
Management slightly increased guidance on revenue from $398-$404 to $400-$404, as well as on EPS from $0.63-$0.65 to $0.64-$0.66 and adjusted EBITDA from $135-$138 to $138-$140. On the one hand, I like the fact that the company's guidance is in line with market expectations, on the other hand, we're not seeing a high increase at all, despite the strong results to date and the solid tone of management when they speak about their own expectations.
My expectations
At the moment, based on market data, management comments and personal expectations, I believe that we will see inflation slowdown in the second half of 2023, which could put pressure on revenue growth. Despite the fact that a significant part of the business growth is based on volume growth, I think that price cuts could make a significant negative contribution to overall revenue growth. Despite the fact that management is sounding pretty confident during the Earnings Call following Q3 2023 (fiscal) results , I think the modest increase in guidance confirms what I'm saying.
Also, based on management comments, I believe we will see pressure on the gross margin as early as the fourth quarter. Thus, the company predicts an increase in gross margin by 200 bps at the end of the year (fiscal). Based on revenue of about $400 million (company's guidance), we can conclude that the next quarter gross margin will be around 49%, which looks weaker than in Q4 2022 and Q3 2023.
So we anticipate that Q4 margin will materialize really more in line with our year-to-date trends is kind of a good way to think about it, where we are guiding to about 200 bps for margin to be improved for the total fiscal year.
Risks
Macro: decreasing inflation may have a negative impact on the company's business growth rates, as price growth, as well as volume growth, is a key driver of sales growth. The company is able to effectively pass on inflation to the end consumer, which supports revenue, however, in the event of a slowdown in inflation or deflation, we may see a decrease in revenue growth in the following quarters. In addition, the inability to pass on higher inflation to the end consumer could put pressure on business operating margins.
Competition: a high level of competition can lead to the need to invest in prices or additional marketing costs, which can negatively impact profitability by increasing operating costs.
Valuation
At the moment, in my personal opinion, the company's shares are not cheaply priced. So, this matches with the current Valuation Grade, which is C-. If we look at the P/S ('FWD') multiple, we can see that the company is trading at 3.7x, which is 243% higher than the sector media. On the one hand, the company can trade at an industry premium due to higher operating margins and revenue growth rates, however, according to P/E ('FWD') and EV/EBITDA ('FWD') multiples, the company is also trading around the sector median.
Conclusion
Despite the fact that I like the company and the current operating margin trends, I don't think now is the best time to go long. Thus, we can see pressure on both revenue growth due to lower inflation in the second half of 2023, and on the overall level of operating margin due to reduced business scale. In addition, the shares are currently trading at or above the sector median in accordance with multiples. I will continue to closely monitor the company's financial statements and will gladly change my view if I see a change in macro trends or an attractive valuation.
For further details see:
Duckhorn Portfolio: Strong Current Trends But No Clear Catalysts To Grow