📍 TL;DR

• Fundamental analysis is exceptionally difficult at the moment thanks to a staggering number of crosswinds.

• GOOS stock provides a perfect example.

• Management targets from the Investor Day suggest the stock is a multi-bagger. But four years’ worth of declining earnings imply an attractive short opportunity.

• Picking a side is no easy task.

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Personally speaking, this is the most difficult equity market I’ve ever seen. And I don’t mean that in terms of the short- or mid-term direction of the market. Those types of questions are never easy. What I’m referring to is a much more important question (at least for my investing style): what is this business worth?

Right now the answer often feels like, “Who the hell knows?” Looking backwards, which year was the most “normalized” from 2019-2022? Looking forwards, what, exactly, is 2023 going to be on that same fuzzy scale?

Of course, the answer is: “it depends”. It depends on the company — and it depends on the sector. The biggest irony surrounding the market right now is that so many investors are focused on the macro cycle — unemployment, interest rates, the Fed, etc. — when within the economy, there is enormous cyclical variability among industries.

Some sectors are probably close to the trough (semiconductors likely top that list). Some look equally near the top: we called out boating stocks last year, and other big-ticket items like residential furniture probably qualify as well. Travel demand certainly is roaring, and there’s some logic to the idea that consumers’ post-pandemic willingness to pay pretty much any price to go pretty much anywhere has a shelf life.

For some sectors, it’s not even clear where in the cycle they are. Take building products, for instance. With interest rates up and the housing market frozen, are we coming down from a peak in 2023 after a roaring 2021-2022? Or are we in fact still in the “early innings” of a boom? Home Depot HD 0.00 management has argued the latter, positing that the millions of homeowners shackled in the golden handcuffs of a 2-handle mortgage won’t be able to move for years — and so will have to spend on major projects to get any kind of upgrades to their living situations.

It’s tough to argue against the best home improvement retailer of all time (and one of the best retailers of any kind). But, on the other hand, every bit of history we have suggests that renovation demand is tied pretty closely to housing demand — is this time really different?

Valuation Matters

These issues all play into valuation. But there are purer questions surrounding what multiples investors should pay. Have we all decided — again — that stock-based compensation doesn’t really count? Do higher rates persist, in turn suggesting that equity multiples should be reduced for a multi-year period (at least)? Who is taking a 6% earnings yield with minimal growth and equity risk when they can get 4.5% in a six-month CD?

To be sure, these questions existed to some degree in, say, 2017. But the range of reasonable answers appears far wider. As a result, so does the range of reasonable answers to that important question of what a business is actually worth. Cut profit margins for a leveraged business by a couple hundred basis points, reduce the multiple a turn or two and increase out-year cash interest by 30% and suddenly a screaming buy went to an easy short.

But it’s not an easy short, because a short requires that the market agree with you sooner rather than later, and it’s certainly possible that the market believes margins in fact are going to go higher or that the U.S. consumer will keep spending or that we’re all going to pretend dilution isn’t real for at least two more years.

And by the time the market figures out you were right all along — assuming you were right all along — you spent two years of your life watching your portfolio shrivel while “it’s gotta be cheap it’s down 85% from the highs!” types take victory laps on Twitter.

I am, of course, hyperventilating for effect. For those of us who enjoy doing the work, “the most difficult equity market I’ve ever seen” is almost interchangeable with “the most interesting equity market I’ve ever seen”. Even so, it is difficult to peg fair value with any degree of confidence.

And that long introduction brings us to Canada Goose GOOS 0.00 — a story which encapsulates so many of the challenges facing investors at the moment.

What We Know About Canada Goose

Canada Goose is an apparel company centered around heavyweight, down-filled, parkas. The company has expanded its assortment in recent years to include lightweight jackets, fleece, footwear, and accessories (among others), but heavyweight down still drives close to 60% of total sales. Canada Goose products are high-performance and expensive: its parkas retail for well past $1,000.

The company was founded in 1957, but was a niche business for several decades. In 2001, for instance, Canada Goose generated roughly C$2 million in sales. Fiscal 2023 (ending March) guidance contemplates revenue just shy of C$1.2 billion. Roughly two-thirds of that revenue is direct-to-consumer, through both the company’s website and 51 retail locations. The remainder comes from ~1,500 third-party points of sale.

Canada Goose went public in 2017, and it’s been a roller-coaster since then:

source: finviz.com

The strong post-IPO rally was interrupted in late 2018 when the company became entangled in international politics. After the chief financial officer of China’s Huawei Technologies was arrested in Canada, China threatened “severe consequences” and media outlets in the country pushed for a boycott. The tensions arrived just after Canada Goose had made a push into the region, opening its first two stores and launching an online pilot with Alibaba BABA 0.00. GOOS tanked almost 40% in five weeks, and it’s never sniffed those highs again

The company did post a reasonably solid FY20, with revenue up 15%, though adjusted profit was pretty much flat. The pandemic wreaked havoc on FY21 (revenue -5.7% for the full year despite a 48% increase in Q4, though that quarter of course benefited from a softer comparison). The recovery so far hasn’t been quite what investors hoped for, either.

In the context of a roaring apparel market, FY22 was poor: adjusted operating income was nearly 15% below the FY19 and FY20 levels. Revenue grew, but margins were the big problem, plunging from 25% in FY19 to just under 16% three years later. FY23 looked better for a while, but after this month’s fiscal Q3 report Canada Goose slashed its full-year outlook. Margins are guided to a range of 14.2%-15.3% — down ~1,000 bps from FY19. Adjusted EPS of C$0.92-C$1.03 (US$0.69-US$0.77) is well below the C$1.36 print from four years earlier.

In that context, the volatility over the nearly six years Canada Goose has been public is absolutely not a surprise. Nor has it paid to ride out that volatility. At Wednesday’s close, annualized returns from the IPO price (just below US$13) are a touch over 8%. Returns from the first-day close are roughly half as high.

The Bear Case

That history seems to set up a reasonably attractive short case. Indeed, almost 24% of the float (though ~12% of shares outstanding) are sold short at the moment.

The fundamentals seem to support that case. This is a company that claims to be a luxury provider. Yet, again, its margins are going to compress roughly ten percentage points in five years.

Simply put, that does not happen to luxury companies. Not ‘true’ luxury companies, anyway. It happens to faddish products, and to companies that are buying revenue growth (which is still holding up at a roughly 20% annualized rate since the IPO).

At Wednesday’s close, Canada Goose has an enterprise value right at C$4 billion. Adjusted operating income guidance of C$167-C$182 million, and depreciation and amortization of ~$90 million, suggest Adjusted EBITDA in the range of C$265 million, for a 15x EV/EBITDA multiple.

That’s a high multiple. Canada Goose isn’t necessarily a declining business; as we’ll see, there’s hope for the company to reverse its profit slide. But for five years, it’s been a business whose profits have declined. Presume further margin compression and profit erosion — whether because of recession, or the products simply not hitting, or poor management, or all of the above — and there’s a pathway toward this being a profitable short.

Investors can also look to another apparel company with a similar story. Like Canada Goose, that peer claims to be a luxury purveyor (but probably isn’t); like Canada Goose, it sees a huge opportunity in China specifically and Asia more broadly; and like Canada Goose, it cut guidance this month. That lowered outlook led its stock down 23.6%; GOOS fell 23.7% when it did the same.

That company is Capri Holdings CPRI 0.00, owner of Michael Kors, Jimmy Choo, and Versace. CPRI trades at less than 9x adjusted EPS guidance for the year and about 8x EBITDA. Apply those multiples to GOOS and the stock gets halved. No wonder so many traders are short.

Investor Day And The Bull Case

And yet, it does seem incredibly difficult to assume that the margin compression of the last 4-5 years necessarily has to persist going forward.

This is a company that is ramping its footprint in a hurry (the company only had two stores at the end of FY17). It got caught up in geopolitics. It was hit by a worldwide pandemic — while selling products that are designed (and priced) to be worn outdoors for long periods of time. Even the weather (at least in the U.S.) hasn’t cooperated in recent years.

On the expense front, supply chain issues have been a factor and input costs have risen.

In a pre-pandemic environment, the default analysis of a self-proclaimed luxury business whose operating margins went from 25% to 15% would be to understand whether they could hold 15%. In normal times — including recessions, because, again, this is supposed to be a luxury business — that kind of compression almost can’t happen without significant flaws in the underlying brand.

But then, these are not normal times. They haven’t been for a while, and for Canada Goose, “normal times” haven’t really applied since roughly November 2018. I certainly wouldn’t assign a price target to GOOS based on 20% margins, let alone 25%. But nor am I willing to write off the possibility of a recapture of some of the company’s lost profitability.

Management Speaks

Canada Goose management is far more aggressive. At last week’s Investor Day presentation, the company targeted a doubling of operating margin by fiscal 2028. That year, Canada Goose expects C$3 billion in revenue at 30% adjusted operating margins

It’s worth noting up front that the market does not believe that projection at all. GOOS closed trading the day of the presentation up 1.7%, while the S&P 500 rose 1.1%. More to the point, that kind of upside is nowhere close to priced in. If those targets are hit, GOOS is trading at less than 4x FY28 Adjusted EBITDA, and under 6x FY28 adjusted net income.

Put another way, if Canada Goose does hit those targets, GOOS is a multi-bagger. Shares could easily increase 400%, particularly given that management plans to buy back shares along the way.

To be sure, the odds of Canada Goose hitting those targets appear slim. When management and the market diverge, the smart play is usually to side with the market. The revenue bogey (~20% annualized) itself looks difficult, with management essentially saying that because they’ve grown 20% of late, they can grow 20% going forward as well. But the margin target, particularly in the context of recent results, looks like an impossible ask.

Here’s how management sees it playing out:

source: Canada Goose Investor Day presentation, February 7

Only about 200 of the 1500 bps in expected margin expansion is coming from cost of goods sold (Canada Goose expects gross margins to go from ~68% to ~70%). Even that projection faces a potential roadblock: management expects pricing to offset input costs, but that’s only possible if a) the brand is as strong as management believes it is, and not as weak as the market believes it is and b) if broader inflation doesn’t chip away at demand from the more price-sensitive customers.

But the big leaps are coming from the expansion of DTC sales (penetration of which has expanded greatly in recent years), store productivity, and operating leverage. Of course, all of those things, like the more modest expected improvement in gross margins, rely on steadily increasing, full-priced sales.

That in turn takes us back to our original point, via the first “Key Callout” on the slide above: “DTC comp performance and return to historical levels key”. Management itself says the business has to get back to where it was. If it does, longs win. If it doesn’t, shorts profit.

Of course, the easiest pathway for the business to get back to where it was is if the brand, as management seems to believe, never really left. In normal times, the performance of the business alone would be proof that wasn’t the case. But it bears repeating: these are not normal times.

As of this writing, Vince Martin has no positions in any securities mentioned.

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