2023-08-29 09:00:00 ET
Summary
- YETI's share price has surged in August due to strong Q2 earnings and an uplift in guidance.
- The company is expanding its product range and brand presence, which could drive further growth.
- However, there are risks, including competition from cheaper alternatives and reliance on wholesale partners for revenue.
- Now at a 17x FY24 P/E, YETI is no longer a compelling value proposition. Downgrading the stock to neutral on valuation for now.
With very few exceptions this quarter, the earnings season has proven to be disappointing for most companies, including and especially those in the consumer products sector. In the wake of high rates and an uncertain macroeconomy, consumers are still spending heavily on travel and experiences, but outlays on products has been substantially lower - a trend felt deeply in the retail sector.
YETI ( YETI ), however, has been a meaningful exception. The maker of coolers has seen its share price skyrocket in August, on the back of a very strong Q2 earnings print and guidance uplift. Year to date, the stock is now up 16%, roughly in line with the S&P 500.
Guidance boost is compensated for in higher share price; bull and bear theses are now balanced
The core catalyst behind YETI's upward drive in share price, beyond Q2 earnings (which we'll review in the next section), was a boost to the company's full-year outlook in spite of product recalls that impacted first-half revenue.
As seen in the snapshot above, the company is raising the low end of its revenue range to 4% y/y growth, boosting its gross margin outlook to a range of 55.5-56.0% (50-100bps higher than a prior 55.0% view), and increasing adjusted operating margins by 50bps. Pro forma EPS, meanwhile, got a ~$0.10 (~5%) boost on both ends of the range.
I last wrote a bullish article on YETI in May, when the stock was changing hands at $37 per share. In this more volatile market environment that also features high risk-free interest rates, however, I think all investors should monitor positions more closely. In light of YETI's recent upward spike and resulting valuation, I am now neutral on the stock and recommend locking in gains here.
I now see a mixed bag of positives and negatives for this stock. On the bright side for YETI:
- The company is extending its immensely popular brand into new products. Drinkware and coolers are still the bread-and-butter categories for YETI, but the company is now taking advantage of its rising brand profile to roll out new products. During the pandemic, the company announced a new collection of bags, backpacks, duffels, and luggage - another high-margin category that can fuel further growth. The company is also adding heavy-duty cargo buckets and containers this year.
- Regional and international expansion. YETI has been primarily popular in the South and Midwestern regions of the U.S., but brand penetration on the West and East coasts as well as internationally is still low and provides YETI with plenty of room for growth. The company's recent tilt toward online and social media marketing also makes it easier for the brand to flower in new places.
At the same time, however, we can't ignore several risks:
- YETI is a premium-priced product that has few distinguishing factors versus peers. In a pinched consumer environment, buyers may choose cheaper alternatives. REI, in particular, has its own house brand for the majority of YETI's gear.
- YETI relies on wholesale partners for roughly half of its revenue, so even if the brand is holding up strong, it won't be able to avoid a downturn in the retail industry if channel partners are feeling squeezed. Stores could close or decide to slim down their SKU assortments, ultimately risking YETI's exposure to end-customers.
And with YETI stock now ~30% higher since my last article, there's no longer a compelling value argument to be made here. For FY24, Wall Street analysts are expecting YETI to generate $2.76 in pro forma EPS, up 27% y/y (data from Yahoo Finance ) on the back of 11% y/y revenue growth. This puts YETI's valuation at 17.0x P/E based on expected FY24 EPS. Of course, if the company does achieve double-digit EPS growth, this premium could be warranted - but execution next year is not a given, especially in a challenging macro environment.
The bottom line here: I've enjoyed my gains on YETI so far, but at the moment I feel more comfortable selling off this winner and moving to the sidelines until prices rationalize down more.
Q2 recap
Q2 results were muddled due to the impacts of the company's product recall, so we'll start there. Earlier this year in February, the company recalled several of its cooler products and put in reserves for expected returns as well as unsalable inventory.
With this in mind, Q2 revenue declined -4% y/y to $402.6 million, missing Wall Street's expectations of $411.3 million (-2% y/y). The Street, however, would have very limited visibility on the impacts of the recall, which YETI disclosed as a -$24.5 million reserve headwind to the quarter. In the absence of this reserve, revenue would have grown 2% y/y.
By channel, direct-to-consumer revenue grew 1% y/y to $226.4 million, or 55% of the company's overall revenue (in the absence of the recall, revenue growth in DTC would have been 4% y/y). Wholesale revenue, meanwhile, declined -10% y/y to $176.2 million, or a -1% decline excluding the recall.
It's important to note that while YETI is leaning more toward its direct channel for growth, as I previously mentioned contraction in the wholesale business poses a long-term risk to YETI as the company counts on overall store exposure for sales. Channel partners are an important way for YETI to boost its overall fixtures and brand presence, and especially if partners are burdened with the hassle of a recent recall, future orders may be at risk.
New products continue to be an important driver of growth, as the company notes that consumers are responding well to new form factors. Per CEO Matt Reintjes' remarks on the Q2 earnings call :
Regarding overall consumer demand, we continue to see a range of performance across our wholesale and DTC channels. There remains a focus on Drinkware with strong trends around hydration, color and new styles. We're seeing this play out within our own portfolio and across specific consumer demographics. Customers are increasingly gravitating towards many newer formats of our bottles, straw lid tumblers and our new color match bottles.
As we continue to grow and diversify our Drinkware category, we have expanded our products to include new size and customization offerings across a range of younger water bottles and we're pleased with the highly successful introduction of our Rambler beverage bucket."
Admittedly, the company did perform well on margins - which gave management the confidence to boost the full-year profit outlook. Gross margins of 53.2% in the quarter rose 120bps y/y, and even included a -150bps negative impact from the recalls.
This was offset through opex, as pro forma EPS of $0.57 declined -10% y/y owing to higher employee salaries and higher headcount. Earnings did, however, beat Wall Street's expectations of $0.46 with considerable upside.
Key takeaways
To me, in the current high interest rate environment, a stock has to provide exceptional value to compete with 5% risk-free rates. YETI, at a ~17x forward P/E, no longer falls into that category for me, especially as we continue to see medium-term risks to the retail industry. Briefly put: it's time to take the chips off the table with this stock.
For further details see:
YETI: Time To Take Chips Off The Table (Ratings Downgrade)