Description

Naked Wines is a high-quality e-commerce business that we believe is mispriced due to a recent business model transformation, relatively low liquidity (trades $500 K - $1 m/day), and a listing on the AIM in the UK.  Naked is the largest direct-to-consumer (“DTC”) wine business in the US.  The company has over 600,000 subscribers, who pay $40 a month to get access to attractively priced wines from over 200 winemakers who produce wines exclusively for Naked.  The business model creates a win/win for both producers and customers by leveraging scale and cutting out various intermediaries found elsewhere in the US wine industry.  Naked is well-managed, profitable, generates attractive economics, and is building a unique competitive advantage in a growing market.  The company’s business is surging right now due to COVID, but the valuation remains reasonable at less than 1x this year’s sales and 12x our estimate of this year’s net income before growth spending.  We believe Naked Wines stock can compound at least 15-20% annually during the next decade and might re-rate before then given strong expected results and a possible relisting in the US in the next few years.    

Business Overview and Update

Naked was previously known as Majestic Wine, which was written up by Scrooge833 in 2017 and ThatDu04 in 2019.  I recommend reading both to get up to speed on the background.  The brief history is that Majestic bought Naked in 2015 and brought on Naked’s charismatic founder, Rowan Gormley, to serve as CEO for it’s combined business, which included a large UK brick and mortar chain.  In 2019 Majestic decided to focus entirely on Naked’s online business and sold the brick and mortar chain along with a small wholesale business.  Gormley also retired in 2019, and Nick Devlin, previously President of the US business at Naked, was appointed CEO.  Gormley still owns over 5% of the company today.  We’ve been impressed by Devlin, of whom Gormley said when he took over, “I think he will boost shareholder value more than I could from this point.”  Devlin is based in Napa – more than half of Naked’s sales are from the US, with smaller businesses in the UK and Australia. 

In the fiscal year ending this past March, Naked sold over £200 million of wine, and the business had been growing at 10-15% in recent years.  The US business has seen the fastest growth, and the overall US DTC market, even pre-COVID, was expected to continue to grow at a healthy rate:

Source: company, https://www.sovos.com/shipcompliant/resources/wine-dtc-report/

COVID has supercharged this trend and Naked’s US business in particular.  A few weeks ago, in a trading update, the company reported that growth from April through July increased to 76% year over year.  Based on our research, we believe that strong growth continued in August, particularly in Naked’s US business, which we estimate is growing at over 100% YoY. While not a central part of our thesis, it does not appear that sustained growth of this magnitude is widely expected.  The sell-side consensus for revenue is £281 million this fiscal year, £317 million next year, and £370 million the year after.  We would not be surprised if this year’s number is closer to £370 million than £281 million.

More important than a short term earnings beat is the fact that there are significant scale advantages in Naked’s business model, and COVID has accelerated the growth of the company’s moat by several years.  With additional scale, Naked can access better wine makers, who are attracted by the company’s ability to commit to significant volumes pre-harvest and to provide advance funding for the purchase of grapes.  By removing the middle man found in the traditional “three-tier” distribution model, Naked can share the benefits of this scale with their winemakers and customers. 

The additional scale also allows Naked to more fully utilize a national distribution infrastructure that can minimize delivery times of a bulky, expensive-to-ship product.  In April and May of this year, for example, Naked’s US business saw fulfillment costs per order drop 18% vs. last fiscal year.  The company believes its existing infrastructure in the US can service a substantially larger business. 

Naked as a company is highly data-focused, which we believe will further contribute to its competitive advantage over time.  Naked’s subscribers actively engage with each other in online forums and have written over 20 million reviews of individual wines.  The company is actively adding to its internal data science team, and we believe they are early in monetizing this growing asset.    

Management

We highly recommend reading Naked’s annual reports and other shareholder communications, which are among the best we have seen.  The company’s data focus is clear from their disclosures, which include better than average analysis of cohorts, marketing spend, and steady-state profitability.  In our discussions with Devlin, he has proactively discussed sharing scale economics with customers as well as his admiration for Costco’s business model.  He has bought Naked shares personally in recent weeks, as has CFO James Crawford. 

Naked’s shareholder base is also high-quality for such a small business.  The Apthorp Family, the original founders of Majestic Wine, plus former CEO Rowan Gormley, together own over 16% of the business.  Conifer Capital, run by Greg Alexander and formerly known as Acacia (affiliated with Ruane, Cunniff), owns just under 10%.  Punch Card Capital holds 7% and two funds based in Germany with good reputations (Shareholder Value Management and JMX Capital) own another ~11%.  Collectively, that is almost half of the shares in the hands of long-term owners who know the business well. 

Valuation

It’s impossible to be precise given the surge in recent growth, but we believe the probability adjusted range of outcomes for the Naked Wines stock is quite attractive today.  The company reports “standstill EBIT,” which estimates the company’s profitability if it weren’t spending heavily to acquire new subscribers.  While this requires some faith in how the company calculates the figures, overall, we believe they are reasonable.  Standstill EBIT this past fiscal year was £10 million.  We believe this could be as high as £30 million in the current fiscal year, compared to a current enterprise value of £285 million.

Looking out over the next decade, with steady but not heroic growth after the COVID surge, and some modest margin expansion, we see standstill net income reaching over £40 million by 2025 and almost £100 million pounds by 2030.   If we’re directionally correct, we believe this will result in the stock compounding at close to 20% annually during this time frame.  While I’m sure we’ll be wrong in our exact forecast, our faith in management and the company’s growing competitive advantage give us further conviction in an attractive overall outcome.    

We also think it makes sense for Naked to relist in the US in the coming years, given the increasing US focus for the business and US-based management team.  While not necessary for a good outcome, we would not be surprised to see the stock significantly rerate if this occurred. 

Risks

• COVID ends, and people cut back on online wine purchases
• Higher churn than usual from the recent surge in new subscribers (our research does not suggest this is happening yet)  
• Marketing spend gets less efficient over time
• Competition from Wine.com, Vivino, and scale brick and mortar players like Costco

Catalyst

• Rapid continued growth 
• Relisting to the US