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Summary:

With 170% share price upside using the midpoint of Aritzia’s 3 year guidance, 344% upside in a 3 year bull case (not a typo) and 10% downside in a 3 year bear case, Aritizia offers an asymmetric return proposition from a company and management team that has delivered over 30+ years.

I think this is a relatively straightforward bet on normalization of margins so I wont cover background. I wrote the first VIC report on ATZ almost 4 years ago in Jan 2020 and completely exited the stock around $50 as the price seemed rich. ATZ continued to run hitting a high of $60 in early 2022. Execution was on trend in C2022, however C2023 has been a kitchen sink of a year, with many problems occurring simultaneously, causing the stock to fall all the way to $21 before stabilizing at current levels of $24.

The Aritzia brand by all accounts continues to be strong. Scully posted a nice writeup here in May (though he was early) where he conducted proprietary surveys that match sellside surveys from this year that the consumer brand is in great shape with a high affinity from loyal shoppers.

I think going long the shares come down to a few simple questions:

-          Are Aritzia’s F2027 Targets reasonable?

-          What will the stock trade at?

-          What is their track record of hitting targets?

-          Do the causes of this year’s mess seem one time or more permanent?

So my apologies in advance that I won’t be breaking new ground here, but I don’t think the investment thesis needs it at this point.

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Are the Fiscal Year End February 2027 targets reasonable?

Lets take a look at where they have guided the street, and what that implies to get there.

• Revenues: 3.5 – 3.8 Billion correlating with a 15-17% CAGR off F2023
• EBITDA: 19% margin
• Storecount growth: 8-10 per year with F2027 target of 150 at midpoint
  
  
  

Now here’s a simple bridge to get there from F2024 consensus numbers, along with all available historicals.

I’ll give them credit for hitting storecount growth as its inline with historical percentage growth and easy to control.

Given stores, we can back in to implied SSSG/Ecom growth to get to midpoint revs of $3.650 Billion. It works out to an 8.4% CAGR from F2024 levels to F2027. The CAGR for the F2016-F2024 level (including covid shutdowns and then reopens and then normalization) was 11%. Of the 8.4% growth about 2/3rds will be Ecommerce (where ATZ is still light vs peers) and the rest from B&M SSSG. This seems pretty doable vs that 11%.

So revs seems fine, what about margins of 19%?

This seems a bit harder to reach but still doable. EBITDA margins pre-covid peaked at 18.4% and at the time there was a strong belief there would be some margin leverage from scale. I don’t think that has changed. A company 4.5xing revenue, where a decent portion of the spend is marketing, with a large mix shift to ecommerce, should be able to see some operating leverage.
  

At normal D&A and tax rates we would have an 11% net income margin.

Where would the stock trade if they hit their numbers?

I look at it through a bull/base/bear lens, with base being their F2027 targets

I had to make assumptions about exit trading multiples. I think given the metrics of each scenario, those are fair, with the bear case using a basically no growth P/E of 10x and the NIM being well below the F2017-F2020 pre-covid range.

The total upside, and 3 year IRRs are massive in both the Bull and Base case. In the Bear case we are looking at a very small loss.

(note: I assumed all excess cash is used for buybacks, consistent with guidance, at a fixed 15x current year EPS throughout the forecast period.)

Does management hit their targets?

The short answer is yes.

This team has been running the company together for years, with both the Founder/Chairman and CEO there for 35 years plus.

I know the current view is management has a mixed track record, but until this year that just wasn’t true. I was there at the IPO roadshow 7 years ago and they went and did exactly what they said they would.

Up until this year, this was a company that executed and hit their numbers. 

Do the causes of this year’s mess seem one time or more permanent?

This is a retailer, they have a great track record but the risk with retail is you will get a year like this where they miss a fashion cycle and pay for it. In this case the probelm is a lack of newness as they focused on core fashion during covid due to supply chain challenges. This just happened to come at the same time they were doing a massive upgrade to their DC network, and over-ordered inventory because of covid supply chain challenges. All these issues seem to have peaked and are now reversing, with F2025 expected to be a much cleaner year.

Inventory ended the summer quarter 10% above prior year levels, but when looking ahead at inventory in store + in transit + on order they are 15% below last year’s level.

For the DC’s they operated out of 3 historically (2 external), and are moving to 2 much larger ones (1 moving internal). The Ontario DC is complete and as of Sept end was ramping. That DC is 550k square feet vs the 150k external one they used before. At the same time they are moving to a DC that is 2x the size of the current one in Columbus. These moves, and the use of temporary DCs during the process have caused a drag on GM this year. This is already reversing and should lead to large GM expansion next year.

In regards to SG&A they are almost finished a 60mm efficiency plan, which will be reflected in 2025 numbers as well. There was a lot of inefficient spend during Covid as it was more important to keep the stores full than focus on long term optimization, which is happening now.

Conclusion:

A company with a proven track record of delivering. Strong management team in place that owns a ton of stock. Great unit economics (18 month store payback) with still a lot of runway for growth (US, eventually UK, China). Strong customer affinity to the brand. No debt, lots of cash flow, with the financial bottom already in. Trading 11x next years EPS and a base case upside of 170% over the next 3 years.

If you’re comfortable with those 4 questions like I am, then this stock is a screaming buy.

Appendix:

Sept 28th call transcript highlighting DC gross margin hit and overall SG&A inefficiencies.


Shifting to supply chain, I'm absolutely thrilled to announce that our new distribution center in the Toronto area went live at the end of August as scheduled. We seamlessly completed the transition out of our prior third-party operated facility without any disruption to the business. We've had a successful ramp-up period with productivity KPIs at roughly 90% of our corporate targets by week 5, and our fill rate is already in line with that of our existing distribution center on the West Coast and in line with top of industry metrics.

We have already exited 3 of the 6 additional temporary off-site warehouse facilities and are working towards subleasing the remainder by the end of the year. This has resulted in a significant and immediate reduction in our inventory carrying costs, particularly with labor having accounted for more than half of the additional cost pressure. We also continue to make these strides in finding efficiencies to optimize for our increase in scale over the last 2 years and better allow us to scale in the future. Some of the areas in which we've already begun to realize benefits include vendor negotiations, process optimization and KPI improvement.

Gross profit margin was 35%, declining 690 basis points from 41.9% last year and marking the peak of our anticipated margin pressure for fiscal 2024. The decline was primarily due to the following headwinds: higher product costs, normalized markdowns, temporary warehousing costs and preopening lease amortization for flagship boutiques and our new distribution center. 

SG&A expenses were $171 million, up 16% from last year. SG&A as a percent of net revenue was 32%, representing an increase of 400 basis points compared to 28% last year. The increase in SG&A expenses was primarily driven by the annualization of investments in retail and support office labor from the back half of last year as well as distribution center project costs. Adjusted EBITDA in the second quarter was $21 million, a decrease of 74% from last year. Adjusted EBITDA was 4% of net revenue compared to 15.7% last year. This margin decrease primarily reflects 3 things: ongoing inflationary pressure, multiple transitory costs and the run rate from investments made in talent in the back half of last year.

The second quarter reflects peak margin pressure in fiscal 2024, and we continue to expect sequential margin improvement in the second half of the year compared to the first half. At the end of the second quarter, inventory was $501 million, up 10% from the end of the second quarter last year.

Question in regards to margin guidance and cadence of improvement.

Sure. So a lot to cover in that question, but maybe I'll just take a piece of it and then we can come back if there's other components. So as I said, we were slightly better than we had anticipated, both from a gross profit and an SG&A perspective, but we have maintained our annual guidance of 300 basis points of pressure in both gross profit and SG&A. And the benefits that we saw in the second quarter within gross profit were primarily related to improved freight costs. And then from an SG&A perspective, it was just benefits from retail wages and as so labor that helped us exceed our initial expectations for the quarter. But as I look forward there's no real change in what we're expecting as we roll through Q3 and Q4.

And as we've said all along that we thought it would be a tale of 2 halves with meaningful pressure in the first half of the year and that pressure subsiding in the back half. And the benefits that we're expecting in Q3 from a gross profit perspective would be from the product cost improvements that we've talked about with select pricing actions and then the lapping of cost pressures from the back half of last year and then subsiding temporary warehousing costs. So obviously, and Jen mentioned it, but the new DC opening is critical to our margin improvement, both from a gross profit perspective and SG&A because the project costs are now done, which we're hitting SG&A and within gross profit, we're seeing the benefit obviously, from just the improved handling costs and the closing of all of the auxiliary facilities. So again, a lot to unpack in your question there. I haven't even hit the FY '25 part yet. But does that answer your question on this fiscal year before I move on to FY '25?

Stephen MacLeod

Yes, it does.

Todd Ingledew

Okay, great. Yes. So from an FY '25 perspective, no change there as well. We expect approximately 150 basis points of improvement from IMU, and that's from the select pricing actions and also product cost savings. We expect another 150 basis points to 200 basis points from our smart spending initiatives, which we've outlined and then 125 basis points from transitory cost subsiding. So obviously, the distribution center and some of the preopening lease amortization, etcetera.

Catalyst

Results continuing to normalize, starting with earnings report in Jan

Very easy year over year comps starting with earnings report in May

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