Description

Quick Pitch

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.

Below are a few images of the opening of the Flagship Beijing store; the image on the left is during opening day (December, 30th 2018) and the image on the right is a month later on a weekend. What’s  interesting about these pictures is that the opening of the flagship was just over a month after the arrest of Meng Wanzhou, and the subsequent boycott of all CG products. Despite the brand being caught up in international politics, in the end, Chinese consumers voted with their wallets-- with Canada Goose’s Beijing store selling out of all men’s products within hours. Furthermore, even months after opening, there were still long lines on the weekends. These images are a testament that there is significant pent up demand in China for authentic Canada Goose products and that the brand resonates well throughout greater China. With the extremely low penetration of the brand in China, it makes strategic sense that the company’s future focus is on China with the largest growth in store count.

Long-term Forecasts Overly Conservative?

The above tables show management’s forecast on how the next few years should play out, with planned growth projects in manufacturing, distribution and new store openings. While management has always been overly conservative with its estimates, we think these estimates are extremely conservative in relation to the growth trajectory over the past five years, growing at over a 40% CAGR. Management is essentially saying that the future growth will be around half the prior five year growth trajectory, with profitability increasing ~ 5% faster. To some degree, it depends on how much Dani Reiss throttles back the wholesale channel, but we still think the estimates are too conservative with future Chinese growth, new flagship store openings, a 61% y/y inventory build, brand product extensions, and a continued acceleration of its online channel.

“I believe in FY20 will be achieved and probably superseded. I think they are very reasonable to almost conservative, to be honest. I know that the mindset around management is to be realistic, and they’ve always tried to be realistic and not optimistic, even though I think privately there is that level of optimism.”

“To me, the revenue growth ability is, I have to say, it’s certainly limitless in the near term, meaning whatever that means, 3-5 years, or in the foreseeable future, and with that said, and with the forecast that I believe that management have provided that I believe are reasonable and realistic, as opposed to optimistic, the limits might be around logistics and literally supplying the right product at the right time.”

-Paul Silvertown, former GM and VP of Global Sales at Canada Goose Holdings. (ThirdBridge interview)

Additionally, the compensation structure at Canada Goose for C-level executives and especially Dani Reiss, benefits the executives financially by being overly conservative by way of its bonus structure. To further align shareholders, the bonus structure at Canada Goose is based on overall operating profit targets and a sliding scale payout based on percentage of completion of the target. Anything below 85% of the targeted EBIT level receives no bonus payout; anything above 85% up to 100% receives a straight-line basis payout. Achievement above 100% of the EBIT target would result in Dani Reiss earning 100% of the bonus, plus any additional amount for each 1% above the target level multiplied by a 4.4% multiplier. Therefore, the management team is inclined to put in place highly conservative EBIT targets and reap the rewards with larger bonuses. Coincidentally, all C-level executives in 2019 received a bonus multiplier based on 2019 EBIT forecasts.

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.

Lululemon Analog

In 2005, Lululemon (LULU) initially started with only 14 stores; these stores were all located within North America, very similar to Canada Goose’s initial expansions. Lululemon began as a vertically integrated technical athletic apparel manufacturer and retailer. Similarly, Canada Goose started as a functional outerwear manufacturer of snowmobile suits and harsh weather outerwear. Since its start, Lululemon has successfully made the transition from being known solely as a female yoga retailer to brand extensions into menswear and adjacent categories, thereby expanding the brand’s addressable market. There are quite a few similarities between the two brands:

• Both have had substantial ownership from Private Equity during their parabolic growth phases.

• Both have had large early geographic sales concentrations in Canada; in 2005, 91.5% of Lulu’s net revenue was represented by Canada. Early on, Canada Goose had essentially all its revenue from Canada, and currently still has ~35% of sales from Canada.

• Lululemon was majority owned by Chip Wilson, who, in December 2005, sold 48% of his interest to Advent International Corporation, which bought 38.1% of the total shares outstanding.

• The Reiss family, including Dani Reiss, sold Bain Capital Partners a controlling 70% stake in Canada Goose; after multiple secondary offerings, Bain now controls 28%, and Dani Reiss retains ownership of 18%.

• Both brands have been involved in controversy. In March 2013, Lululemon had to recall 17% of its inventory of leggings because the product was see-through. In November 2013, Chip Wilson appeared on Bloomberg TV and stated, “Quite frankly, some womens’ bodies just don’t work for it… Even our small sizes would fit an extra-large. It’s really about the rubbing through the thighs, how much pressure is there.” These comments prompted boycotts of the brand and Lulu printed several consecutive quarters of negative comps. Following the public outrage, Chip Wilson resigned as chairman and sold 50% of his existing holdings. For the subsequent years 2013 to 2014, Lulu’s stock re-rated substantially, dropping approximately 55% from the peak.

• As stated previously, Canada Goose has had issues with the sourcing of coyote furs based on the inhumane trapping of animals and the down used in the lining of coats and parkas.

Both Lululemon and Canada Goose have been the subject of copycats and counterfeit products. With its fashionable yoga pants, Lululemon created an athletic apparel category in its own right; consequently, the brand  has had a large number of copycats such as Adidas, Nike, Under Armour, Gap, Old Navy, Athleta, H&M, Amazon Essentials, Target, Walmart, Nordstrom, American Eagle, Aeropostale chasing the growth of activewear. Though Lululemon has no actual patented fabric or manufacturing process, being the original innovator in the space, it retains the mind share of the consumer with its strong brand affinity. Despite an almost endless sea of competing athletic products from retailers over the years, Lululemon has retained its leadership and premier pricing status. In a competitive retail landscape that is highly promotional, it is estimated that only about 10% of Lulu’s products ever go on sale. While Nordstrom, Amazon and many others have their own private label with exact blueprints of Lululemon styles and fabrics, Lulu has retained its loyal customer base and fashionable brand identity. Canada Goose on the other hand has been a victim of its own success with cheap Chinese counterfeit products that use dog hair as fur hoods and plastic and cardboard filler as insulation. There are so many counterfeit websites selling Canada Goose products management has created a web-page dedicated to counterfeit identification and a URL lookup to verify authorized resellers. Canada Goose has also been subject to most major brands developing copycat parkas with hood lined faux fur and a label on the shoulder of the jacket similar in style to most CG jackets. Certainly the negative is that counterfeits and copycats have not helped with the brand, however, it has likely helped the global brand awareness of the style and world class quality of Canada Goose jackets.

The similarities don’t stop there. Canada Goose has followed the private equity playbook almost verbatim from Advent International’s successful foray twice in Lululemon, netting roughly 8x, and 5x its money. Both Bain and Reiss have implemented changes that directed the brand appeal more towards women, expanded the brand to be global, and aggressively pursued an online and direct-to-consumer strategy. Advent International was instrumental in improving gross margins recently at Lululemon by 800 basis points, while still running about 7% below gross margins at Canada Goose. 

What’s unique about Canada Goose and Lululemon is they run vertically integrated operations which allows for the full capture of potential margin as products sell out, often at full price. Canada Goose derives about half of its sales from the wholesale channel--  but that portion of the business is being de-emphasized with an intentional move of slowing the wholesale channel growth to low-single-digits. We think eventually DTC will represent 75-80%+ of the total sales, and wholesale rounding out the remainder, similar to more normalized levels at Moncler. Furthermore, we think online margins are by far the highest channel for Canada Goose. And while management does not break out online sales, we estimate that approximately 20%+ of sales comes from its online channel, while Lululemon gets over 27% of its sales online. The relevance of this channel is exemplified by Lululemon’s operating margin differential between owned retail stores (25.5%) and Q3 ‘19 online margins of 41.9%. The 1,640 point delta between the two channels is an important aspect of the bull thesis for Lululemon, whereby continually shifting sales towards its online channel results in continued margin expansion even as topline decelerates. Even brands as mature as Nike are making a successful foray into an online direct-to-consumer business. Nike does not report margins for its online business segment, but estimates believe it could be as high as 1,000 bps higher than its wholesale margins. Nike has also been signalling the importance of the channel with its recent hire of CEO John Donahoe (previously CEO of eBay and ServiceNow). The online channel only represents 15% of its business but has expectations that it could achieve 30% share in the next few years.

Dani Reiss’s obsession with mimicking Lululemon does not stop at just strategy. Dani has tapped fellow Canadian and Lululemon founder Chip Wilson as one of his four most trusted advisers since going public.   

WSJ Article:

When Mr. Reiss was navigating taking Canada Goose public several years ago, he says Mr. Wilson was a great resource as the founder of another apparel company. “I knew he’d been through that experience,” Mr. Reiss says. “I wanted to learn everything I could from him about what it’s like, what the pitfalls and advantages are.” Mr. Wilson told him to keep running the business like he always had, rather than change his approach after an IPO. “In talking to Chip, I realized that it’s really important as a public company to focus on your culture,” Mr. Reiss says. “You double down on it…and don’t allow the fact that you’re now public to have an effect on it.

Key Executives and Board Members

• Dani Reiss- President and CEO of Canada Goose.

• Jonathan Sinclair- Canada Goose CFO, was most recently CFO of Jimmy Choo-- bought out by Micahel Kors at multiple roughly 6 times sales and 58x EPS.

• Maureen Chiquet- Director, Former CEO of Chanel and trusted adviser to Dani Reiss.

• Jean-Marc Hue- Director, Former CFO and Executive Director of Unilever.

• John Davison- Director, currently CEO and President of Four Seasons Holdings Inc.

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.

Legal Disclaimer:

This presentation is intended for informational purposes only and you, the reader, should not make any financial, investment, or trading decisions based upon the author's commentary. Although the information set forth above has been obtained or derived from sources believed to be reliable, the author does not make any representation or warranty, express or implied, as to the information's accuracy or completeness, nor does the author recommend that the above information serve as the basis of any investment decision. Before investing in a security, readers should carefully consider their financial positions and risk tolerances to determine if such a stock selection is appropriate. At any time, the author of this report may trade in or out of any securities that are mentioned in the report as long or short positions in his own personal portfolio or in client portfolios that he manages without disclosing this information. At the time this report was published, the author had a long position in GOOS either in his personal account or in accounts that he managed for others.

This report’s estimated fundamental value only represents a best efforts estimate of the potential fundamental valuation of a specific security, and is not expressed as, or implied as, assessments of the quality of a security, a summary of past performance, or an actionable investment strategy for an investor. This is not an offer to sell or a solicitation of an offer to buy any security.

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.