Description
“I never make predictions, especially about the future.”--SAMUEL GOLDWYN
“It’s tough to make predictions, especially about the future.”--YOGI BERRA
Boldly (or recklessly) ignoring the advice of these two legends, I predict a good future for Columbia Sportswear Company (the business) and COLM (the stock). I believe COLM represents very good value at its current price of $48.30, with a high likelihood of good returns over two to five years even if things go only moderately well for the company, and little risk of permanent capital loss. After deducting the company’s net cash from the stock price, we are paying 11.8x trailing EPS, about 13.5x expected (depressed) 2005 EPS, and 10.4x my projected 2006 EPS. This seems a very reasonable price for a high-quality business with:
* A strong brand, well-established in the U.S. and with a rapidly growing international business.
* An outstanding history of revenue growth (15.6% CAGR over the last ten years and 18.4% CAGR over the last five years).
* An outstanding history of profit growth (operating income 17.1% CAGR over the last ten years and 28.6% CAGR over the last five years).
* Consistently high profit margins that have improved over time (19-20% operating margins in recent years).
* A stellar balance sheet (net cash of $318 million or $7.82 per share at March 31).
* Strong free-cash flow because of the company’s high profitability and low cap-ex needs (all manufacturing is outsourced).
* A stock buyback program initiated last year and expanded this year.
* Over half of the stock is owned by the Boyle family, including over 38% by President/CEO Tim Boyle, and over 13% by Chairman Gert Boyle, who have together run and built the company over the last 35 years.
INVESTMENT THESIS
Columbia’s stock is down 22% from the high of $62 in November 2004. Much of the decline occurred in late April: though the company announced decent first quarter results, management stated that sales growth this year will be about 5% (vs. about 13% previously expected) and net income will decline by 8%-12% (vs. about 10% increase previously expected). Investors and analysts are concerned about the following (related) issues:
(1) The slowdown in top-line growth this year (as reflected in the order backlog and management’s projections), and possibly in the future;
(2) Lower operating margins this year (and possibly in the future) resulting from a combination of higher SG&A costs and lower gross margins;
(3) The resulting decline in EPS this year, and implications for EPS growth in the future;
(4) Increased competition from both higher-end apparel companies and private-labels in the company’s outerwear business.
In my view the market has overreacted to the short-term problems of an outstanding business, and COLM represents a very attractive opportunity of the Buffett variety: a growth company, with a strong brand, favorable economics (high profit margins and limited cap-ex and working capital needs, resulting in strong free-cash-flow despite the growth), a very strong balance sheet, and a proven management team with a large stake in the business. Management is also very committed to continued growth going forward: although the outerwear business in the U.S. has matured, the company’s sportswear and footwear business continue to have high growth rates, and international markets offer a large opportunity for the company. Additionally, for the first time since the IPO in 1998, the company started buying back stock last year, and has continued to do so this year (this is discussed in more detail under “Stock Buybacks”.)
Based on my analysis and discussions with the company, I believe that the business will grow at a decent rate (perhaps 15% annually, though management thinks high-teens is possible) over the next few years (starting in 2006), and that operating margins will return to their 2001 to 2004 levels of 19-20%. Using a moderately optimistic scenario of 15% annual top-line growth for 2006 to 2010, 18% operating margins, and modest stock buybacks (1.25 million shares repurchased per year, resulting in net reduction in shares outstanding of 0.5 million annually), EPS in 2010 would be $7.12, and net cash would be over $14. A P/E of 15x would translate into a stock price of $121 (including the cash), for an annualized return of 20.2% over the next five years; 20x would give 26.5% annualized returns. A more conservative scenario of 10% sales growth, 16% operating margins and a 15 multiple would give 13.2% annualized returns; a 12 multiple would give 9.0% annualized returns. Also, given all of the company’s strengths and the current stock price, it’s hard to visualize a scenario where the investment would be disastrous over time.
(I’ve used a five-year time horizon above; we could instead use a shorter period, such as three years. Using three years with the same assumptions used above, we get the following: Assuming 15% revenue growth and 18% operating margins, a 15x valuation gives annualized returns of 23.1%, 20x gives 34.1%. The more conservative 10% sales growth and 16% operating margins scenario would give 14.6% annualized returns with a 15 multiple, and 7.7% with a 12 multiple.)
Revenue growth of 15% annually seems plausible: Outerwear (42% of 2004 sales) is expected to grow at mid-to-high single-digit rates; sportswear and footwear (together 53% of 2004 sales) should grow at 20-25% rates; and accessories and equipment (5% of sales) at over 20% annually. These together give us a blended growth rate of about 15%.
A BRIEF HISTORY OF THE COMPANY
Columbia Sportswear, based in Portland, Oregon, was founded in 1938 by Paul Lamfrom, father of current chairman Gert Boyle. The Lamfroms were Jewish immigrants who had fled Hitler’s Germany for the U.S. the previous year. Gert’s husband Neal Boyle joined the company in 1949, and became President upon his father-in-law’s death in 1964. Following Neal’s unexpected death of a heart attack at age 47 in 1970, Gert (now 81) took over running the company. Prior to that she had been a full-time homemaker and mother, with three children, the youngest of whom was then twelve. Her son, Tim Boyle, now 55, joined the company in 1971 and is now the President and CEO.
The mother-son team has done a remarkable job building the business over the last 35 years. The company was struggling when they took over, with annual sales of $800,000. The first years were difficult, and survival was the primary goal. Sales increased gradually after that, approaching $10 million in 1984 and $18.8 million in 1987. Growth then accelerated, with sales increasing to $192 million in 1993, and $353 million in 1997 (just before the IPO). 2004 sales were $1.095 billion, exceeding $1 billion for the first time; operating income was $211 million, and net income $138 million.
The company went public in March 1998, selling 9.66 million shares at $12 per share (all split-adjusted, and including the greenshoe). Virtually all of the net IPO proceeds of $106.9 million was immediately paid out as a dividend to the pre-IPO shareholders.
The company was originally a regional hat distributor, but moved into outerwear in the 1950s as the use of hats by men started declining. Outdoor activities such as hunting, fishing, hiking, and skiing were popular in Oregon and the Pacific Northwest, and Columbia built its reputation designing, manufacturing and selling outerwear, including skiwear. It was only in the 1980s that the company started expanding its product line beyond outerwear, with sportswear, and later (starting in 1993) with footwear. A small part of the revenues comes from the sale of accessories (hats, scarves, gloves) and equipment (tents, sleeping bags).
Columbia’s name and products are best known to many because of its “Tough Mother” print and TV ad campaign, originally launched in 1984 and continuing through today, in which Gert Boyle is portrayed as Mother Boyle, an overbearing and cantankerous taskmaster who constantly enforces Columbia’s tough quality and value standards. In the TV ads, Columbia’s products are tested by Gert on her son Tim in hostile environments: wearing a Columbia jacket through a car wash; mountain climbing; strapped to the roof of a car while driving in the mountains.
(Note: For anyone interested in additional background, a new book, “One Tough Mother” written by Gert Boyle has recently been published. It is an easy read, and is an inspiring story of succeeding against the odds and living the American dream.)
PRODUCT LINE
Columbia describes itself as a global leader in the design, manufacture, marketing and distribution of active outdoor apparel. It is one of the largest outerwear manufacturers in the world, and is the leading seller of skiwear in the US. The company works to develop a reputation for quality, performance, functionality and value, and prides itself on offering consumers among the best price-value equations in the outdoor apparel and footwear markets. It focuses on developing high-volume products at moderate price points.
No apparel company can completely escape fashion trends, but Columbia does not attempt to be a fashion leader, instead focusing on durability, functionality, quality and value in its products and marketing. Many of its new products are based on existing designs such as its Bugaboo parka, which has been a strong seller since the early 1980s when it was first introduced.
The company was built on its outerwear business, but it has broadened its product line over time so that it is now able to offer retailers and consumers a coordinated “head-to-toe” line of merchandise. The company expanded its sportswear offerings in the 1980s (from its foundation of hunting and fishing shirts), and introduced rugged footwear in 1993. At that time, outerwear was still almost 80% of total sales, sportswear was just under 15%, and accessories (hats, scarves, gloves, etc.) was close to 5% of sales. By 2004, outerwear sales represented just 42% of the total, with sportswear at 36.2% and footwear at 16.9%. Sportswear and footwear now account for the bulk of the company’s growth, and the company continues to see these product categories, particularly footwear, offering significant opportunities in the future. Management believes that footwear will eventually be the largest product category. A new footwear distribution center was opened in Kentucky in January 2005, built at a cost of over $40 million, in anticipation of long-term footwear growth. One of the main reasons profits are expected to decline this year are because of additional operating and depreciation expenses of this distribution center.
Net Sales by Category
2004 1997 1993
$ mill % $ mill % $ mill %
Outerwear 460.3 42.0% 220.2 62.3% 153.2 79.8%
Sportswear 396.4 36.2% 91.3 25.8% 28.4 14.8%
Footwear 184.6 16.9% 24.3 6.9% 1.2 0.6%
Accessories 46.1 4.2% 17.6 5.0% 9.3 4.8%
Equipment 7.9 0.7% 0.0 0.0% 0.0 0.0%
Total 1,095.3 100.0% 353.4 100.0% 192.1 100.0%
Growth has been predominantly organic, with only two acquisitions, both relatively small, in recent years. In September 2000, Columbia acquired the Sorel brand for $8 million. Sorel has been selling cold-weather footwear for over 40 years, and Columbia is expanding the brand into other categories (such as Sorel outerwear for extended outdoor wear), and attempting to make Sorel a year-round brand for outdoor-oriented customers. The other acquisition was Mountain Hardwear in March 2003 for $36 million; this company designs and sells technically advanced equipment and apparel intended for extreme environments, for specialized activities such as mountaineering, backpacking and climbing. The product line includes both apparel (such as outerwear with Windstopper fleece and Gore-Tex shells), and equipment (technically advanced tents and sleeping bags) for mountaineering, camping, and ultralight backpacking).
MANUFACTURING: ALL OUTSOURCED
All of Columbia’s products are designed in-house, and are sourced from independent manufacturers, primarily in the Far East. This, in my view, is a key attraction of Columbia as an investment: it lets the company focus on the designing and selling of its products, and results in significant free-cash-flow because of the low cap-ex needs of the business. This is looked at in more detail below under the “Cash-Flow” section.
CUSTOMERS & MARKETS
Columbia’s products are sold through about 12,000 department stores and specialty stores (such as sporting goods stores and footwear stores) in over 60 countries. The U.S. still accounts for the majority of Columbia’s sales, but international sales have been growing at a faster rate and represent an increasingly important part of the company’s business. Europe, in particular, is considered a huge growth opportunity, because of the weather and the fondness for outdoor activities. In 1993, over 95% of the sales were in the U.S. and Canada. Last year U.S. sales were 60.9% of the total, with Canada at 10.7%, Europe at 15.5%, and other international markets 12.9%. Sales outside of North America were just $9 million (4.7% of the total) in 1993, but had increased to $311.7 million in 2004, or 28.4% of the total. The company has sales offices in Europe and owns and operates a distribution center in France (opened in early 2003), selling directly to retailers in Western European countries. Columbia also sells directly to retailers in Japan and South Korea. Independent distributors are used in several other countries around the world, including Australia, New Zealand, South America, China, Russia, and portions of Europe. Last year the company also entered into distribution agreements in the Philippines and South Africa. Gross margins on sales to the independent distributors are about half the gross margins on direct sales, but because of lower SG&A costs the operating margins are similar.
Management expects the North American business to continue growing, but clearly views the international markets as offering a far greater growth opportunity. Margins on the international business are lower, but have been improving and there is room for additional improvement as the infrastructure costs (sales offices, distribution centers, and warehouses) are spread over a larger revenue base.
Columbia has a flagship store in Portland (opened in 1996) to showcase its products, and has seven outlet stores for clearing excess inventory. There are no plans to build additional retail space.
Sales by Region
2004 1997 1993
$ mill
U.S. 666.7 286.9 170.0
Canada 116.9 31.1 13.1
Europe 170.3 0.0 0.0
Other** 141.4 35.4 9.0
Total 1,095.3 353.5 192.1
% of Total
U.S. 60.9% 81.2% 88.5%
Canada 10.7% 8.8% 6.8%
Europe 15.5% 0.0% 0.0%
Other** 12.9% 10.0% 4.7%
Total 100.0% 100.0% 100.0%
**includes Europe in 1997 and 1993
STRONG AND CONSISTENT PROFITABILITY
Columbia has a history of remarkably high and consistent profitability, compared with other apparel/footwear companies (Lands’ End, Polo Ralph Lauren; Timberland; VF Corp), or with U.S. business in general. The operating margin in 2004 was 19.3%; in the three previous years it was 20.0% (2003), 20.1% (2002) and 19.0% (2001). Margins have improved as the company has grown: in the four prior years (1997 to 2000) the operating margin averaged 13.5%. These strong and consistent margins are one indicator of the company’s brand strength and pricing power. Given the balance sheet strength and the absence of debt, net income margins have been similarly high (12.7% in 2004). ROE has also been high, though it has declined in the last few years as cash has built up on the balance sheet. ROE (using the average of beginning and ending equity) in 2004 was 19.5%, and in the three prior years was 21.6%, 24.8% and 29.5%. If we calculate ROE net of the company’s net cash position (i.e. equity in denominator = reported equity – cash + debt), then ROE has been pretty steady at just over 30% in each of the last four years.
BALANCE SHEET
The balance sheet is very strong, with cash of $338 million and debt of just $20 million as of March 31, for net cash of $318 million or $7.82 per share. At the end of 1998 (the IPO year) the balance sheet had cash of $7 million and debt of $62 million, or net debt of $55 million. This swing of $373 million in the net cash position over the last six (and one-quarter) years has primarily been from retained earnings, an indicator of Columbia’s strong free-cash generating ability. This cash build-up has occurred even as the company has grown, from sales of $427 million in 1998 to $1.095 billion in 2004. Over the same period the number of shares outstanding has increased from 37.9 million to 40.1 million at the end of 2004, for a gain of less than 6%, the result of options being exercised net of some recent stock buybacks.
CASH-FLOW
I found it useful to look at a summary of Columbia’s cash-flow in recent years. Looking at the six-year period from the start of 1999 to end-2004 (I picked 1999 because the IPO was the preceding year), here’s the picture that emerges:
Total cash-flow 1999-2004 ($ millions)
Net income: $542
D&A: 103
Cap-Ex: (172)
Acquisitions: (38)
Working capital increase: (138)
Other: 20
Stock issuance (options): 55
Stock buybacks: (44)
Debt payments, net: (50)
Increase in cash & investments: 279
In other words: The aggregate reported net income was $542 million over the last six years. Of this, $138 million was used for the additional working capital necessary for the growth (primarily receivables and inventory); $69 million was used for net PP&E purchases (D&A minus cap-ex); $38 million for acquisitions; and $20 million was generated from smaller items. Stock transactions generated $11 million net (option exercises less stock buybacks). That left a surplus of $328 million. After net debt reduction of $50 million, there was an increase of $279 million in cash & investments.
Viewed another way, the company’s sales increased from $427 million (1998) to $1,095 million (2004), or by $668 million. The capital (incremental PP&E and working capital) required to finance this growth was about $245 million (Cap-Ex minus D&A plus cost of acquisitions plus working capital increase), or about 37% of the increase in sales. In other words, despite growing the top-line at a 17% CAGR over these six years, the company required for growth only about 45% of the net profits it generated ($245 million out of $542 million net income); the remaining 55% was free-cash-flow that we can see accumulating on the balance sheet.
(Looking at the balance sheet, net PP&E at the end of each year ranges between 12% and 15% of that year’s sales, and working capital (current assets excluding cash less current liabilities excluding short-term debt) at year-end ranges between 22% and 30% of sales. The sum of PP&E and working capital at the end of each year has been between 38% and 44% of sales. This is consistent with the previous paragraph’s point that incremental capital required for growth was 37% of sales.)
Based on the above, let’s assume that a $100 increase in sales requires $40 in capital for PP&E and W/C. If the company can continue to generate operating margins of 19-20%, the additional sales will result in $19-20 of incremental operating income, or a 43% to 45% pre-tax return on the incremental $40 investment. If the operating margin was 15%, the pre-tax return is 37.5%, still excellent. This suggests to me that the economics of this business are outstanding.
Using an example to further illustrate future cash-flow: Assume sales in the previous year were $1,000 and net income $125 (based on recent net margins of about 12.5%). If the future top-line growth rate is 15% and the company can maintain its net income margin, then sales in the current year will increase by $150 to $1,150, and net income by $18.75 (12.5% of $150) to $143.75. The incremental sales of $150 will have required $60 (40% of $150) in additional W/C and additional net PP&E (i.e. cap-ex spending in excess of depreciation). So $83.75 (or 58%) of the net income will be free-cash-flow, adding value on top of the 15% growth. (If the growth rate is 10% instead of 15%, net income will be $137.50, and $40 of incremental capital will be required, leaving $97.50 of surplus cash, or 71% of the profits; a slower growth rate but more free cash on the balance sheet at the end of the year).
STOCK BUYBACKS
Columbia did not repurchase any of its stock from the time of the IPO in 1998 through the end of 2003. During that time, the company went from having net debt of $55 million (at the end of 1998), to net cash of $244 million at end-2003, a swing of $299 million. The company authorized a $100 million repurchase program in April 2004. In 3Q04 the company repurchased $35.2 million of stock and in 4Q04 $7.9 million. In the first quarter of this year $4.5 million was purchased, and an additional $14 million (approximately) was repurchased in April. The company announced a second $100 million authorization in January, and had $138 million available under the authorizations as of end-April.
Given that the stock price has dropped from the levels of late 2004 and early 2005, I would hope that the company has actively been buying back stock since its first quarter earnings announcement. Management has indicated that they do not intend to pay dividends anytime soon, and a large acquisition is unlikely. Given that the cash continues to pile up despite the growth, my guess is that the company will continue repurchasing stock. But given the relatively short history of stock buybacks, it will be some time before I have more confidence in management’s long-term commitment to reducing the number of outstanding shares.
I have assumed in my projections (under “Investment Thesis” above) that the company issues 750K shares each year for options exercised and the employee stock purchase plan (this is a little higher than the average in recent years). I then assume that 1.25 million shares are repurchased every year, resulting in a net reduction of 500K shares each year.
ADDITIONAL COMMENT
In their quarterly earnings announcements, management provides guidance for the current quarter and the rest of the current year. In comparing the actual results for each quarter with the guidance provided, it becomes clear that management’s projections tend to be pretty conservative, so that actual results exceed the guidance. There can be no guarantee that this will continue in the future, but it does give us some sense of management’s mindset.
RISKS
(1) Increased competition: Little concerns me about the ambition, ability and integrity of Columbia’s management. (Regarding ambition, to quote the head of investor relations, “Tim Boyle wants to be Nike.”) The balance sheet strength provides additional comfort about the company’s ability to weather any difficult periods. The key risk, in my opinion, is that the competitive landscape is changing or will change such that the growth and margins earned in past history become just that. Still, it is hard to imagine a scenario where the investment result is anything close to disastrous, given all of the company’s strengths and the current stock price.
(2) Cash uses/capital allocation: Another risk is that the company does not use its accumulated cash and future free cash to maximize value for the outside shareholders. The company started buying back stock last year, and has continued doing so this year; but management has not made clear its commitment to significant buybacks over time. Their actions on this front over coming quarters and years are worth observing closely.
Catalyst
(1) Significant stock buybacks: the company started repurchasing stock last year and has continued doing so this year.
(2) Improved margins over the next few quarters.
(3) Resumption of past growth rates.