Sebastian Widmann/Getty Images Entertainment

Sebastian Widmann/Getty Images Entertainment

By David Huston and Nick Gomez

(Note: Values are in Canadian dollars unless US dollars are stipulated).

Canada Goose (NYSE:GOOS ) (TSX:GOOS:CA ) is a clothing retailer that was established in 1957 in Toronto as Metro Sportswear, which specialised in woollen vests, raincoats, and snowmobile suits. From there it has grown into a global high brand retailer with flagship stores in Toronto, New York and mainland China and Tokyo that weave together the company's Arctic heritage and modern innovations across a wider array of products.

This is an exciting time to consider investing in the company - not because it's firing on all cylinders and therefore richly valued as a business, but because there are challenges facing them that we believe are not insurmountable and create a potential situation where the share price does not match the present valuation of future cash flows.

Canada Goose is a profitable retailer with a positive outlook for revenue and earnings growth in 2023 and 2024:

Using a discounted cash flow analysis we find that Canada Goose is valued approximately 40% below where we would expect it to be; US$17 compared to fair value of US$28. That means there's a large margin of safety factored in:

We need to view this in the context of a growth business and where it is projected to be over the next two years:

The company has made headlines as it surpassed $1 billion in revenue and is on track to hit $1.37 billion in 2023. That's 24.5% revenue growth next year and a gross margin over 66%. Net income will nearly double over the coming years as they raise the number of stores from 41 ramping up to 64 by 2024. There is a commensurate increase in the Return on Equity (ROE) and Return on Assets (ROA) that signals analysts are bullish on their ability to increase revenue at a clip and further drive gross and net margin expansion.

Management guidance for FY 2023 is for EPS to hit $1.60 to $1.90, and this largely depends on performance in Mainland China during the peak holiday season (this winter) in the face of continued Covid-19 disruptions and lockdowns.

The company trades for a PE of 29.39 as of September, which is below the average 32.3x Global Luxury PE and towards average for the Retail/Consumer Growth segments of the market.

The Q1 report that recently came out for July 2, 2022 showed a net loss of $63.6 million, which is down further against the $57.5 million loss in June 2021. That's not necessarily too revealing given that the winter period forms a huge part of their revenue and profit.

At Away From the Herd, we follow a standard rubric for assessing the income statement and balance sheet. Here is a summary of our findings using "Red, Amber, Green" markings for simplification:

Canada Goose ranks quite highly in terms of having 10 years of strong revenue growth, a high and growing gross and net profit margin, low interest and depreciation expenses and a distinct lack of debt.

There are unusual expenses (circa 1% of gross income) for the second year in five that are worth keeping an eye on. The Net Income to Total Revenue trend is fair to average, and at 8.6%, doesn't suggest that it is a business making excessive levels of net income; companies with >20% net earnings to revenue often have a competitive advantage or moat and lower operating costs. As a retailer though we might give it the benefit of the doubt. The one amber flag that should really grab your attention is the somewhat spotty EPS track record. Canada Goose did experience a significant hit in 2020 and appears to be moving towards a tougher spot for earnings again in 2022.

The balance sheet is very strong and doesn't require a lot of attention: debt is low, and what debt they have is long term rather than short term. In particular the ratio of PPE to Debt to Net Earnings - which is made to show how good a business is at turning its assets into net earnings - is extremely strong. They don't need a huge amount of capital and debt in order to grow the business, meaning in the good times when people are spending, this is a very profitable company.

Canada Goose has struggled in one of its key markets: China. First, many will remember the uproar when Huawei chief executive Meng Wanzhou was arrested in Canada in 2018 and detained for nearly three years. In return, China accused Canadian businessmen Michael Spavor and Michael Kovrig of espionage and it wasn't until last year that both countries negotiated a swap. Following that there has been a second negative catalyst with rolling lockdowns in China resulting in store closures.

Let's have a look at the revenue breakdown for Canada Goose and what proportion of its business sits in mainland China, to understand the impact that these challenges may be having.

Canada Goose's annual revenue in FY 2021 by region

The business is evenly distributed between Canada, the US, Asia, and Europe although it has a distinct weighting towards Asia which represents 29% of revenue. According to Canada Goose's website there are 48 locations (including pop-up stores and smaller locations) and 20 of those registered locations are in Asia, while 18 of those are in China. It would be fair to say that China is an important jurisdiction for sales and growth and represents the majority of Asia apart from one store in Japan and one in Taiwan.

In terms of specific issues there was a claim raised against the company in September 2021 by the Shanghai market regulator in relation to misleading customers and not obeying advertising laws. The company was fined 71,000 USD. The fine and the publicity were certainly bad for business and resulted in the company altering its approach to advertising in China.

The company came under fire again as recently as December 2021 with an issue around refusing to receive a returned item from a customer, in a manner that was considered out of keeping with Chinese local consumer laws. A consumer tried to return a luxury parka and was told that they couldn't, although they subsequently went on to argue that it had a defective label and they were ultimately successful in making this case to the regulator

What this means is that clearly there are issues in one of their major geographies, and this has had an impact on the share price. What's interesting though is that a lot of this has been resolved. China and Canada have at least on the surface resolved their issues, the stores in China are largely open and generating revenue, and there don't seem to be any continued actions around boycotting the brand.

For hiring and key personnel, the company has recently hired Larry Li to oversee the entire Mainland China market. He has a deep experience of Chinese retail, as a sector, and held roles at Dunhill and LBMH Group as well as Givenchy and Kenzo.

The great thing about Canada Goose is that it's a strongly seasonal company that earns significant portions of its revenue and profit during the winter season. That also overlaps with the 600 pound gorilla: Christmas time.

What's interesting here though is that the share price appears to follow a seasonal trend too. Previous all-time highs in the share price occurred in the winter, with a strong ATH of $92.18 reached in November 2018 and again $64.82 reached in November 2021.

There's not a huge data set to pull from but it would appear that after coming very close to the Pandemic lows in 2020 (US$12.84), at US$17.24, we are seeing another divergence of the RSI and MACD, and the price signalling underlying strength (green dash-lines on chart below).

There is a gap between US$22-US$24 that needs to be overcome, but we expect this to be resolved. We will be looking for a breakout above this resistance zone before entering a long position.

Canada Goose is a luxury retailer with a growth strategy that is well-aligned to the world demographics and has a concrete plan to grow revenue with stores opening across the Asia Pacific region and parts of Europe.

The company is below fair value on a DCF basis and it has a relatively undemanding PE of 29 that is significantly discounted compared to where it was at the beginning of the year (PE was nearly 100). In terms of the Income Statement and Balance Sheet, there are a few amber flags to monitor, but overall the health of the business is strong.

Catalysts to the upside include a seasonal trend in the shares and a subsequent re-rating as they continue to deliver on their store expansion. Although there are challenges that remain in China, stores remain open, and traffic continues to tick upwards in terms of footfall at their key stores.

Overall - although there is pressure to issue 'buy' alerts when reviewing a business - we remain in a wait and see position. We want to see Canada Goose's shares overcome key resistance to the upside and show further positive momentum. We also want to see more evidence that earnings are not going to be impacted by the challenges in China and key markets in Asia. When those criteria are met, we have several trading strategies that we would use to layer in exposure to Canada Goose.

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This article was written by

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.