2023-09-29 06:34:03 ET
Summary
- Vista Outdoor Inc is planning to spin off its Outdoor products segment and focus on fixing its lackluster performance.
- The company's current ratio is slightly on the inefficient side because of inventory buildup.
- Despite some positive metrics like return on invested capital, the company's growth and efficiency metrics are lacking, leading to uncertainty and a higher margin of safety in valuation.
- I'll revisit once the company completed the spinoff.
Investment Thesis
Vista Outdoor Inc (VSTO) is getting close to spinning off its Outdoor products segment and setting priorities accordingly to fix the lackluster segment. I wanted to take a look at the company as a whole to see if it is a good time to invest. Not surprisingly the company's FW PE ratio of 7 is quite cheap, however, I would be more excited to own it once the laggard has been spun off as I can see some inefficiencies in the financials.
Financials
As of Q1 '24, the company had $63m in cash and $886m in long-term debt. That is a lot of debt for such a small company. The company went on a shopping spree in recent years, which meant leverage. I'm all for companies using leverage if the burden is manageable and benefits the company in the long run. So, is the debt manageable for VSTO? Historically, the interest coverage ratio has been around hovering between 8x and 10x, which meant that EBIT was able to cover annual interest on debt 8 to 10 times over. That is a healthy ratio, and for reference, anything over 2x is considered a healthy ratio. I consider anything over 5x to be healthy as I'm more on the conservative side. As far as the most recent quarter is concerned, which I don't pay attention to too much because q/q numbers tend to fluctuate more in terms of performance, the coverage ratio was around 6x.
The company's current ratio has been very strong over the years. It is a little too strong in my opinion, to the point where I think it's not efficient. It is good to have a strong current ratio, which means that the company won't have trouble paying off its short-term obligations, however, to me it also seems that there's an opportunity wasted in terms of utilizing assets like cash efficiently. In this case, it seems like the company has a lot of inventory in this case.
It seems that the company has become less efficient at selling through its inventory levels because the inventory turnover ratio was around 3 as of FY23. Typically, anything over 5 is considered good, as that means the company can sell through its inventory within 1-2 months. According to my calculations, the company's days inventory outstanding or DIO was around 4 months, which coincides with its low inventory turnover measure of 3. The higher the inventory turnover, the lower the DIO.
In short, the company could be more efficient, but at least it has no problem paying off short-term obligations due to the high current ratio.
Speaking of efficiency and profitability, the company's ROA and ROE have seen better days. Due to the large charges under the Other Non-operating income section, the company's GAAP figures were quite horrible over the last 5 years, with only 2 out of the 5 years being positive. If we strip out those charges and project them a little into the future, these will become much healthier.
The company has an outstanding return on invested capital, which tells me that the company is enjoying some decent competitive advantage and a moat. I look for companies that can achieve at least 10% ROIC and VSTO satisfies that.
The company managed to achieve around 6% CAGR of revenue growth in the last decade, which isn't great in my opinion. I will base my valuation parameters on this number going forward also as I don't believe it can achieve a higher number without a decent catalyst.
The GAAP margins have seen better days also and I would expect these to return to FY20-21 levels where the company saw no one-off charges.
Overall, I would say it's quite a mixed bag. Some metrics are decent like the outstanding ROIC and coverage ratio, and some are less so, like the lack of growth and efficiency metrics. It's very unclear how the company is progressing at the moment, which leads to me adding a higher margin of safety to my valuation.
Valuation
For the revenue assumptions for the base case, I went with a 7% decline in FY24 as analysts estimate. From then on, I decided to go with a 4% CAGR until FY33. For the optimistic case, I went with around 6% CAGR, while for the conservative case, I went with a 2% CAGR for the next decade, to give myself a range of possible outcomes.
In terms of margins, I improved gross margins by around 650bps or 6% over the next 10 years, while improving operating margins by around 300bps. This will bring net margins from around 11% in FY24 to around 18% by FY33, which seems reasonable to me.
On top of these estimates, I went ahead and added a 35% margin of safety because of the mixed financials and overall uncertainty of the company. With that said, Vista Outdoors' intrinsic value is $54 a share, implying that the company is currently trading at a deep discount to its fair value.
Outlook
As many already know, the company is looking to separate its two segments into two separate, publicly traded companies. I think this is going to be beneficial for investors new and old, which shows me that the company is going to try to focus on each segment individually bring out the strengths of each company, and tame expenses in the process. One revenue segment in particular I'm not happy with how it has performed in the past and I'm sure that is the big reason for this demerge: to fix the Outdoor Products segment.
This segment has been performing poorly in the past and does not contribute much to the bottom line. It contributed 12% to the gross profit margin in FY23, while the Sporting products segment contributed almost double that. That's not the worst part. When it came to the operating income, the lackluster segment contributed barely 2% to the operating margins.
The management and the board of directors sees that and decided to fix the situation, by spinning it off and assigning people that will prioritize turning this segment around when it is going to be its own publicly traded company.
Closing Comments and Investor Takeaway
So, it looks like the company is quite appealing at these levels, so why don't I recommend buying it right now? As I covered earlier, the big question is the demerger that is going to happen in the future. I am interested to see how the two separate entities will operate going forward, and I would want to be the owner of the more profitable part of the business once the laggard segment is spun off. Therefore, I recommend holding off from buying, even though it looks cheap.
I'm not in a hurry to own this one yet, and once the company spins off into two, I will be looking into both of the companies separately and see which one is going to be more enticing, but I'm sure we know which one that will be.
I would also like to see the management tackling the debt outstanding because it may get dangerously difficult to pay off the interest on the debt if the company is going to experience down years in terms of revenues.
For further details see:
Vista Outdoor: I'll Wait For The Spin-Off