- KPB & Co Research
Canada Goose Holdings Ltd (TSE: GOOS, NYSE: GOOS) has seen its stock price gone up by more than 4X since it went public on March-2017. The stock opened at approximately $CAD 21 per share and in less than 2 years the stock went to a high of CAD$ 92 per share. Today, the stock sits at CAD$ 59 per share, which is still fairly high. The company's 30+ percentage growth in revenues, and profits were the carrots that led many to BUY. In our view, the long-term potential for the company is compelling, however at these prices, investors are taking on massive execution risks, even in a scenario where economic conditions remain buoyant. In a scenario where economic activity slows, the cyclical nature of the business could leave investors exposed to significant losses. It is with these thoughts in mind that we argue for patience, do not kill the goose that laid the golden egg.
With forward revenues estimated at US$800Mn for the fiscal year ending in March-2019, Canada Goose is a fledgling clothing manufacturer with a large white space opportunity in the global premium outerwear category. At the time Bain Capital took a 70% stake in the business, the company had less than 200Mn in revenues, and distributed its products primarily through wholesale channels throughout Canada. Also, the company manufactured varied Stock keeping units (SKUs) of only one product line, using facilities located primarily in Canada. Today, after growing quickly over the last 3-years, the company has expanded its manufacturing facilities in Canada, built 2 retail stores in Canada, 3 in the USA, 1 in London, and is about to open a store in China. The company also built 9 e-commerce stores throughout Europe. Judging by the amount of work that was done, it appears CEO Dani Reiss has been pretty busy as well. Yet, his work is just beginning. The announced 5 retail store openings for fiscal 2019, barely scratch the surface of the growth potential of the company. This potential is best understood by reflecting on the statement:
we sold approximately 52 jackets in fiscal 2018 per 1,000 addressable customers, as defined as people living above the 37th Parallel with annual household income of greater than $100,000. In larger addressable markets such as the United States, Western Europe, Japan, South Korea and China, our corresponding penetration levels range from one to 10 units per 1,000 addressable customers. As we continue strengthening our brand and building out customer access globally, achieving 35% of our current penetration in Canada would more than triple annual unit volume.
Canada Goose 3-Year Sales History
Yet, We Still Urge Caution
Canada Goose (TSE: GOOS, NYSE: GOOS) is trading at a sky-high valuation (CAD$3.5Bn market cap) when there is tremendous amount of work to be done. The current price per share is in excess of 50X estimated forward earning per share, which implies high double-digit growth in revenues and cashflows for at least another 10 years. Recently, management, including Bain Capital, sold 10Mn subordinate voting shares in the open market leaving us to wonder whether they believe the valuation is currently streched. We think the growth opportunity is compelling, but we are not willing to take that kind of execution risk, especially given what is on the horizon.
First, the business is highly cyclical as outlined in the risk of uncertainties section of form 20-F. Should there be a downturn in the economy, this business will be one of the first to experience a cyclical reduction in demand, and the company's sky-high valuation will likely follow. Second, the company is in the very early stages of development and there are likely skeletons in the closet that have yet to come out. One example is the identification of material weaknesses in the company's internal control over financial reporting for fiscal year 2017 and 2018. While the nature of this shortcoming is not enough to short the stock, this issue is a red flag and underscores the amount of work management needs to build a solid enterprise. Third, approximately 40% of all sales is attributable to 2 main wholesalers. Management did not provide clear disclosure on the breakdown of sales attributable to company owned channels versus wholesale, but we estimate that the number is somewhere north of 60%. This is important because it means that the company has little control over the customer experience which is a major strategic disadvantage is today's retail landscape. The company also relies on only a handful of suppliers for the raw materials used to make its clothing.
How A Canada Goose Jacket is Made
As the business expands we expect further diversification in the company's supply chain, and distribution channels, but can you identify a company that has done this smoothly? Even the best managers make costly mistakes. Lululemon experienced supply chain issues and had its stock price cut in half. Chipotle also had issues in its supply chain and also had its stock price cut in half. All of these companies are emerging growth companies with sales at several multiples of Canada Goose's.
The cherry on top is that as a minority shareholder in a controlled holding company, we have little shareholder rights. The corporate overlord can beat us to a pulp, if things go wrong. Bain Capital control over 60% of the Goose. Our subordinate shares has less voting power than ordinary shares.
We don't disagree that Canada Goose is in a unique position to use its enormous brand equity to drive top line sales growth in the months ahead. After all, the company's iconic brand can be seen on many movie stars, athletes, and social media influencers further which will certainly strengthen the brand equity in the eyes of customers.
Our point of contention is that that growth is likely already accounted for in the stock price. At these levels, the stock price represents more than downside risks than upside. When the risks are unbalanced to the downside, caution is warranted.