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Aritzia Inc. vs. Roots Corp.: Which Is the Better Buy?

It’s the class of 2016 vs. the class of 2107.

Aritzia Inc. (TSX:ATZ) went public in October 2016; Roots Corp. (TSX:ROOT) had its IPO exactly one year later. Both are retailers; both are trading around $12.50.

Which is the better buy?

The argument for Aritzia

As IPOs go, Aritzia is the disappointment of the two.

The specialty retailer opened its first day of trading October 3, 2016, almost 20% higher than its IPO price of $16. Today, it’s around $12.30. Aritzia traded as low as $10 in late November and hasn’t been above $16 for 14 months.

Former investment manager Stephen Jarislowsky used to avoid IPOs because in his opinion, you could often pick up the stock at less than its IPO price within 12-24 months of a company going public.   

Well, Aritzia’s entered Jarislowsky’s window of opportunity; the question is whether investors ought to consider this beaten-up stock an opportunity at its current prices.

Personally, I’ve never been a fan of Aritzia, and said so at the time of its IPO and again a year later. I just wasn’t buying the growth story Aritzia was selling.

Now in the second year as a public company, can Aritzia turn things around?

In January, here’s what I had to say about Aritzia:

“So, where does it go from here? It will probably continue to deliver mid-single-digit same-store sales growth. But considering it sold shares at $16 and its same-store sales growth was north of 20%, today’s business doesn’t seem nearly as attractive,” I wrote on January 12. “You’d better hope it can continue to cut the fat from its operating expenses while increasing its gross margins, which it’s done because that’s the only way it’s going to deliver a stock price approaching $20.”

The company announces fourth-quarter results in less than three weeks, and we’ll know more then.

However, a quick look at free cash flow through the first three quarters of fiscal 2018 suggests it won’t generate as much as it did in 2017 ($81 million). If that’s the case, the current free cash flow yield of 5.7% will drop significantly, making it far less of a value play.

If, on the other hand, margins and same-store sales haven’t deteriorated and free cash flow is around $81 million, Aritzia stock would be a possible buy.

But I’d wait until after earnings to consider buying.

The argument for Roots

The iconic Canadian brand had a miserable start to its life as a public company. It had a pre-IPO price range of $14-$16 and a price at $12, two dollars below the bottom-end of the range, which is never good, and then opened October 25, 2017 at $10 a share.

I took a look at the company’s preliminary prospectus last September and wasn’t very impressed.

However, Roots announced the company’s holiday fourth quarter April 18, which were better than analyst estimates, pushing its stock close to $13 before settling back a little.

Still, its stock is now trading above its IPO price, making me very curious about its results.

Three things stand out for me.

First, same-store sales increased 15.1% in Q4 2017 and 12.1% for the entire year.

Second, although it doesn’t break out its online sales from retail stores, the two segments combined delivered 17.0% and 16.3% increases in revenue in the fourth quarter and full year, respectively, which is very healthy.

Finally, margins improved in the quarter and during the year, leading to adjusted net profits that were 35.3% higher in 2017 at $0.69 a share, thereby allowing it to cut its debt by 20%.

Bottom line

The company is growing the business at a manageable rate.

And the winner is…

Roots free cash flow yield is currently 2.6%, compared to 5.7% for Aritizia.

However, I see the two businesses going in two different directions. Unless Aritzia’s fourth-quarter numbers shine, I’m inclined to recommend Roots as the better buy, although I’ll be able to say for sure come May.

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Fool contributor Will Ashworth has no position in any stocks mentioned.

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