Value Investment - GOOS - Further Expansion
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Canada Goose (NYSE: GOOS) is a vertically integrated 63-year-old manufacturer and retailer of outdoor apparel for men, women, and children-- traditionally known for the famous parka. Canada Goose (CG) is an organic growth story controlled by an excellent family owner/operator and Bain Capital. 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. Since coming public, its stock and sales have doubled; however, the underlying operating profits have gone up five-fold. Fixed cost leverage has become more apparent as the business continues to scale and shift from the low margin wholesale business to the direct-to-consumer (DTC) channel, which has a gross margin uplift of ~ 3,000 basis points. It is rare 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 stock is off almost 50% from all-time highs. The stock is down due to a multitude of, what we believe, are short-term issues, including volatility in wholesale inventory/shipments, a 61% build in inventory y/y, exposure to unrest in Hong Kong, the China Coronavirus, and recent selling by Bain Capital at the stock’s recent peak. While these issues have put pressure on the stock, we believe virtually all the issues are transitory, known, and fixable over time. In our view, these short-term pressures have created an excellent entry point, given the vast white space opportunities and growing global demand that is nascent in its lifecycle.
The Real McCoy
The global parka movement was essentially created by Canada Goose, with its signature fur trimmed hooded jackets. On the back of these famous parkas, Canada Goose has launched itself from a regional Canadian brand to a global leader in luxury outerwear. This is a brand with a long lineage of producing some of the highest quality outerwear across the globe, and that sense of quality is synonymous with its brand extensions into other categories such as apparel, light outerwear, and eventually, footwear.
While the Canada Goose brand is quite familiar in cold weather climates within North America, the brand is still in its infancy in other parts of the U.S. and even more so globally. For instance, the brand started its direct-to-consumer push just over 5 years ago and only recently opened its first two physical stores in Toronto and New York City in 2016. Canada Goose is unique in that, while it has global brand recognition, it is only one third the size of its closest competitor, Moncler. Globally, there are only 20 physical stores and sales are still below CAD $1bn. Given the vast whitespace, we think there is 25%+ sales growth with 30%+ EPS growth for the next 3-5 years and double-digit EPS growth for at least the next decade is feasible.
The distribution network and manufacturing capabilities have been built out over the past few years to satiate strong product demand. Consumer demand has historically outweighed the amount of product Canada Goose can manufacture in Canada. While it is a good problem to have, CG management has had to invest a significant portion of free cash flow back into the business to continue this growth trajectory. Over the past two and a half years, the team has built 4 manufacturing facilities (8 total facilities within Canada). Furthermore, a recent acquisition of Baffin (shoe manufacturer) in November of 2018 was a natural brand expansion into a new category that we think is relevant to Canada Goose customers. Capital spending has been extremely high, given all the recent fixed cost investments to keep up with top-line growth, which has doubled approximately every 2 years. Capital spending in FY 2019 as a percentage of sales was 8.2% (versus peers ~4%) and, given the planned C$75mn (7.5% of sales) investment in FY 2020, capital spending should start normalizing further with more free cash flow generation being used on the recently initiated stock buyback.
It is clear that the Canada Goose brand resonates well with consumers as a global luxury outerwear brand; however, the market still does not value it as such. If one factors in CG’s growth rates relative to peers, Canada Goose trades at a steep discount to almost all luxury peers and a steep discount to its closest competitor, Moncler. We believe much of the disconnect is from the consensus perception of the brand within North America-- most of which we think is misplaced when taking into consideration three quarters of the incremental growth is coming from outside North America. Below are a few viewpoints we’ve heard over the past few months after speaking with investors in the space.
Consensus View
Variant View
A Unique Customer Engagement Experience
Canada Goose has a unique approach to its 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 no for-sale inventory; the store is comprised of an entire buyer experience built around a snow storm, 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.
Stock Weakness
The stock is down for a multitude of reasons-- from PETA outcry over the use of coyote fur on the hoods, to concerns over the volatility of seasonal inventory builds, as well as Hong Kong unrest. At one point, Canada Goose was at the center of an international controversy where it was put in the spotlight after the CEO of Huawei, Meng Wanzhou’s arrest. Meng’s arrest in Vancouver caused the Chinese to target any global Canadian brands, and by the circumstances of its name, Canada Goose was a target. During this political entanglement, Canada Goose’s stock cratered 17% and at that time valuation was extended and trading at over 12x EV/sales, and almost 70x LTM EV/EBITDA. Moreover, at roughly the peak share price, Bain Capital and Dani Reiss initiated two large secondary offerings. In less than six months, over 51% of the float was dumped onto the open market and over 18% of the fully diluted shares, putting tremendous pressure on the stock following this supply shift.
On the most recent conference call, concerns regarding Hong Kong created yet more uncertainty of the protests, potentially impacting sales and store traffic at its 2 flagship locations. Furthermore, there are some labor cost headwinds with minimum wage increases (Now C $14/hr) in Ontario, Canada, partially mitigated by having over 1,350+/2,000 manufacturing laborers in Manitoba (C $11.35/hr) and Quebec (C $12/hr). In addition to all these concerns, management is remaining elusive with regards to giving more short-term transparency the sell-side desires. Canada Goose CEO, Dani Reiss, is focused on the long-term vision of the company, which can, at times, lead to frustration from investors and the sell-side; but he remains a focused owner operator with a 5+ year vision for the company. This is further exemplified by the way Dani has handled the acquisition of Baffin shoes and the almost constant bombardment of sell-side questions on the timing of an upcoming Canada Goose shoe line. While there are certainly some transitory issues, we feel the company is better positioned as a global brand than it was at the time of its IPO, yet the stock is trading at its cheapest multiple since coming public on a PEG, EV/sales, and forward P/E basis. The market at these levels is pricing some of these concerns as permanent events-- something we think is unlikely.
Throttling Demand While Shifting from Wholesale to DTC
Management has a mid-term target of throttling wholesale distribution to a growth rate of no more than high-single-digits. The real crux of the bull thesis is that margins will hold up and expand further as DTC transitions to become a larger portion of the revenue mix. Early on the wholesale channel was the backbone of the company, management realized the importance of a direct-to-consumer approach whereby management would have more control over inventory and sales. This strategy mimics some of the vertical integration at both Moncler and Lululemon, where direct-to-consumer makes up over 77% share of the business at Moncler and a large share of the business at Lululemon. Canada Goose’s rapid rise in DTC has been unprecedented with regards to execution, from 2015 at minimal levels of DTC business, to having more than half the sales derived from the high margin DTC business.
“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
“The allocation model privileges our in-stores first and then e-commerce. And then we consider the replenishment of wholesale orders, only when it makes sense to do so.” --Johnathan Sinclair. Q2 2020 CC
Abundant Future White Space Opportunities
At roughly one-third the size of Moncler in terms of sales, there are tremendous global white space opportunities for this well-respected 60-year-old family-run business that has primarily been relegated to North America. While Canada Goose still derives most of its sales from Canada (> 35%), three quarters of the incremental growth is 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, since Canada Goose only has 20 global flagship locations and two stores in Europe and five stores in the United States.
Though arguments have been made that Canada Goose products are only relevant for cold weather climates, we think that Canada Goose has done an excellent job at expanding into adjacent categories in light outerwear, raincoats, apparel, sweaters, hybrid knits, and accessories. With its strong global brand power, we think Canada Goose can continue to use product extensions to expand its addressable market throughout various geographies, especially in China. In 2020, of the five planned international stores, three flagship stores are planned for China. China remains a vastly underpenetrated market despite the brand recognition there.
China remains the dominant market for luxury good spending globally and the only large market to grow year-over-year, but it has represented only a fraction of Canada Goose’s total sales. While Asian consumers tend to have an affinity to the brand, the first physical mainland China store was the Beijing flagship store, which opened less than thirteen months ago. Even though China only represents a fraction of sales, we predict that as the brand matures, future Chinese sales could represent over 40% of the company’s total sales-- similar to that of other large European luxury brands.
Luxury Outerwear Duopoly
In 2003, Moncler was taken over by Italian entrepreneur Remo Ruffini, who introduced Moncler as a global outerwear brand. When Moncler IPOed on the Milan Stock Exchange in December of 2013, it was 27 times oversubscribed and rose 47% on the first trading day. Today, there are only two global luxury brands that primarily sell functional and fashionable outerwear-- Canada Goose and Moncler. Originally parka and coat specialists, both Moncler and Canada Goose have begun brand extensions beyond those niche categories by utilizing their strong brand-power to move into adjacent categories. While Moncler price points are slightly higher on average, Canada Goose has also come out with a higher priced line of outerwear called BRANTA and has had various higher priced seasonal collaborations with worldwide designers, which typically sell-out in the first few days. Though Moncler and Canada Goose sell very similar items, individually, they have vastly different strategies. Moncler has been on an aggressive global store expansion with 205 current stores, whereas Canada Goose has a global store base of only 20.
Moncler’s product strategy is also quite different in that it produces a substantial amount of new designs every season in limited quantities and also uses independent designers under its Genius product line to continue to refresh the brand every year. Conversely, Canada Goose’s core products are more timeless in its design, with the signature parka remaining essentially the same design since its inception decades ago. Canada Goose also does some modest innovations, with its aforementioned collaborations and BRANTA line of clothing, though not nearly to the extent of Moncler. Another difference in strategy is Moncler typically makes small quantities of different designs and allows them to sell-out or eventually be marked down; Canada Goose makes higher quantity batches in the hopes of utilizing its distribution network to fill in pockets of demand. In our view Moncler has more fashion risk on an annual basis, whereas Canada Goose has risk in its higher inventories of certain lines of outerwear, potentially risking inventory markdowns. This inventory markdown risk is partially mitigated by controlling the wholesale channel inventory levels as well as the potential to reposition inventory globally for demand pattern changes. Finally, Canada Goose still has not ventured into the discount outlet channel like Moncler, which has recently started opening up outlet centers to liquidate unwanted product at up to 50% off. Eventually Canada Goose will need to go to the outlet route, but for now, demand is so high that it can continue selling out products at full price.
“With core products, the degree of risk around obsolescence or non-saleability is minimised (with CG) as opposed to a company, and I’ll have to use the word Moncler, that makes new products almost every season, where you are risking the consumer not liking what you do, and how do you get rid of it, and so on and so forth. To me, the whole word around inventory and inventory management is critical.” -Paul Silvertown
Canada Goose may have taken some pointers from Moncler on its direct-to-consumer business, but some of its true innovation lies in its retail-light business model. This model was exemplified with Canada Goose’s recent opening of its Toronto flagship store. Throughout the store, a customer can purchase a Canada Goose jacket through online shopping kiosks and can have the purchase delivered by the end of the day. The intent of giving customers a retail experience they can talk about and share on social media is to produce its own organic marketing as well as reinforce the brand quality and trust. The genius of the approach is driving customers to its highest margin channel-- ecommerce. Early on, Canada Goose focused on driving its younger customer base to its online channel. Based on conversations and data compiled from various sources, we estimate that Canada Goose has 20%+ online sales, compared to Moncler at around 10%.
The last difference in strategy we’ve noted is where the products are manufactured. Canada Goose has remained committed to manufacturing core products in Canada to focus on quality control and maintain ability to manage the product inputs in the manufacturing process. For their knitwear sector, Canada Goose does outsource to Italy. Moncler’s manufacturing strategy, which is to lower costs, produces their products in cheaper eastern European countries such as Bulgaria, Moldova, Hungary, and the former Soviet Republic of Georgia. While this helps to boost margins even further, we think it hurts the French and Italian heritage of the brand.
A mild winter has raised new concerns, with John Morris at DA Davidson recently sending out a note notifying clients about discounted Canada Goose products in the wholesale channel. Based on our checks we disagree and tend to side more with Omar Saad of Evercore ISI who commented that, “There is no meaningful discounting on the ground.” Our recent checks actually indicate significantly more Moncler items being discounted, especially online. On the Neiman Marcus website, we found 38 Moncler designs on sale, with most discounted 50% off the MSRP. Of the Canada Goose products that came up on a sales search, there were only two items on sale-- both were scarfs and one was completely sold out. On the Saks Fifth Avenue website, we found 35 Moncler designs on sale and zero Canada Goose products on sale. Bergdorf Goodman had four Moncler designs on sale and zero Canada Goose sales. Finally, Bloomingdales had zero products on sale for both Moncler and Canada Goose. A quick search online at Nordstrom, and six Moncler designs came up with the majority at a 40% markdown; a search for Canada Goose sales revealed no items marked down. We also tried to load Canada Goose items into various shopping carts and use coupon code metasearch functions for discounts, but we had no success in lowering the MSRP.
While it’s tough to get a full handle on the wholesale channel with both online and brick-and-mortar sales, we think that Canada Goose’s online channel is an excellent indication of overall inventory and sales, especially now that management is prioritizing the DTC channel over the wholesale channel. Selling out of inventory on CG’s online channel should indicate very light inventory or complete sell throughs at the wholesale level in various designs. For instance, we went through all of the men’s outerwear, which included over 125 designs on Canada Goose’s website; of the various size and color combinations, we noted 725 fully sold out. Canada Goose women’s collection appeared to be even more popular with only around 110 designs in outerwear, in total 879 color and size options were fully sold out. This does not include designs that completely sold out in every size, but we think it gives a good approximation of the demand in the most prioritized channel. One caveat is the data doesn’t fully reflect less common sizes such as XXXL and XS, which are made in much smaller quantities.
We conducted the same analysis on Moncler’s website; of the 150 men’s designs only 421 color and size combinations were sold out for all men’s outerwear. For Moncler women’s outerwear, there were over 165 designs available online, with only 333 color and size combinations sold out. What’s remarkable about this is that Moncler has always had more designs with a shallower level of inventory because of the constant refresh the brand does almost every season. Though there is no indication of how many items were pulled due to being fully sold out in all colors and sizes, there were a few categories that remained on the site as “out of stock”. Another consideration is that Moncler has a much larger retail footprint than Canada Goose, and carries certain designs in its boutiques only-- so the comparisons are fairly accurate but not entirely apples-to-apples.
Moncler is more established than Canada Goose at almost three times the sales, however it has been growing at about half the rate of Canada Goose, all while sporting a significantly higher multiple. Additionally, there has been a recent takeout premium built into the price of Moncler based on Kerings potential interest. Even then we still believe that Canada Goose should trade at a decent premium to Moncler given its underpenetrated markets, nascent product extensions, and burgeoning brand awareness in both Europe and Asia.
Since coming public, Canada Goose has always traded at a significant premium to Moncler on both a EV/sales and forward P/E. Canada Goose’s multiple has compressed over the past 12 months, while Moncler’s EV/sales and forward P/E ratio have expanded in the past 12 months. The most glaring divergence is in Canada Goose’s PEG ratio vs. Moncler; in the past 12 months, it was roughly at parity, and now Moncler is trading at almost a 3 turn premium to Canada Goose. The huge differential in the PEG is unwarranted, even if one considers below consensus topline growth for Canada Goose.
Relative Value Comps
Global luxury retailers have always traded at premium multiples to the market, with their higher profit margins and duration of brand power. It also has been one of the few bright spots in retail with consistent growth and on average expanding margins. At the opposite end of the spectrum, the more commoditized fashion brands typically use aggressive discounting to generate store traffic and sales volume and typically don’t have the sustainable growth of the luxury peers. In the cohort of global luxury retailers we have included some of the top brands in their individual categories that we think are representative of the quality and brand power of Canada Goose. To our surprise, Canada Goose appears as one of the cheapest stocks among global luxury peers. The gap among peers is quite compelling, and clearly the market at this price is saying the growth rates will start normalizing at substantially lower rates than consensus estimates.
Risks
--Bain Capital and Dani Reiss initiate a sale of the business to a luxury conglomerate off a depressed multiple.
--PETA concerns around the use of animal furs for the hoods of Canada Goose’s signature parkas; based on industry conversations, it appears likely that Canada Goose will eventually eliminate coyote fur from the hoods.
--A high end discretionary product can be susceptible to economic cycles; the brand grew rapidly throughout the ‘08/’09 GFC, but given its global footprint, no assurances can be made that Canada Goose will be able to keep its growth trajectory.
--Continued geo-political issues and a renewed interest in a Chinese boycott of Canada Goose products.
--Continued counterfeits that degrade the brand value over time.
--A super-majority voting structure controlled by Bain Capital and Dani Reiss.
Summary
In May 2019, management initiated its first ever stock buyback, a 1.6 million share buyback amounting to about 1.5% of the fully diluted shares outstanding. It’s rare to see a high growth/high ROE company spending money to buy stock, but we think the buyback sends a clear signal that the stock price is compellingly cheap at these levels-- especially now, off almost 55% from its late 2018 peak. 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. Since coming public, the stock and sales have doubled; however, the underlying operating profits have gone up five-fold. Fixed cost leverage 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 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 quite compelling in today’s market for a global luxury retailer in its infancy.
Catalyst
--Sale of business to luxury conglomerate, Moncler currently being solicited.
--Successful brand extensions into accessories, shoes, and apparel.
--China success with new stores in 2020.
--Continued higher than expected topline and EPS growth.
--Further expansion of the higher margin DTC business taking more share from wholesale.
I and/or others I advise do not hold a material investment in the issuer's securities.
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I0_USD_of_Warren_Buffet
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Canada Goose (NYSE: GOOS) is a vertically integrated 63-year-old manufacturer and retailer of outdoor apparel for men, women, and children-- traditionally known for the famous parka. Canada Goose (CG) is an organic growth story controlled by an excellent family owner/operator and Bain Capital. 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. Since coming public, its stock and sales have doubled; however, the underlying operating profits have gone up five-fold. Fixed cost leverage has become more apparent as the business continues to scale and shift from the low margin wholesale business to the direct-to-consumer (DTC) channel, which has a gross margin uplift of ~ 3,000 basis points. It is rare 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 stock is off almost 50% from all-time highs. The stock is down due to a multitude of, what we believe, are short-term issues, including volatility in wholesale inventory/shipments, a 61% build in inventory y/y, exposure to unrest in Hong Kong, the China Coronavirus, and recent selling by Bain Capital at the stock’s recent peak. While these issues have put pressure on the stock, we believe virtually all the issues are transitory, known, and fixable over time. In our view, these short-term pressures have created an excellent entry point, given the vast white space opportunities and growing global demand that is nascent in its lifecycle.
The Real McCoy
The global parka movement was essentially created by Canada Goose, with its signature fur trimmed hooded jackets. On the back of these famous parkas, Canada Goose has launched itself from a regional Canadian brand to a global leader in luxury outerwear. This is a brand with a long lineage of producing some of the highest quality outerwear across the globe, and that sense of quality is synonymous with its brand extensions into other categories such as apparel, light outerwear, and eventually, footwear.
While the Canada Goose brand is quite familiar in cold weather climates within North America, the brand is still in its infancy in other parts of the U.S. and even more so globally. For instance, the brand started its direct-to-consumer push just over 5 years ago and only recently opened its first two physical stores in Toronto and New York City in 2016. Canada Goose is unique in that, while it has global brand recognition, it is only one third the size of its closest competitor, Moncler. Globally, there are only 20 physical stores and sales are still below CAD $1bn. Given the vast whitespace, we think there is 25%+ sales growth with 30%+ EPS growth for the next 3-5 years and double-digit EPS growth for at least the next decade is feasible.
The distribution network and manufacturing capabilities have been built out over the past few years to satiate strong product demand. Consumer demand has historically outweighed the amount of product Canada Goose can manufacture in Canada. While it is a good problem to have, CG management has had to invest a significant portion of free cash flow back into the business to continue this growth trajectory. Over the past two and a half years, the team has built 4 manufacturing facilities (8 total facilities within Canada). Furthermore, a recent acquisition of Baffin (shoe manufacturer) in November of 2018 was a natural brand expansion into a new category that we think is relevant to Canada Goose customers. Capital spending has been extremely high, given all the recent fixed cost investments to keep up with top-line growth, which has doubled approximately every 2 years. Capital spending in FY 2019 as a percentage of sales was 8.2% (versus peers ~4%) and, given the planned C$75mn (7.5% of sales) investment in FY 2020, capital spending should start normalizing further with more free cash flow generation being used on the recently initiated stock buyback.
It is clear that the Canada Goose brand resonates well with consumers as a global luxury outerwear brand; however, the market still does not value it as such. If one factors in CG’s growth rates relative to peers, Canada Goose trades at a steep discount to almost all luxury peers and a steep discount to its closest competitor, Moncler. We believe much of the disconnect is from the consensus perception of the brand within North America-- most of which we think is misplaced when taking into consideration three quarters of the incremental growth is coming from outside North America. Below are a few viewpoints we’ve heard over the past few months after speaking with investors in the space.
Consensus View
- Canada Goose is a saturated brand that is starting to experience brand fatigue.
- North America is a fully penetrated market with limited growth opportunities outside of the traditional cold weather markets.
- A parka retailer like Canada Goose sells a commodity product that is exposed to malls and physical store-based traffic trends.
- The high multiple more than reflects any future growth and/or margin expansion priced into the stock.
- This is another recent IPO that is overpriced and overhyped.
- China geopolitical issues and the never-ending trade war will directly impact Canada Goose.
- Concerns around demand and product/sales being pulled forward from distributors.
- The Hong Kong protest situation will impact the brand longer than expected.
- The Coronavirus impacting demand in China.
- The Chinese boycott and political issues with regard to Huawei could permanently impair the brand in China.
Variant View
- Canada Goose is the original innovator in winter apparel fashion and functionality and has significant pricing power.
Transition to a direct-to-consumer focus from wholesale will continue to help margins expand going forward.
- The direct-to-consumer transition from wholesale has rapidly accelerated fixed cost leverage with gross margins expanding ~ 2,200 basis point in 5 years.
- The consensus growth profile for Canada Goose is highly conservative given Asia/China expansion, brand extensions, and coming footwear line (Baffin acquisition).
- Canada Goose is one of the few global luxury brands in its infancy that has had consistent top-line growth along with consistent margin expansion.
A Unique Customer Engagement Experience
Canada Goose has a unique approach to its 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 no for-sale inventory; the store is comprised of an entire buyer experience built around a snow storm, 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.
Stock Weakness
The stock is down for a multitude of reasons-- from PETA outcry over the use of coyote fur on the hoods, to concerns over the volatility of seasonal inventory builds, as well as Hong Kong unrest. At one point, Canada Goose was at the center of an international controversy where it was put in the spotlight after the CEO of Huawei, Meng Wanzhou’s arrest. Meng’s arrest in Vancouver caused the Chinese to target any global Canadian brands, and by the circumstances of its name, Canada Goose was a target. During this political entanglement, Canada Goose’s stock cratered 17% and at that time valuation was extended and trading at over 12x EV/sales, and almost 70x LTM EV/EBITDA. Moreover, at roughly the peak share price, Bain Capital and Dani Reiss initiated two large secondary offerings. In less than six months, over 51% of the float was dumped onto the open market and over 18% of the fully diluted shares, putting tremendous pressure on the stock following this supply shift.
- 06/22/2018: 10,000,000 shares offer by Bain, Dani Reiss, and John Black at $62.42 per share. Bain sold 8.4mn shares, Dani Reiss sold 1.5mn shares, and John Black sold 100,000 shares.
- 11/28/2018 10,000,000 shares offered by both Bain and Dani at $64.52 per share. Bain sold 8.49mn shares, Dani Reiss sold 1.5mn, and Jean-Marc Huet sold 10,000 shares.
On the most recent conference call, concerns regarding Hong Kong created yet more uncertainty of the protests, potentially impacting sales and store traffic at its 2 flagship locations. Furthermore, there are some labor cost headwinds with minimum wage increases (Now C $14/hr) in Ontario, Canada, partially mitigated by having over 1,350+/2,000 manufacturing laborers in Manitoba (C $11.35/hr) and Quebec (C $12/hr). In addition to all these concerns, management is remaining elusive with regards to giving more short-term transparency the sell-side desires. Canada Goose CEO, Dani Reiss, is focused on the long-term vision of the company, which can, at times, lead to frustration from investors and the sell-side; but he remains a focused owner operator with a 5+ year vision for the company. This is further exemplified by the way Dani has handled the acquisition of Baffin shoes and the almost constant bombardment of sell-side questions on the timing of an upcoming Canada Goose shoe line. While there are certainly some transitory issues, we feel the company is better positioned as a global brand than it was at the time of its IPO, yet the stock is trading at its cheapest multiple since coming public on a PEG, EV/sales, and forward P/E basis. The market at these levels is pricing some of these concerns as permanent events-- something we think is unlikely.
Throttling Demand While Shifting from Wholesale to DTC
Management has a mid-term target of throttling wholesale distribution to a growth rate of no more than high-single-digits. The real crux of the bull thesis is that margins will hold up and expand further as DTC transitions to become a larger portion of the revenue mix. Early on the wholesale channel was the backbone of the company, management realized the importance of a direct-to-consumer approach whereby management would have more control over inventory and sales. This strategy mimics some of the vertical integration at both Moncler and Lululemon, where direct-to-consumer makes up over 77% share of the business at Moncler and a large share of the business at Lululemon. Canada Goose’s rapid rise in DTC has been unprecedented with regards to execution, from 2015 at minimal levels of DTC business, to having more than half the sales derived from the high margin DTC business.
“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
“The allocation model privileges our in-stores first and then e-commerce. And then we consider the replenishment of wholesale orders, only when it makes sense to do so.” --Johnathan Sinclair. Q2 2020 CC
Abundant Future White Space Opportunities
At roughly one-third the size of Moncler in terms of sales, there are tremendous global white space opportunities for this well-respected 60-year-old family-run business that has primarily been relegated to North America. While Canada Goose still derives most of its sales from Canada (> 35%), three quarters of the incremental growth is 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, since Canada Goose only has 20 global flagship locations and two stores in Europe and five stores in the United States.
Though arguments have been made that Canada Goose products are only relevant for cold weather climates, we think that Canada Goose has done an excellent job at expanding into adjacent categories in light outerwear, raincoats, apparel, sweaters, hybrid knits, and accessories. With its strong global brand power, we think Canada Goose can continue to use product extensions to expand its addressable market throughout various geographies, especially in China. In 2020, of the five planned international stores, three flagship stores are planned for China. China remains a vastly underpenetrated market despite the brand recognition there.
China remains the dominant market for luxury good spending globally and the only large market to grow year-over-year, but it has represented only a fraction of Canada Goose’s total sales. While Asian consumers tend to have an affinity to the brand, the first physical mainland China store was the Beijing flagship store, which opened less than thirteen months ago. Even though China only represents a fraction of sales, we predict that as the brand matures, future Chinese sales could represent over 40% of the company’s total sales-- similar to that of other large European luxury brands.
Luxury Outerwear Duopoly
In 2003, Moncler was taken over by Italian entrepreneur Remo Ruffini, who introduced Moncler as a global outerwear brand. When Moncler IPOed on the Milan Stock Exchange in December of 2013, it was 27 times oversubscribed and rose 47% on the first trading day. Today, there are only two global luxury brands that primarily sell functional and fashionable outerwear-- Canada Goose and Moncler. Originally parka and coat specialists, both Moncler and Canada Goose have begun brand extensions beyond those niche categories by utilizing their strong brand-power to move into adjacent categories. While Moncler price points are slightly higher on average, Canada Goose has also come out with a higher priced line of outerwear called BRANTA and has had various higher priced seasonal collaborations with worldwide designers, which typically sell-out in the first few days. Though Moncler and Canada Goose sell very similar items, individually, they have vastly different strategies. Moncler has been on an aggressive global store expansion with 205 current stores, whereas Canada Goose has a global store base of only 20.
Moncler’s product strategy is also quite different in that it produces a substantial amount of new designs every season in limited quantities and also uses independent designers under its Genius product line to continue to refresh the brand every year. Conversely, Canada Goose’s core products are more timeless in its design, with the signature parka remaining essentially the same design since its inception decades ago. Canada Goose also does some modest innovations, with its aforementioned collaborations and BRANTA line of clothing, though not nearly to the extent of Moncler. Another difference in strategy is Moncler typically makes small quantities of different designs and allows them to sell-out or eventually be marked down; Canada Goose makes higher quantity batches in the hopes of utilizing its distribution network to fill in pockets of demand. In our view Moncler has more fashion risk on an annual basis, whereas Canada Goose has risk in its higher inventories of certain lines of outerwear, potentially risking inventory markdowns. This inventory markdown risk is partially mitigated by controlling the wholesale channel inventory levels as well as the potential to reposition inventory globally for demand pattern changes. Finally, Canada Goose still has not ventured into the discount outlet channel like Moncler, which has recently started opening up outlet centers to liquidate unwanted product at up to 50% off. Eventually Canada Goose will need to go to the outlet route, but for now, demand is so high that it can continue selling out products at full price.
“With core products, the degree of risk around obsolescence or non-saleability is minimised (with CG) as opposed to a company, and I’ll have to use the word Moncler, that makes new products almost every season, where you are risking the consumer not liking what you do, and how do you get rid of it, and so on and so forth. To me, the whole word around inventory and inventory management is critical.” -Paul Silvertown
Canada Goose may have taken some pointers from Moncler on its direct-to-consumer business, but some of its true innovation lies in its retail-light business model. This model was exemplified with Canada Goose’s recent opening of its Toronto flagship store. Throughout the store, a customer can purchase a Canada Goose jacket through online shopping kiosks and can have the purchase delivered by the end of the day. The intent of giving customers a retail experience they can talk about and share on social media is to produce its own organic marketing as well as reinforce the brand quality and trust. The genius of the approach is driving customers to its highest margin channel-- ecommerce. Early on, Canada Goose focused on driving its younger customer base to its online channel. Based on conversations and data compiled from various sources, we estimate that Canada Goose has 20%+ online sales, compared to Moncler at around 10%.
The last difference in strategy we’ve noted is where the products are manufactured. Canada Goose has remained committed to manufacturing core products in Canada to focus on quality control and maintain ability to manage the product inputs in the manufacturing process. For their knitwear sector, Canada Goose does outsource to Italy. Moncler’s manufacturing strategy, which is to lower costs, produces their products in cheaper eastern European countries such as Bulgaria, Moldova, Hungary, and the former Soviet Republic of Georgia. While this helps to boost margins even further, we think it hurts the French and Italian heritage of the brand.
A mild winter has raised new concerns, with John Morris at DA Davidson recently sending out a note notifying clients about discounted Canada Goose products in the wholesale channel. Based on our checks we disagree and tend to side more with Omar Saad of Evercore ISI who commented that, “There is no meaningful discounting on the ground.” Our recent checks actually indicate significantly more Moncler items being discounted, especially online. On the Neiman Marcus website, we found 38 Moncler designs on sale, with most discounted 50% off the MSRP. Of the Canada Goose products that came up on a sales search, there were only two items on sale-- both were scarfs and one was completely sold out. On the Saks Fifth Avenue website, we found 35 Moncler designs on sale and zero Canada Goose products on sale. Bergdorf Goodman had four Moncler designs on sale and zero Canada Goose sales. Finally, Bloomingdales had zero products on sale for both Moncler and Canada Goose. A quick search online at Nordstrom, and six Moncler designs came up with the majority at a 40% markdown; a search for Canada Goose sales revealed no items marked down. We also tried to load Canada Goose items into various shopping carts and use coupon code metasearch functions for discounts, but we had no success in lowering the MSRP.
While it’s tough to get a full handle on the wholesale channel with both online and brick-and-mortar sales, we think that Canada Goose’s online channel is an excellent indication of overall inventory and sales, especially now that management is prioritizing the DTC channel over the wholesale channel. Selling out of inventory on CG’s online channel should indicate very light inventory or complete sell throughs at the wholesale level in various designs. For instance, we went through all of the men’s outerwear, which included over 125 designs on Canada Goose’s website; of the various size and color combinations, we noted 725 fully sold out. Canada Goose women’s collection appeared to be even more popular with only around 110 designs in outerwear, in total 879 color and size options were fully sold out. This does not include designs that completely sold out in every size, but we think it gives a good approximation of the demand in the most prioritized channel. One caveat is the data doesn’t fully reflect less common sizes such as XXXL and XS, which are made in much smaller quantities.
We conducted the same analysis on Moncler’s website; of the 150 men’s designs only 421 color and size combinations were sold out for all men’s outerwear. For Moncler women’s outerwear, there were over 165 designs available online, with only 333 color and size combinations sold out. What’s remarkable about this is that Moncler has always had more designs with a shallower level of inventory because of the constant refresh the brand does almost every season. Though there is no indication of how many items were pulled due to being fully sold out in all colors and sizes, there were a few categories that remained on the site as “out of stock”. Another consideration is that Moncler has a much larger retail footprint than Canada Goose, and carries certain designs in its boutiques only-- so the comparisons are fairly accurate but not entirely apples-to-apples.
Moncler is more established than Canada Goose at almost three times the sales, however it has been growing at about half the rate of Canada Goose, all while sporting a significantly higher multiple. Additionally, there has been a recent takeout premium built into the price of Moncler based on Kerings potential interest. Even then we still believe that Canada Goose should trade at a decent premium to Moncler given its underpenetrated markets, nascent product extensions, and burgeoning brand awareness in both Europe and Asia.
Since coming public, Canada Goose has always traded at a significant premium to Moncler on both a EV/sales and forward P/E. Canada Goose’s multiple has compressed over the past 12 months, while Moncler’s EV/sales and forward P/E ratio have expanded in the past 12 months. The most glaring divergence is in Canada Goose’s PEG ratio vs. Moncler; in the past 12 months, it was roughly at parity, and now Moncler is trading at almost a 3 turn premium to Canada Goose. The huge differential in the PEG is unwarranted, even if one considers below consensus topline growth for Canada Goose.
Relative Value Comps
Global luxury retailers have always traded at premium multiples to the market, with their higher profit margins and duration of brand power. It also has been one of the few bright spots in retail with consistent growth and on average expanding margins. At the opposite end of the spectrum, the more commoditized fashion brands typically use aggressive discounting to generate store traffic and sales volume and typically don’t have the sustainable growth of the luxury peers. In the cohort of global luxury retailers we have included some of the top brands in their individual categories that we think are representative of the quality and brand power of Canada Goose. To our surprise, Canada Goose appears as one of the cheapest stocks among global luxury peers. The gap among peers is quite compelling, and clearly the market at this price is saying the growth rates will start normalizing at substantially lower rates than consensus estimates.
Risks
--Bain Capital and Dani Reiss initiate a sale of the business to a luxury conglomerate off a depressed multiple.
--PETA concerns around the use of animal furs for the hoods of Canada Goose’s signature parkas; based on industry conversations, it appears likely that Canada Goose will eventually eliminate coyote fur from the hoods.
--A high end discretionary product can be susceptible to economic cycles; the brand grew rapidly throughout the ‘08/’09 GFC, but given its global footprint, no assurances can be made that Canada Goose will be able to keep its growth trajectory.
--Continued geo-political issues and a renewed interest in a Chinese boycott of Canada Goose products.
--Continued counterfeits that degrade the brand value over time.
--A super-majority voting structure controlled by Bain Capital and Dani Reiss.
Summary
In May 2019, management initiated its first ever stock buyback, a 1.6 million share buyback amounting to about 1.5% of the fully diluted shares outstanding. It’s rare to see a high growth/high ROE company spending money to buy stock, but we think the buyback sends a clear signal that the stock price is compellingly cheap at these levels-- especially now, off almost 55% from its late 2018 peak. 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. Since coming public, the stock and sales have doubled; however, the underlying operating profits have gone up five-fold. Fixed cost leverage 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 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 quite compelling in today’s market for a global luxury retailer in its infancy.
Catalyst
--Sale of business to luxury conglomerate, Moncler currently being solicited.
--Successful brand extensions into accessories, shoes, and apparel.
--China success with new stores in 2020.
--Continued higher than expected topline and EPS growth.
--Further expansion of the higher margin DTC business taking more share from wholesale.
I and/or others I advise do not hold a material investment in the issuer's securities.
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