The stock of exclusive fashion brands maker Aritzia (TSX:ATZ) fell by as much as 23% the day after reporting its fourth-quarter 2023 earnings last week. Shares ended the weak nearly 16% lower following a rebound from a fresh 52-week low printed Wednesday. Long-term-oriented investors may take the current dip as a buying opportunity, but short-term capital should find a better home somewhere else.
Following a two-year explosive growth spree powered largely by ecommerce and a retail footprint expansion into the United States, Aritzia has impressively increased its annual revenue run rate by 156%, from $857 million in fiscal 2021 to a staggering $2.2 billion for fiscal 2023. However, growth may slow down significantly during the current year, earnings margins are increasingly under pressure, and cash flows may be strained over the next 24 months as the company invests in more infrastructure.
Why Aritzia’s latest earnings disappointed
Unquestionably, 43.5% year-over-year revenue growth to $637.6 million during the fourth quarter ending February 26, 2023 was a good growth show. However, gross margins shrank due to growing warehousing costs and persistent inflation. Quarterly operating margins at 10.6% were weaker than a 12.1% print a year ago as growing marketing and employment costs ate deeper into profits. The company remains profitable. However, the outlook for fiscal 2024 and beyond weighs heavily on ATZ’s stock valuation in the near term.
Slowing revenue growth, shrinking earnings margins, and negative free cash flows could exert significant pressure on Aritzia’s stock price over the next 12 months.
Following strong 46.9% revenue growth during fiscal 2023, Aritzia watered down the market’s growth expectations in its latest earnings guidance. Revenue guidance for fiscal 2024 at $2.42–$2.5 billion represents 10%–14% annual growth. Revenue growth has slowed significantly, and margins may suffer this year
Aritzia’s earnings margins under pressure
Aritzia expects the recent declines in gross margins and operating margins to persist or worsen in the near term. Following a 220 basis points drop in gross margins in fiscal 2023, management expects a further 200 basis point year-over-year compression in gross earnings margins this year due to persistent inflationary pressures, additional warehousing costs, and higher leasing costs.
Annual operating margins recently dropped to 13.1% (from 15.8% in fiscal 2022), and operating earnings margins may shrink further this year as selling, general, and administration (SG&A) expenses continue to grow as a percentage of net revenue. The company expects annual SG&A expenses to increase by 150 basis points in fiscal 2024 driven by additional distribution center project costs and growing employment costs.
Watch cash flow
Free cash flow generation at Aritzia turned a negative $119.7 million during the past year from a positive $221.9 million a year earlier. Heavy capital investments and inventory build-ups strained ATZ’s free cash flow and the trend may persist over the coming years as the company invests $500 million to reach a $3.8 billion revenue run rate by fiscal 2027.
Given that Aritzia had $86.5 million in cash and cash equivalents at the end of February and targets spending $220 million in capital projects this year, it’s highly likely that the company may resort to some debt financing, grow leverage, and increase its financial risk profile.
Should you buy the dip on Aritzia stock right now?
Slowing growth, short-term margin pressures, heavy capital expenditures, and potentially strained cash flows may weigh heavily on Aritzia stock over the next 24 months. Short-term trades may hurt. Opportunities to buy the dips on ATZ may be plenty during this timeframe. Long-term investment positions may produce positive returns as growth targets are met, margins stabilize, and cash flows eventually turn positive again by 2027.
The market is justified in punishing ATZ stock right now. Its current expense growth outlook is real and tangible, while top-line growth has slowed and the long-term growth outlook remains all but speculative.
That said, future earnings margins could be stronger as the company front-loads its growth expenses to the early years, freeing up earnings and cash flow during the final years of its strategic growth plan ending in 2027.
Bay Street analysts have a 22.3% annual earnings growth estimate on ATZ stock over the next five years. A forward-looking price-to-earnings (PE) multiple under 15 makes Aritzia stock a steal for long-term investors. The future could be brighter.
