Description

Summary

Aritzia is an attractive company with a clear path to double digit annual growth in the next few years by increasing its US store footprint and expanding its ecommerce offering.

Background

Aritzia Inc. (Aritzia) is a Canadian women’s apparel retailer that sells mostly its own exclusive brands (95% of FY20 revenue). Founded in 1984 and listed in October 2016, Aritzia is based in Vancouver, Canada. The company operates 67 stores in Canada and 29 in the US (US expansion started in 2007). Aritzia operates in the attractive apparel segment between luxury and discount where the majority of consumer spending takes place. The company has experienced significant growth with a five-year net revenue CAGR of 18% and a ten-year net revenue CAGR of 19%. EPS has grown by a 5-yr CAGR > 30% with FCF yield of 10%.

Investment thesis

·         Stores and Online have extended runways for continued growth

Aritzia’s growth has been driven by its expanding store footprint (stores were 77% of FY20 revenue) and high growth ecommerce operations (ecommerce was 23% of FY20 revenue). Continued expansion in its store real estate will drive growth going forward while investment in ecommerce capabilities supports even further growth. The US is their main growth market for both stores and online.

Aritzia’s expansion has been at a measured, consistent pace with only 6 stores opened each year. This disciplined rate of rollout has resulted in Aritzia never closing a store in its 36-year history. Management thinks there’s potential for 100 more stores in the US, alone. This is reasonable given the number of markets that Aritzia still hasn’t penetrated (e.g. Philadelphia) and that opening 100 more stores would leave their footprint at about 2x their Canadian footprint. That leaves at least 10 more years of growth driven by opening stores alone.

Ecommerce penetration of 23% is below US industry average of c.39% with potential to grow to 40% over the next 5 years (this is where Urban Outfitters is now). The management team has proven success in executing on ecommerce after growing its penetration from 12% to 23% in the last 5 years (5-yr CAGR > 30%).

Significant investments have been made to support further growth in ecommerce. The strength of these investments was apparent when the company could seamlessly transition to an online-only distribution model during the forced store closures due to COVID-19. They were able to increase ecommerce sales by more than 150% without an interruption to operations.

·         Vertical integration and disciplined capital allocation ensure growth will translate to the bottom line

Aritzia produces average retailer margins. Current profitability levels leave room for margin expansion driven by operating leverage which management has sacrificed as it continues is expansion (adding more operating leases and investing in ecommerce capabilities). These margins are likely to remain consistent. The main contributor to margin consistency going forward will be (1) inventory management and (2) maintaining positive ecommerce growth. Management has a solid track record in managing inventory and ecommerce is at a higher margin than store sales, according to management. This is supported by no margin contraction as ecommerce has grown.

Aritzia’s profitability is supported by its high productivity in stores. Aritzia has a store trading density of >$1,300/square foot. Management has attributed this productivity to strong volume growth from its stores. It’s well above their target $1,000/square foot.

·         Superior returns with highly cash generative, capital light business model

Aritzia’s capital allocation strategy is as follows:

·         Open c.6 new stores p.a. at a cost of $2.5M each, target trading density of $1,000/square foot and 24-month payback period (current average is closer to 18 months)

·         Reposition or refurbish 4-5 stores p.a. (either moving a store in an existing mall or expanding the store) at a cost of $2.0M each, target trading density of $1,000/square foot and 24-month payback period (current average is closer to 18 months)

·         Invest in ecommerce capabilities on an ongoing basis with an impact on SG&A and/or capex, depending on the nature of the cost

No dividends are paid however the company has bought back shares. Emphasis has been on repaying debt and reinvesting in the business (which is the right choice given attractive ROIC). Low leverage with enough internally generated funds to support growth plans.

·         First class management team that can deliver growth

Hill has a c.23% beneficial interest in Aritzia. He receives only a nominal annual salary of C$2, ensuring that his interests are aligned with shareholders. His management team has an average tenure of 19 years at Aritzia. This is a highly experienced management team that understands their customer and can appropriately allocate capital to maximise shareholder returns. On listing in 2016, they set out a five-year plan and were on track to achieve each of these metrics before the pandemic.

History

Founded in 1984 by current CEO, Brian Hill who is a third-generation retailer. The Hill family opened the first Aritzia store in 1984 and began selling their own brands in 1994. Expansion was measured with their first US store opened in 2007 and online sales launched in 2013.

Valuation

Aritzia trades at 22x P/E based on consensus FY22 EPS of C$1.01. The thesis isn’t based on any expectations of multiple expansion. The valuation is considered reasonable, given Aritzia’s growth prospects and the visibility thereof.

Impact of the pandemic

Aritzia has not been immune to the effects of the COVID-19 pandemic. Despite this, the company has maintained a strong balance sheet and sustained customer loyalty by expanding its online offering. Aritzia is well positioned to take advantage of the opportunities created by the pandemic with leases at more affordable rates and accelerating its ecommerce penetration, particularly in the US.

Catalyst

More stores opened, increased ecommerce penetration, potential for further buybacks