By David Huston and Nick Gomez
(Note: Values are in Canadian dollars unless US dollars are stated).
Canada Goose (NYSE: GOOS) (TSX:GOOS:CA) is a clothing retailer established in 1957 in Toronto under the name of Metro Sportswear, specializing in wool vests, raincoats and snowmobile suits. From there it has grown into a global brand retailer with flagship stores in Toronto, New York, mainland China and Tokyo that combine the company’s Arctic heritage with modern innovations across a wider range of products. .
It’s an exciting time to consider investing in the business – not because it’s running at full capacity and therefore highly valued as a business, but because it’s facing challenges which we believe , are not insurmountable and create a potential situation where the stock price does not match the current estimate of future cash flows.
under the hood
Canada Goose is a profitable retailer with positive prospects for revenue and profit growth in 2023 and 2024:
Using a discounted cash flow analysis, we find that Canada Goose is valued about 40% below what we expect it to be; US$17 against a fair value of US$28. This means that there is a large safety margin taken into account:
We need to consider this in the context of a growing business and where it should be over the next two years:
The company made headlines by surpassing $1 billion in revenue and is on track to reach $1.37 billion in 2023. That represents 24.5% revenue growth next year and a margin gross over 66%. Net income will almost double in the next few years as they increase the number of stores from 41 to 64 by 2024. There is a commensurate increase in return on equity (ROE) and return on assets (ROA ) which signals that analysts are optimistic. on their ability to increase revenue in the blink of an eye and further drive gross and net margin expansion.
Management’s guidance for FY2023 is for EPS to reach $1.60 to $1.90, and much of that depends on how mainland China performs during the peak holiday season (this winter) in the face of disruptions and continued Covid-19 lockdowns.
The company is trading for a September PE of 29.39, which is below the 32.3x global luxury PE average and close to the average for the retail and consumer growth segments of the market.
The recently released first quarter report for July 2, 2022 showed a net loss of $63.6 million, which is still down from the loss of $57.5 million in June 2021. This is not necessarily too revealing given that the winter period constitutes a large part of their income. and profit.
Income statement and balance sheet
At Away From the Herd, we follow a standard rubric for evaluating the income statement and balance sheet. Here is a summary of our findings using the “Red, Amber, Green” markings for simplicity:
Canada Goose ranks quite well in terms of having 10 years of strong revenue growth, a high and growing gross and net profit margin, low interest and amortization charges, and a clear lack of debt.
There are unusual expenses (about 1% of gross income) for the second year out of five that are worth watching. The net income to total income trend is fair to average and, at 8.6%, does not suggest that this is a company achieving excessive levels of net income; companies with a net profit to revenue ratio of more than 20% often have a competitive advantage or moats and lower operating costs. As a retailer, we could give it the benefit of the doubt. The only orange flag that should really grab your attention is the somewhat spotty EPS track record. Canada Goose took a hit in 2020 and appears to be heading for a tougher profit situation again in 2022.
The balance sheet is very strong and doesn’t need much attention: the debt is low and the debt they have is long term rather than short term. In particular, the PPE/debt/net profit ratio – which is designed to show how well a company is doing in turning its assets into net profit – is extremely strong. They don’t need a huge amount of capital and debt to grow the business, which means that in good times when people are spending, it’s a very profitable business.
Problem in China
Canada Goose has struggled in one of its key markets: China. First, many will remember the uproar when the CEO of Huawei Meng Wanzhou was arrested in Canada in 2018 and detained for almost three years. In return, China accused Canadian businessmen Michael Spavor and Michael Kovrig of espionage and it was only last year that the two countries negotiated a swap. Following this, there was a second negative catalyst with continued lockdowns in China leading to store closures.
Let’s look at Canada Goose’s revenue distribution and the proportion of its business in mainland China, to understand the impact these challenges may have.
Canada Goose FY 2021 Annual Revenue by Region
The activity is split evenly between Canada, the United States, Asia and Europe, although it has a distinct weighting towards Asia, which represents 29% of sales. According to the Canada Goose website, there are 48 locations (including pop-up stores and smaller locations) and 20 of those registered locations are in Asia, while 18 of them are in China. It would be fair to say that China is an important jurisdiction for sales and growth and accounts for the majority of Asia except for one store in Japan and one in Taiwan.
In terms of specific issues, there was a complaint raised against the company in September 2021 by the Shanghai market regulator regarding misleading customers and failure to comply with advertising laws. The company was fined $71,000. The fine and the publicity were certainly bad for business and caused the company to change its approach to advertising in China.
The company was once again the target of fire as recently as December 2021 with an issue regarding the refusal to receive a returned item from a customer, in a manner deemed not to comply with Chinese local consumer laws. A consumer tried to return a luxury parka and was told he couldn’t, although he later claimed it had a faulty tag and was eventually able to argue the case with of the regulatory body.
This means that there are clearly issues in one of their major geographies, and this has had an impact on the share price. Interestingly, many of these issues have been resolved. China and Canada have at least on the surface solved their problems, stores in China are wide open and generating revenue, and there doesn’t seem to be any ongoing action around the brand boycott.
For hiring and key personnel, the company recently hired Larry Li to oversee the entire Mainland China market. He has extensive experience in Chinese retail, as an industry, and has held positions at Dunhill and the LBMH Group as well as Givenchy and Kenzo.
The great thing about Canada Goose is that it is a highly seasonal business that makes a significant portion of its revenue and profits during the winter season. It also overlaps with the 600-pound gorilla: Christmas time.
What’s interesting here though is that the stock price also seems to follow a seasonal pattern. Previous all-time highs for the stock price have been in winter, with a strong ATH of $92.18 hit in November 2018 and again $64.82 hit in November 2021.
There isn’t a huge data set to mine, but it looks like after getting very close to pandemic lows in 2020 ($12.84), at $17.24 we are seeing a further divergence of the RSI and MACD, and price signals underlying strength (green dotted lines on the chart below).
There is a gap between US$22 and US$24 that needs to be filled, but hopefully this will be resolved. We will look for a break above this resistance area before entering a long position.
Canada Goose is a luxury retailer whose growth strategy is well aligned with global demographics and has a concrete plan to increase revenue with store openings in the Asia-Pacific region and parts of Europe.
The company is below fair value on a DCF basis and it has a relatively undemanding PE of 29 which is significantly reduced from where it was at the start of the year (PE was close to 100). In terms of the income statement and balance sheet, there are a few orange flags to watch out for, but overall the health of the business is strong.
Upside catalysts include a seasonal trend in stocks and subsequent revaluation as they continue to deliver store expansion. Although challenges remain in China, stores remain open and traffic continues to grow in terms of footfall at their main stores.
Overall – although there is pressure to issue “buy” alerts when reviewing a company – we remain in a wait-and-see stance. We want to see Canada Goose shares overcome key resistance on the upside and show further positive momentum. We also want to see more evidence that earnings will not be impacted by challenges in China and key markets in Asia. When these criteria are met, we have several trading strategies that we would use to increase our exposure to Canada Goose.