Canada Goose Holdings Inc. (TSX:GOOS)(NYSE:GOOS) was among the biggest losers yesterday, even as its quarterly results that were released were significantly higher than those from the same quarter last year.
Total revenue for the third quarter of fiscal 2018 increased 27%, the gross margin increased to 63.6% from 57.5%, and earnings per share were $0.58 — a 49% increase from last year.
And this follows a very strong second quarter when revenue increased 34.7%, and the gross margin increased to 50.5% from 46.4%, as direct-to-consumer revenue increased fourfold, with the North American e-commerce business showing clear strength.
So, how could the stock get hit so badly after all of this good news?
Well, it’s all about expectations: what investors or the market is pricing in to the shares.
This goes beyond published earnings expectations. When investor psychology becomes so wildly optimistic, and a stock trades at sky-high valuations, the stock is vulnerable.
This is what has happened with Canada Goose.
Canada Goose has been an investor darling from the beginning. The stock was hot right out of the gate and posted a 26% return on the first day of trading. And even with the dramatic fall, the stock is still 136% higher than it was 11 months ago.
The next question to ask is whether we should use this weakness as an opportunity to buy the stock. I think not. While valuations are obviously lower than two days ago, they are still high. The stock trades at 62 times this year’s expected earnings and 50 times next year’s earnings, with an expected growth rate of 51% this year and a 24% growth rate in 2019.
In my mind, I keep coming back to a few key points.
Firstly, the company’s debt-to-total-capitalization ratio is a very high 59%, so the pitfalls of higher interest expense and lower financial flexibility could catch up to the company in more difficult times.
Secondly, while Canada Goose is an iconic brand with a long history of success, and it is clearly doing many things right, it is in the retail industry, which is cyclical and subject to fads that come out of fashion just as quickly as they go in fashion. And with little diversity in its product offering, the risk is magnified. These risks are not reflected in the stock.
Also, consumer debt is at record levels, and interest rates are on the rise, so the fact that consumers will have less disposable income available to them is a risk. In this scenario, premium-priced products are the first to be cut.
In summary, I think the stock does not have an attractive risk/reward profile, and I would remain on the sidelines.