Description

Executive Summary

Leatt Corporation is a secular growth company in cyclical industry (personal protection equipment for mountain bikes and motorbikes) that is currently towards the tail end of an extremely painful de-stocking cycle. The de-stocking cycle is significantly depressing Leatt’s sales and profitability.  Once this de-stocking cycle ends, we think the company should enjoy a snap back in revenues and earnings as their sell-in re-couples with industry sell-out. From here they should enjoy organic growth in-line with the mid to high teens growth the company has historically achieved (sales grew organically with a ~17% CAGR from 2012 to 2022). Despite a pristine balance sheet ($12.9M of net cash), the industry malaise has crushed the stock and it’s down ~80% from its 2021 highs. As a result, you now can buy this secular growth machine for 0.76x depressed 2023 sales and ~0.6x normalized sales. While operating margins peaked at 22.9% in 2021, we expect them to remain depressed for a number of years as the company invests in growth and lets operating leverage raise them to their targeted range of 15-20% which we think they’ll hit in 4-5 years.  Despite the depressed margins, the stock is still trading at just 15.1x our 2025 EPS estimates (11x ex. net cash) and we think EPS can CAGR at 45% for the next four years as margins return to the targeted range and topline growth returns to historical trend levels. We think the stock could be a triple in a little over two years ($22.50 end of ’26 target price = 15x 2027 EPS  + net cash) with significant upside from there.

Company overview and history

Leatt was profiled on VIC over two years ago (March 17, 2022). The write-up offers a good description of the business and its history, some of which I’ll repeat here.  

Leatt designs and distributes personal protection equipment for mountain bike (MTB) and motorbike (Moto) riders globally. The company sells products which include helmets, knee pads, chest protectors, jerseys, riding boots, and its flagship neck brace. The company sells its products through three channels: consumer direct (its website, ~8% of LTM sales), one-step distribution (direct sales to dealers -retail stores that typically sell bikes and equipment or just equipment, ~29% of LTM sales) and two-step distribution (sales to distributors who then sell to dealers, 63% of LTM sales). For sales in the US Leatt sells direct to dealers (one-step distribution) and for all other international markets (except South Africa) Leatt sells to distributors (two-step distribution).

The company has a unique origin story that is importantly intertwined with the brand. In 2001, Dr. Chris Leatt, a doctor in South Africa, was a spectator at a motorcross competition when a rider who he knew flipped over the handle-bars of his bike, broke his neck, and died. Chris was a motorcross enthusiast and was about to teach his own young son how to ride but determined that he wouldn’t do so until he found a neck brace that would protect him from a similar injury. When Chris couldn’t find this product, he spent the next four years developing one. In 2005 he patented the Leatt Neck Brace and started Leatt Corp to sell it. In 2007, sales started to take off after a professional motorcross rider recommended it on TV. 

Leatt’s Neck Brace

For several years the Leatt Neck Brace was all the company sold and the unique aspects of the product – its first to market innovation, focus on safety, and high quality – came to be what the brand represents in the eyes of Moto and MTB riders. In 2010, Chris Leatt hired Sean MacDonald, the current CEO, to lead business strategy of the company so that he could dedicate himself full time to new product development. What followed was an impressive and pretty relentless pace of product development that has powered substantial organic growth. In 2010, Leatt launched a chest protector that interlocked with the neck brace. This was followed by the launch of knee protectors in 2013, gloves and helmets in 2015, jersey, shorts, and pants in 2017, goggles in 2019, and boots in 2020. In addition to attacking new product categories, the company has consistently enhanced and expanded its product line in each new category. To try to quantify this we did an analysis of all the Leatt products by their Spanish distributor Tailo, who makes there catalogs available online. From 2018 to 2023, Leatt increased the number of different products that they sell through Talio from 81 to 174.

Leatt’s products are not just “me too” products. One of the key differentiators of the company is that they take a first principles approach to new product development. In a 2020 interview on the Gravel Travel Adventure Motorcycling Podcast Dr. Chris Leatt explains the new product development process well.

We don’t typically look at what else is on the market. Instead we say if you’re trying to limit a specific type of injury, how would you go about limiting that injury…. Just look at our boots. We did a complete literature review of how people were injuring their ankles…in motorcross. We looked at the boots in the market and then we replicated [standard leg injuries] using land mine equipment to induce higher forces in the lower limb….We tested this with all the boots in the market [and we found that if we] cut out the middle of the boot and put it back on the rider we got much better results. That’s because we created an alternative load path… and the sudden we found we can reduce the tibula load force by up to half vs. other boots on the market. The starting point is not accepting what’s common place, but really dissecting the problem and coming up with a solution.

The results of Leatt’s new product development process have been well received by the market. They consistently win awards in the industry for innovation and design, and more importantly, consistently gain share in the product categories they attack. For example, RacerX, a motorbike magazine in the US, does annual surveys of their readers about which equipment they own. In the Knee Brace category, for example, Leatt went from 1.6% share in 2014, to 6.2% share in 2017, to 10.7% share in 2020, and 13.5% share in 2022. Their market share evolution seems to follow a similar trajectory in the different categories that they attack.  Below is a great analysis of their market share in different categories as measured by this survey over time (credit: twitter @LazyBeavers).

This relentless product innovation and increasing category penetration, not surprisingly, has had an impressive impact on topline growth. From 2012 to 2022 the company grew their sales of non-neck brace products from $4.3M to $70.9M, a 32% CAGR. This growth has been critical for the company because sales of their neck brace products have actually be steadily declining in recent years as a lack of high profile neck injuries among professional riders has made this risk less prominent in the minds of riders and now fewer riders feel the need to wear them than they did a decade ago (importantly Leatt’s share in this category has been flat over this time period at around 60% market share). One or two high profile injuries among professional motorcross riders could reverse that trend and cause a spike again in Leatt’s neck brace sales but we’d prefer that not happen and at 6.1% of last twelve month sales for Leatt, neck braces are increasingly a rounding error for the company. It’s worth noting that even if you include the big fall in neck brace sales over the past decade, Leatt’s sales still grew with 16.5% organic CAGR from 2012-2022.

While the law of large numbers will make it harder for non-neck braces to continue to grow at 30%+, the company has been clear that they believe they can continue to grow topline at a double digit rate well into the future. For example, on their 4Q22 call the CEO said “There’s a bit of a correction here, obviously…but we do feel that…with some of the new products that we’re now bringing to the market, we can return to at least double-digit revenue growth on a sustainable basis.” Based on our work around market share potential by category, we believe that a mid-teens organic growth rate is easily achievable for the company in the medium term.

The protective equipment market for bikes and motorbikes is competitive and there’s pretty established leaders in each of the categories that Leatt is going up against (Fox Racing in knee and chest protectors, Alpinestars in boots, Bell in helmets) so their ability to gain share is impressive. To try to understand how Leatt gains share we did a number of calls and we thought a former Fox Racing executive (big Leatt competitor) had some valuable insights:

“Leatt made neck braces and Fox has never played in that space. And that’s mostly for like dark, gnarly, downhill guys on mountain bikes and for moto guys…I had friends that were very serious moto guys and every one of them had a Leatt neck brace. They would talk about the latest neck braces and because the Leatt neck brace was seen as premium…those people would also get Leatt guards [body protective equipment] too.”

In short, it seems like their innovative neck brace gave the brand a lot of credibility with the most aggressive, risk-seeking riders who then naturally chose to trust the brand and buy their other products as Leatt expanded their product line. And it’s not surprising that if the most “gnarly” downhill mountain bike riders on the mountain are wearing Leatt gear head to toe, then the brand might become a bit aspirational for the younger or more timid riders who look up to those guys.

While Leatt has impressively grown sales from nothing in 2005 to $76M in 2022, there’s still tremendous room for organic growth. They still only have LSD market share in many of the categories that they’ve launched in recent years (including helmets, goggles, books and gloves) and still have new product categories they can attack. In 2022, Fox Racing estimated that the entire market for Mountain Bike and Motorcross gear was $3.4B in the US. Leatt did $19M of sales in the US in 2022, suggesting <1% market share.

Cycle Dynamics

While it was under the radar for a long time, the secular growth story of Leatt went somewhat mainstream in 2021 when it interacted with an insane cyclical growth story driven by Covid. During Covid, outdoor sports like mountain biking and motorcross surged in popularity for obvious reasons and sales followed suit. Leatt’s sales grew a healthy 36% organically in 2020 before going vertical in 2021 and growing 88% y/y. The rapid growth came with high incremental margins (40% in 2020 and 31% in 2021) taking Leatt’s operating margin up from 7% in 2018 to 22.9% in 2021. At this point the stock started to garner some attention in the small cap corners of Twitter. Interestingly, while many claimed that the stock became something of a “FinTwit darling” it actually never got too optically expensive, peaking out at around $34/sh in late 2021, about 17x its $2/sh EPS in 2021. This is probably because the market sniffed out that while Leatt had a great secular growth story, it was being temporarily “juiced” by cyclical factors that would reverse.

Indeed, that very much seems to be the case. Growth stalled out at the end of 2022. Leatt sales were up 33% for the first 9 months of 2022 but then collapsed 53% y/y in 4Q 2022 as dealers and distributors decided they needed to work down inventory before they could resume buying.  The six quarters since then have continued to be painful with Leatt’s sales down 46% in 1Q23, 31% in 2Q23, 48% in 3Q23, 10% in 4Q23, 19% in 1Q24, and 18% in 2Q24. These weak sales have been accompanied by high decremental margins and Leatt’s 12M trailing operating margin dropped to an awful -7.5% from its peak of 22.9%. 

It’s worth pausing a moment here to discuss opex, operating leverage, and ownership structure for Leatt. One of the negatives of the stock is that the company is still controlled by its founder (and head of product development) Chris Leatt. Chris owns 33% of the common stock but controls about 53% of the voting rights of the company via Preferred shares with super voting rights. This means that the company is run how he sees fit and he takes a very long-term view. The good news is that this has resulted in the company historically being focused on self-funding growth and being disciplined on operating expenses (opex only grew 7% per year from 2012 – 2012 while revenues were growing 16.5%). The bad news is that this can result in brutal decremental margins when sales drop because they don’t see the need to cut expenses so long as they view the drop as temporary. Indeed this has happened over the last eighteen months as Leatt has grown quarterly opex ~9% since 2022 (20M LTM vs. 18.4M in 2022) while sales have dropped 44% ($42.5M LTM vs. $76.4M in ’22) . On the 1Q23 call the CEO explained the rationale well “Some of our peers are currently [reducing] some of their sales teams and looking at ways to cut costs. But for Leatt, that has never really been the Leatt way. When there’s opportunities to get the right people on board, we like to take those opportunities and it’s one of the opportunities that have come out of the market turmoil that we’ve seen.”  On the 2Q24 call he got a little more specific about these investments explaining “An industry-wide turbulence presents an opportunity to grow the Leatt family by adding 10-15 members. Although these investments typically take time to add to our financial results, we believe investing in brand momentum and building a great team remain cornerstones of our future growth plans.” In long run, we believe that these hires are likely smart will help support continue new product development and market share growth in the future but they’ve certainly made for a brutal collapse in margins in the short term.

Sentiment has followed Leatt’s sales and margin with the stock dropping 83% from its 2021 high of $34.70 to a recent low of $5.75, from which it has partially bounced back to ~$7.50. The company ended 2Q24 with $1.99 of net cash on their balance sheet and it has another $3.23/sh of NWC capital so it’s within a couple of bucks of being a net/net and trades at 2.9x 2021 EPS if you back out net cash (and this is for a business that has grown sales organically in the mid-teens for a decade!).

We think the below Tweet probably nicely summarizes the current consensus view of Leatt:

“It is very cheap but will remain so if the business can’t turn around, it’s still a covid one hit wonder”

-Parthenos Capital 2/29/24

We think this consensus view, however, is missing two important factors about Leatt.

First, it really isn’t a big “if” whether the business will turn around or not. The company sells into distributors and dealers who were massively overstocked in 2022 and have just spent 18 months destocking. At some point “sell-in” (the amount that suppliers like Leatt are selling to dealer and distributors) will have to match “sell out” (the amount that dealers are selling to end customers), and when that does happen, Leatt’s sales will get a healthy boost with high incremental margins. We’re writing the pitch now because we believe that “turn” is likely to happen in the next quarter are so.  Indeed, there are several datapoints that suggest that we might be the end of the de-stocking.

First on Leatt’s 2Q24 call they basically said so as CEO Sean MacDonald opened up the call with:

“I am pleased to say that we are beginning to see progress and a return to sustainable growth. Sales of the consumer and dealer direct levels have started to filter through to ordering from our distributors, and we have started to see a level of growth in some key product categories. While there are still some challenging industry and economic headwinds globally as inventory is digested, we believe that this promising uptick in ordering will filter through to our results in due course and is a trend that will contribute to revenue growth over the next few periods and beyond.”

Beyond this, Leatt’s growth, interestingly, has very closely tracked the organic growth of MIPS, a secularly growing bike and motorcross helmet component supplier who sells into basically the same end markets. Because MIPS sells to manufacturers and Leatt sells to distributors, however, MIPS’ growth tends to lead Leatt’s growth by 1-2 quarters. Below are the y/y sales growth numbers for MIPS and Leatt with MIPS’s growth rates advanced by 1 quarter.  

That loan gray bar at the far right shows that after 7 quarters of sales contraction, MIPS's sales finally inflected positively in 2Q24 (although its labeled as 3Q24 above because it is pulled forward 1 quarter). If the historical pattern holds, it seems likely that Leatt sales should inflect to growth in 3Q24.

The second thing that we think this tweet gets wrong is that Leatt is far from a one hit wonder! While, their LTM sales (3Q23-2Q24) are down to $42.5M (52% below the peak 4Q21-3Q22 period), these sales are still 43% higher than their sales in the 12 months prior to covid (2Q19-1Q20 sales were $30M)! Thus even if you believed that the current sales level reflects the new normal (which it almost certainly doesn’t because of the de-stocking dynamics) growing 43% in 4 years is impressive and far more congruent with the company’s long term growth CAGR than with a company that got a big bump during covid and then collapsed.

Financials

As discussed above, we believe that there’s an attractive opportunity right now in Leatt’s stock created by de-stocking dynamics depressing recent revenues and high operating leverage depressing margins. The result has been a wave of negative sentiment as covid-era exuberance has been replaced with FinTwit vitriol at the same time there’s been a lack of earnings to ballast the stock. While the company has generated $42.5M of revenues over the past 12 months, it has lost $3.2M of EBIT, down from $16.6M of Operating Profits in 2021. At recent prices (~$7.50) the company has a $48.8M market cap and a $35.6M enterprise value, hardly cheap if you think EBIT will be sustainably negative, but very cheap if you think sales and margins can return to a more normalized level.

The key question for the stock, then, is how much sales growth can you count on from “sell-in” recoupling with the current levels of “sell-out” and what margins will the company earn when that happens?

It’s impossible to get a precise answer to this but there’s a few ways to triangulate it. One datapoint is that MIPS basically said that they expect this to happen for their own sales in 2024 (i.e., to paraphrase they said that their end markets will be flattish in 2024 but that their growth will come from sell-in recoupling to sell out). Consensus estimates for MIPs point to 35% y/y growth for the full year of 2024 and 60% y/y growth in 2H. If we believe the impact of de-stocking on LEAT will be similar to MIPS (albeit with a 1-2 quarter lag) then estimates for MIPS this year would suggest that Leatt sales need to increase about 35% to be in-line with current sell out.

Another datapoint comes from Pierce, a publicly traded online dealer of motorcross and MTB equipment. Pierce is useful for a glimpse into exactly how much dealer de-stocking is currently going on.  Below are Pierce’s Sales, COGs, and Inventory levels for the past 5.5 years. 

For an equipment supplier like Leatt, Pierce’s Cost of Goods should be a proxy for “sell-out” in a given period and the Change in Inventory + Cost of Goods for a given period should be a proxy for “sell-in.”  Pierce’s financials show that there has been pretty dramatic de-stocking since 2021, with inventory falling from 33.5% of sales to 19.6% of sales in the most recent quarter.  Also, because of this de-stocking, “sell-in” into Pierce has been 763M SEK over the past 12 months, 17% below “sell-out” of 915M SEK over the same period. A supplier to Pierce would need sales to grow about 20% to be in-line with “sell out.”

This suggests that Leatt’s US business, which is all one-step sales to dealers like Pierce, might need to grow about 20% to be in-line with sell-out. Leatt’s international business, however, goes through two-step distribution where large national distributors buy from Leatt and then sell to dealers like Pierce. If we assume that Leatt’s international business is facing 2x the destocking of the US business because of the additional step (not necessarily crazy since LTM international are down 60% from peak and LTM US sales are down 35%), then it would suggest Leatt’s overall business needs to grow 31% to reach “normalized” levels.

Thus it seems that Leatt’s last twelve month sales perhaps need to grow between 31% to 35% to re-couple with sell-out given the intense de-stocking they’ve faced in recent quarters. If we take the midpoint of these estimates and assume LTM sales need to grow 33% to reach “normalized” levels (and also assume that gross margins revert to the 2018-2023 average level of 43.1%), then we arrive at “Normalized” EBIT of $4.5M for Leatt.

In other words if Leatt’s end markets don’t improve at all and we simply get a recoupling of sell-in and sell-out then the company should do about $4.5M of EBIT, putting the stock at about 8x EV/EBIT and 0.63 EV/Normalized Sales.

We estimate that 2025 should look similar to this albeit with slightly higher sales and higher SG&A because we assume that Leatt will continue to take share and invest in growth. Given the company’s low to mid-20s tax rate and 6.5M fully diluted share count, this gets us to about $0.50 of 2025 EPS. From here, however, we think earnings will continue to grow very rapidly given that the company has achieved much higher margins on lower sales in the recent past (e.g. 15% margins in 2020 on 38M of sales) and, having made its big growth investments in 2023 and 2024 will likely let operating leverage shine through to get the margins back towards the 15-20% long term range that they target. Thus, if the company returns to its 15% annual growth cadence post inventory de-stocking, we think earnings could growth 30-40% per year for 3-4 years until margins get back to 15-20% or so and then we’d anticipate earnings growing more inline with topline (likely low DD) as management re-invests more.

Below are our estimates for the company through 2029. We assume the company returns to growth in the back half of 2024 and achieves sales close to “normalized” in 2025. To be conservative, we just have free cash flow piling up on the balance sheet. Finally, we should mention that in practice distributors/dealers typically have a period of “re-stocking” once sales pick back up as they tend to overshoot with cutting inventory. This would obviously result in much stronger near term growth rates for Leatt than we have modeled.

Valuation

Putting it all together, we think Leatt is very compelling at these levels. The stock is trading with a $36M enterprise value and should do about $4.5M of EBIT whenever de-stocking ends (likely in the next 1-2 quarters). From there, the company should be able to continue to grow sales in the mid-teens organically for a number of years as they continue to innovate and gain market share in new product categories. Given the high incremental margin nature of the business, this sales growth should translate to outsized EBIT and net income growth. We’ve put together what we think are reasonable estimates and have them CAGRing EPS at 45% from 2025-2029 (and 2029 EPS is basically just what they did in 2021). We tend to look at companies with  2-3 year forward price targets, so if we look out to the end of 2026 and value this at 15x 2027 EPS (and add back net cash), we get a $22.50 price target, suggesting shares could be a 3-bagger over the next couple of years (with plenty of upside from there).

Catalyst

Sales inflect positively, with strong incremental margins, after 7 quarters of decline.