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Seeking Alpha: Can you briefly summarize your bullish thesis for readers who may not have seen it yet?
CDM Capital: The market has been myopically focused on Canada Goose’s recent problems in China with the unrest in Hong Kong and the more recent outbreak of the Coronavirus. Surprisingly, Canada Goose has declined over 30% since its early November peak while its closest competitor Moncler (OTCPK:MONRF) has gone up over 12%. The market appears to be pricing in a sharp and prolonged deceleration in growth, something that we think is unlikely given its nascent global penetration and industry-leading brand resonance. Since coming public, the stock and sales have doubled; however, the underlying operating profits have gone up five-fold. Margin expansion has become more apparent as the business continues to scale and shift from the lower margin wholesale business to the direct-to-consumer (DTC) channel, which has a gross margin uplift of ~3,000 basis points. It’s uncommon to find a business growing top line at a 40% CAGR in tandem with expanding margins (GM +2,200 bps; 5 years), trading at a discount to luxury peers, while the stock is off almost 55% from all-time highs. At just over 20x forward earnings and likely growing EPS at a 30%+ CAGR, we think the combination is one of the most compelling stories in global luxury retail.
Multiple upcoming catalysts drive future growth, including a further expansion into China, an upcoming brand extension into shoes, and continued diversification into apparel and light jackets. The biggest upcoming catalyst is the expansion into an under-penetrated Asian market where Moncler derives 43% of its sales, Canada Goose as of the most recent quarter only had ~17% of its sales in Asia. Footwear is also a large category expansion that significantly increases the overall TAM, even the more saturated North American market. While management has been quiet on the exact timeline, we think sometime in early 2021, Canada Goose will be releasing its first line of footwear.
Regarding the valuation upside, we think over a five-year time horizon, the stock is worth 3-5x its current market value. That target is obviously dependent on execution, continued double-digit top line growth, increasing margins, and efficient capital allocation. We take some comfort in this forecast given that Canada Goose’s stock is cheaper than it was at IPO, and from its initial pricing the stock increased 4.5-fold in less than two years.
SA: Would shorting Moncler make for a perfect pair trade, or is this not a good short due to a potential takeover by Kering (OTCPK:PPRUF)? Would any other stock (or basket of stocks) make for a better hedge? Or is this such a high-conviction idea that investors should (only half joking) put on a Texas Hedge (long stock and long calls)?
CDM: Great question, we’ve certainly pondered that exact thought process as a way of protecting some of the downside and capturing the multiple compression between the two that we think eventually happens. Moncler also ironically has much more exposure to China/Asia than Canada Goose at over 43% of sales in Asia+rest of world, the majority of which we think comes from China. The problem with that line of thinking is the large European luxury conglomerates have been paying big multiples for control, Tiffany’s (NYSE:TIF) is a great example. Given that Remo Ruffini owns over 25% of Moncler the prevailing view is that Kering would need to make an aggressive offer to sway Ruffini, something in the order of a 30-40% premium from the current price. So, in the end we just don’t want to underwrite takeout risk which we consider to be quite high given there are only two real players in global luxury outerwear. Regarding the Texas hedge, we would avoid buying short-dated calls based on the high implied volatility although we suppose one could play it through buying LEAPS.
SA: As part of your extensive primary research, you spoke with a number of investors who expressed their opinion about why the stock is where it is – do you think part of the mispricing is because these are effectively unsupported opinions not backed up by evidence that you collected for the bullish side of the trade?
CDM: We’ve spent at least a couple of hundred hours researching Canada Goose and the data and information we’ve collected just doesn’t line up with what is now being priced into the stock, especially when comping it to Moncler. Initially our view was that Canada Goose was a short, optically it was pricey (partly due to heavy reinvestment) and one could make a simple argument that the TAM was limited to cold weather climates and consumers only need one parka every 5-10 years. The flaw in the TAM argument in our opinion is that three quarters of the growth is coming from outside the more saturated North American market, and that’s before one considers the upcoming brand extension into footwear. In our view, Canada Goose is a brand that is not experiencing fatigue, but a brand that is really in its infancy in becoming a global luxury outdoor brand. A great example of this is that Canada Goose still derives most of its sales from Canada (> 35%), with three quarters of the incremental growth coming from outside North America. To put this into perspective, Canada represents over 35% of Canada Goose sales yet represents only 2% of the global luxury market. Furthermore, the physical store penetration is still relatively nascent, Canada Goose only has 20 global flagship locations, two stores in Europe and five stores in the United States.
SA: In the retail apocalypse, the list of winners is a lot smaller than the list of losers – can you discuss how/why GOOS is a winner? GOOS appears to sit at the center of a number of powerful trends – can you discuss a few?
CDM: Obviously there have been tremendous struggles in the brick-and-mortar retailing space over the past decade, especially mall-based locations that are dependent on traffic trends. Our view is that any basic apparel product is subject to tremendous competition from the likes of Amazon (NASDAQ:AMZN), Walmart (NYSE:WMT) and more recently online direct-to-consumer niche retailers. Take Gap (NYSE:GPS) for instance, almost every item at Gap can be purchased now through Amazon basics generic clothing line. Commoditized apparel offerings that aren’t differentiated in a way the consumer values really struggle to find any pricing power. What typically occurs is that markdowns become a strategy and it works well early on, but eventually the strategy trains consumers to expect sales thereby diluting the brand equity.
Juxtapose this with Canada Goose, which is a vertically integrated retailer that controls its inventory levels in both the wholesale and DTC channel. One of Canada Goose’s strategies is to let designs completely sell-out, and this season there are a lot of designs and sizes that consumers just can’t get in either the DTC or wholesale channel. This line of thinking is summed up by CEO Dani Reiss discussing how he views his product.
“We plan our direct-to-consumer and wholesale business well, and we are not afraid to be sold out. If somebody can’t find the product, they want in a certain year they’ll come back for it next year, our products are special, they are not commodities” –Dani Reiss, CNBC
Strong brands that have a unique offering can use a direct-to-consumer approach as a fulcrum for the brand, especially the vertically integrated retailers like Canada Goose. The relevance of this channel is exemplified by Lululemon’s (NASDAQ:LULU) operating margin differential between owned retail stores (25.5%) and Q3 ‘19 online margins of 41.9%. The 1,640-point delta between the two channels is an important aspect of the bull thesis for Lululemon, whereby continually shifting sales towards its online channel results in continued margin expansion even as top line decelerates. Even brands as mature as Nike (NYSE:NKE) are making a successful foray into an online direct-to-consumer business. The margin profile in the direct-to-consumer space is so compelling that Nike recently started pulling products from Amazon in an effort to build up its own e-commerce offering. Nike does not report margins for its online business segment, but estimates believe it could be as high as 1,000 bps higher than its wholesale margins. Nike has also been signaling the importance of the channel with its recent hire of CEO John Donahoe (previously CEO of eBay and ServiceNow). The online channel only represents 15% of its business but has expectations that it could achieve 30% share in the next few years. Canada Goose does not break out margins for its online channel, but we think based on discussions it has the highest operating margins among all the channels, similar to both Lulu and Nike. Canada Goose has another big advantage in selling big ticket items directly to consumers versus a Nike or Lululemon where the shipping costs alone might eat up 10-20% of the end sale.
Canada Goose also has a unique approach to its physical retail presence, with most stores offering some sort of cold weather experience to showcase the brand’s various products. Its most recent opening in Toronto took it a step further by offering not for-sale inventory; the store is comprised of an entire buyer experience built around a snowstorm, a cold room, and a crevasse traverse room. Canada Goose’s strategy for their stores is more about brand building and experiences than the traditional retail model. The end goal is to drive customers to its online platform, which has the highest operating margins. Additionally, the unique retail approach gets customers excited about the brand and compels them to share their experiences on social media.
Thanks to CDM Capital for the interview.
Disclosure: I am/we are long GOOS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.