Description
Business Overview
Indigo is Canada’s leading omnichannel book and gift, and specialty toy retailer, with a total of 196 stores across Canada and one retail store in Short Hills, New Jersey. The company operates across four revenue channels:
- Superstores (68.5% of revenue in FY2020)
o 88 large footprint retail locations under the Indigo and Chapters brand names.
- Small format stores (12.7% of revenue)
o 108 stores branded under Coles, Indigospirit, and The Book Company.
- Online (17% of revenue)
o Sales made on Indigo’s website subscription website www.thoughtfcull.co, and in-store kiosks.
- Other (1.8% of revenue)
o Includes Cafes, rewards program subscriptions, redemptions, corporate sales and E-book revenue share from partnership with Kobo.
What has happened since 2018?
Part of the reason why this opportunity exists is due to events that have taken place since 2018 and overall pessimism around brick and mortar retailers. The company has faced a number of challenges that led the company’s stock to decrease 80%.
Key Events
June 2018: Large investment program announced to renovate 16 large-format stores to support shift towards general merchandise, refresh digital platforms and expand supply chain facilities
December 2018: Renovations of stores and Canadian postal strike during the 2018 holiday season
November 2019: Reduced summer promotions led to declines across channels
March 2020: Temporary closure of all 200 retail store locations due to COVID-19 lockdowns
June 2020: Reported disappointing FY20 due to weak retail environment and reduced promotions to preserve margin across channels
Thesis
1. Retail Transformation
Over the past five years, Indigo has pursued a strategic transformation to shift away from selling books to a curated selection of general merchandise. This includes toys, gifts, home goods, fashion, electronics, and other adjacent categories complementary to Indigo’s target demographic. General merchandise comes from third party brands and the company’s own private label products. The shift provides higher margins with lower markdowns than from selling books. Since 2016, revenue from general merchandise increased from 34.5% to 42.7% of total sales, with revenue growing 19.14% in dollar terms over the same period. From 2018 to 2020, the company has also renovated 24 stores and opened five new locations with more retail space to allocated general merchandise. We believe the pivot into quality general merchandise, more private label products, and fewer product promotions will improve margins over time and enable Indigo to manage intense price competition against Amazon in the book category.
2. Omnichannel and Future Growth
Like many retailers, Indigo has focused on becoming an omnichannel retailer. The company invested in a distribution centre in Western Canada in 2018, launched a click-and-collect express service and a partnership with Instacart in Q3 2021. The success of the company’s investments in omnichannel are reflected through the pandemic, where Indigo’s online sales increased by 214%, 114%, 92% for the first three quarters of FY21. In Q3 2021, Peter Ruis, Managing Director of Anthropologie at the Urban Group was appointed President of the company. Indigo also launched a new annual rewards membership program nationally in November 2020, where for $39, customers save 10% on a majority of merchandise. The rewards program enables subscription customers to purchase books for lower than prices listed on Amazon. Given the company's omnichannel strategy, newly renovated retail locations, customer retention programs, we believe Indigo will rebound to modest growth post-pandemic in 2022.
3. Backed by Founding Management
Heather Reisman is the founder of Indigo and has been CEO since inception in 1996. Reisman and her spouse Gerald Schwartz, founder and CEO of Onex Corporation, collectively own 57.2% of outstanding shares on a fully diluted basis. Given Schwartz’s leadership in private equity, presence on the Board of Directors and large stake in the business, Indigo can benefit from his expertise and connections in the industry. In difficult times, such as in May 2020, Schwartz extended a $25M zero interest secured credit facility for the firm’s working capital needs due in February 2021. We believe Schwartz would provide the company a lifeline or backstop the loss of value.
4. Downside Protection in Worst Case
If we assume the worst possible scenario in liquidation, the company has no debt, ~$120M in cash, and ~$554M in lease liabilities.
Valuation
Assuming Indigo achieves a 1.5% CAGR in sales from 2020 to 2025, a gross margin of 40% and 0% growth into perpetuity, we arrive at a share price of $7.36.
Summary
As a leading book retailer in Canada, Indigo has undergone a transformation in the past three years under difficult conditions. Having weathered the worst of COVID-19, we believe Indigo will return to modest growth beyond 2022 with renewed store locations, improving product mix, new management, and rewards program.
Risks: Prolonged COVID-19 lockdowns, inability to make lease payments, more closures of superstore locations, poor inventory management and underperforming product mix
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.
Catalyst
Retail store reopenings, return to growth and penetration in e-commerce across Canada, margin expansion from cost optimization and shift to general merchandise