In recent months, my views regarding Canada Goose Holdings Inc. (TSX: GOOS)(NYSE: GOOS) have mellowed considerably to the point where Iâve gone on record recommending its stock.
Thatâs a far cry from where I stood last October, when I threw out every reason but the kitchen sink as to why investors should stay away from outdoor-wear manufacturer.
âMy advice is to tread lightly when and if the Canada Goose prospectus comes out, because if you thought the Aritzia IPO was expensive, Canada Goose is going to be off the charts,â I wrote October 19. âIn that scenario, the selling shareholders (Bain Capital, company founders) win, while everyone else loses.â
I also recommended that investors tread carefully around the Aritzia Inc. (TSX: ATZ) IPO, which I thought would open around $22 — six bucks higher than its IPO price, and then head below $16 over the next 12 months.
Aritzia opened trading October 3 at $19, closing the day up 11% from its IPO price. It then proceeded to climb as high as $19.40 later that month; itâs been downhill ever since, now trading around $13 with the potential to fall even further.
Meanwhile, Canada Goose went public in March at $17, and itâs up 48% in just five months. Boy, did I get that wrong!
Can it go higher?
I wouldnât have thought so last fall, but Iâve begun to change my tune. One of the things altering my viewpoint, funnily enough, is Canada Gooseâs money-losing second-quarter report.
Fool.ca contributor David Jagielski recently discussed the many reasons why investors should stay away from the companyâs stock, the biggest being rising interest rates, which will simultaneously increase the companyâs interest expense burden while putting a damper on consumer spending.
David has a point that would be stronger if we lived in a linear world, where peopleâs buying patterns are predictable. Unfortunately, thatâs simply not the case. We might think sales of high-priced items would drop in times of higher interest rates or slow economic activity, but real-world examples, such as luxury retail conglomerate LVMH, suggest itâs not so clear cut.
Letâs consider Canada Gooseâs Q2 report
The companyâs operating loss was $17.9 million — the same as a year earlier on 80% more revenue. It delivered $12.5 million in additional revenue with no benefit to the bottom line.
On the surface, itâs an alarming situation made worse by the fact its gross margins improved by 17 percentage points to 46.9%. On a trailing 12-month basis, Canada Gooseâs gross margins are now on par with Lululemon Athletica Inc. (NASDAQ: LULU) at about 52%.
Yet it continues to lose money.
But hereâs where the two companiesâ stories diverge.
Lululemon is an established brand with a strong retail network, a small wholesale business, and a growing e-commerce operation.
Canada Goose is an established brand with a growing retail network, a strong wholesale business, and a blossoming e-commerce division.
Spending 43% more year over year on operating expenses is necessary to scale its activities. It costs money to open these stores — very little of which has anything to do with gross margins: the profit you make from each piece of clothing.
However, consider that its operating ratio in the second quarter dropped from 115% to 92% — a number to keep watching in subsequent quarters. I think youâll find it will keep declining as revenues continue to climb.
Itâs all about scale.
As I commented in my latest article about Canada Goose, the company is not looking to build a store network as broad as Lululemon’s. Itâs only looking for busy locations in various world-class cities, where its target customer frequently shops, such as Yorkdale Mall.
As long as its wholesale and e-commerce segments continue to grow at a healthy clip, I donât see the company running into financial difficulties, despite higher levels of debt.
As of the end of June, it had $234 million in long-term debt, which is less than 10% of its market cap. If that number gets to 50%, then maybe Iâd start to worry, but right now, itâs business is looking good.
Personally, I won’t own its stock because of the whole cruelty-to-animals thing, but if you donât have a problem with that, Iâd be loading up on it if it ever falls back to its $17 IPO price.
That likely won’t happen without a recession.
