Description

Making its debut on VIC, Aritzia is a high growth fashion retailer from Canada, with extremely high rates of return on investment and a long runway for reinvestment. Despite having doubled net income in the 3 years since its IPO, Aritzia (ATZ) barely trades above its IPO prices. At current market prices, we are paying 17x F2021 EPS (year ends Feb so almost NTM), a very attractive price in today’s market.

Description:

ATZ is a vertically integrated women’s fashion retailer. 96% of sales are from fully owned ATZ brands that target different ages and demographics. Artizia controls every step of the design process and their clothes are only sold at company stores and the aritzia.com website.

Representing yourself to the customer as a collection of different brands is a smart way to prevent the risk of the Aritzia brand itself becoming stale. Consumers generally buy from 2 or 3 of the different labels and tend to stick to them. The stores themselves are high end and tend to be on the high streets across North America. The company positions its stores and its prices as everyday luxury.

With so many retail bankruptcies in the past few years, and the middle having been hollowed out, ATZ fits into what is now almost a niche market. Not everyone can afford true luxury and not everyone wants to shop at TJ Maxx, Zara and H&M.

The company was founded in 1984 by CEO Brain Hill. Hill is still the CEO and controlling shareholder. Over the past 35 years he has executed a meticulous rollout. Resisting the temptation to over expand, the company currently operates 94 stores across North America with a plan to expand by 6 new stores per year.  Stores tend to be concentrated in the colder climates of NA. While Canada has a fairly high level of penetration, the US market is underserved with potential for up to 5x the number of stores of the Canadian market. 

Given there are 67 stores in Canada that would translate into a potential of 335 US locations in the future vs the current 27 stores. 

Store metrics:

Aritzia has impressive metrics. The company generates slightly over $1300 sales per square foot of retail space. This is in line with fast growing peers such as LULU ($1587) and above more mature brands such as L Brands ($977) or the Gap ($340). This high efficiency coupled with 18% EBITDA margin allows for fast new store paybacks and high ROIC. New stores earn back the $2.5mm all-in cost per buildout within 18 to 24 months. Company-wide pre-tax ROIC levels are 70% making reinvestment a highly attractive use of capital.

Sales have been growing at a healthy rate. From F2015 to F2020, the topline grew at a 18.1% CAGR. EBIT has grown even quicker, a 33.8% pace, given scale benefits.

The sales growth has been fueled more by SSSG averaging 10.5% over that period than it has by new store opening.

Over my forecast horizon I model a deceleration in SSSG, and all future store openings to be US based. The effect is a changing geographic focus over time to be almost split between Canada and the US.

Financials:

My forecast calls for growth to decelerate but still maintain a healthy pace, CAGRing at 12.5% over the next 4 years. With a small improvement in operating margin, and cash flows partially devoted to share buybacks, EPS CGARs at 20%. Here is a snapshot. 

The company has effectively seen no SG&A scale since F2016 as they have been continuously investing in their capabilities and software. This year their rollouts included Salesforces’ Customer 360 and a direct to consumer marketing tool. Past years have seen the company upgrade their ERP system and expand their warehouses. It is likely ATZ starts to gain some SG&A scale starting next year, and it is unlikely we are going to wake up to a nasty surprise in a few years when we discover underinvestment.

The company put forward 5 year guidance during the IPO raodshow that they claim they are on track to meet or beat. For a F2021 adjusted net income range of $115-$130mm, I am in the middle at $121mm which equates of $1.12 per share.

Balance Sheet:

The company has virtually no net debt. They will end F2020 in a net cash position. Given the slow pace of store rollouts, the cash position should build. I have modeled roughly 3% of shares are bought back each year, but this is not enough to soak up all the cashflow. The company has only started buying back shares in the past 12 months, as it hit net cash for the first time. ATZ did buy a significant amount of shares back last February, when there was a secondary offering by an exiting shareholder.

General thoughts:

I believe the stock has been weak since the IPO despite phenomenal financial results due to the overhang created by insiders selling. Shortly after the IPO Brian Hill executed a share sale bringing his stake down to todays levels. He hasn’t sold since (in fact he bought a small amount) and has communicated he wants to remain at current levels. He also only pays himself $2 per year so the stock going up is his only incentive. Berkshire partners have been consistently selling since the IPO. They bought their stake when ATZ was private in 2005 and then fully exited their position during a secondary offering last February. This overhang should now be gone, allowing the stock to properly run.

I also think the company has stayed cheap because it is a retailer, and in particular a Canadian retailer. If it was American and had posted a long term growth rate of 18% it would be trading somewhere between LULU (41x F2021 eps) and Canada Goose (22.3x F2021 eps). While ATZ didn’t define/create a category like LULU, it also isn’t at risk of being a fad like GOOS. Zero growth, saturated retailers like Urban Outfitters trade for 12x F2021 eps.

Like most retailers, there isn’t a moat here that we can all be comfortable with. Pretty much no retailer in the world has that other than Nike. But like Nike, Aritzia does have a strong brand and a management team that is focused on the long term. I am sure ATZ will have some fashion misses from time to time that cause a quarterly miss but they have been few and far between during the time ATZ has been public.

I would like the company to expand faster. Given the incredibly high ROIC, the fast payback and the excess cash the business is throwing off, it is clearly the best use of capital. 6 stores a year is fine on a 60 store base, but given ATZ should hit 100 stores this year, the needle is moving less and less. But Brian Hill is extremely conservative, perhaps he is waiting for the next recession, and great deals on property leases.

Beyond the US, the company could look to other northern climate regions for expansions. The UK is an obvious fit, especially with the Meghan Markle connection

Target: 

I believe given the attractive rates of growth, long runway for reinvestment and pristine balance sheet, ATZ should trade for 20x forward earnings. In a 12 month timeframe, this would lead to a $27 stock, good for a 42% return from current levels.

Risks: 

Q3 is being reported next week. Given the short amount of sales from black friday in this Q3 vs last years' there's the posibility of disappointing the market. however the company has already guided for this.

Its a retailer. They can miss a season, and like most retailers there are low barriers to entry

Catalyst

Earnings growth, buybacks