The Next High Quality Canadian Company?
Aritzia is a high-quality company, led by a dedicated and smart management team that is incentivized alongside shareholders.
Preface
My goal in 2022 is to become a better writer and investor. That’s why I started this newsletter. I’m transitioning to monthly deep dives on companies that I want to research, learn more about, and think could be good investments.
I’m trying to avoid well-known, well-researched, and large-cap companies. My goal is to cover companies below $20 billion in market cap. Since I’m forcing myself to learn about a company and an industry within a month, I’ll avoid sectors outside of my circle of competence.
Once I feel like I’m providing enough value and getting feedback from readers, I’ll likely put my writing behind a paywall.
I’ve spent all of December researching Aritzia and trying to answer my own questions about whether I’d be willing to invest my own money in Aritzia.
Section 1 - Investment Thesis
I’ll give you my thoughts on Aritzia and some of the key aspects driving my thoughts on Aritzia.
Section 2 - Business Model
Retail is a simple business model but Aritzia has some unique characteristics that make it stand out from other retail locations.
Section 3 - Sustainable Competitive Advantages
What gives Aritzia an advantage over its peers? How strong and sustainable is its competitive advantage?
Section 4 - Management
How comfortable am I with Aritzia’s management team? Would I trust them to manage my money? Have they allocated capital efficiently?
Section 5 - Valuation and Financials
What’s a “fair” valuation for Aritzia? What do peers trade at?
Section 6 - Risks
What are some of the risks with Aritzia?
Section 1 - Investment Thesis
Aritzia has all the tenets of a quality company with a great management team. Aritzia has strong growth, a properly incentivized and aligned management team, the ability to pivot and make tough decisions, and a long runway of growth.
Key Thesis Points:
A strong brand reputation that leads to pricing power
A proven and trustworthy management team
Long and diverse runway of growth opportunities
Key KPIs:
Store location growth
E-commerce growth
USA expansion
Section 2 - Business Model
Aritzia is an omnichannel retailer, meaning it sells clothes both in-person and online. Aritzia had a small e-commerce segment before the coronavirus pandemic. Since March 2020, Aritzia’s management team has built out its e-commerce capabilities. I think the retail locations and online shopping option complements each part of the business. Aritzia focuses primarily on women’s clothing but recently acquired Reigning Champ which likely indicates their interest in selling men’s clothing sometime in the future.
Retail Segment
Aritzia’s retail segment focuses on high-end store locations that have the desired type of foot traffic and demographic. You won’t find Aritzia in small-town Iowa with a population of 1,000 people. Aritzia has stores in most major cities and even multiple stores if the city dynamics support multiple locations.
According to Retail-Insider, Aritzia’s target customer base is “women aged 14 to 30.” More broadly, the core customer base is women who want to buy high-quality clothing and aren’t afraid to pay a premium for brand and for quality.
As other retailers struggle to keep their doors open, Aritzia continues to expand its store locations, get better deals on rent, and prove doubters wrong by putting up impressive results from its store locations. There are concerns around the number of locations that will support an Aritzia store, but I discuss more of that in the risks section below.
E-Commerce Segment
While retail locations have always been Aritzia’s main source of revenue, Aritzia’s management team quickly pivoted to growing its e-commerce capabilities when the pandemic first started. E-commerce revenues accounted for 37% of revenue in Q2 back in October, 42% of revenue in Q1, and was just 20% of revenue back in Q1 of 2020 (the quarter after the pandemic started).
Aritzia’s management team had already planned on building out more e-commerce capabilities but this process quickly sped up as the pandemic took place. One of the major benefits of its e-commerce segment is higher margins. Other companies like Lululemon, Nike, and Canada Goose have higher margins through their respective direct-to-consumer or e-commerce segments than traditional retail locations.
Section 3 - Sustainable Competitive Advantages
Aritzia’s strongest sustainable competitive advantage is its brand.
While fashion choices come and go, Aritzia sells timeless clothing that can be worn across fashion trends, different time periods, and settings.
Aritzia accomplishes this through neutral colors and through high-quality pieces that customers will use for multiple purchases.
Just like other retail companies such as Nike, Lululemon, Apple, and Starbucks have a strong brand that customers love and trust, Aritzia has a loyal customer base. Aritzia’s brand has been building since 1984 when the business was first founded. Aritzia’s brand will not be replicated overnight nor can enough VC funding replicate what Aritzia has built.
Section 4 - Management and Capital Allocation
Brian Hill and Jennifer Wong run Aritzia.
Brian is the founder and Chief Executive Officer of Aritzia and runs the creative side of the business such as clothing choices and fashion trends. He comes from a family involved in retail and opened the first Aritzia boutique in 1984 and has grown the business to where it is today. Brian runs the creative side of the business with the help of many departments.
Jennifer Wong is the President and Chief Operating Officer of Aritzia. She joined Aritzia in 1987 originally as a style advisor. After spending years learning the business through various roles, she was promoted to COO in 2007. Jennifer runs the operations of Aritzia.
Both Brian and Jennifer have spent decades with the business and know the business better than anyone else. They’ve built this business from a regular retail store into a public company that’s worth more than $5bn.
Just this year, Aritzia acquired 75% of Reigning Champ for $63 million and is set to acquire the rest over the next few years. Reigning is expected to make $25 million in revenue and $5 million in adjusted EBITDA for the full 2021 calendar year. I like this acquisition by Aritzia’s management team. Acquiring a strong men’s clothing brand at ~12.6x EBITDA for a strong brand and opening the door to expand into men’s clothing is a smart decision and one that I am comfortable with as a shareholder. Aritzia likely paid a lower multiple considering the synergies by integrating Reigning Champ with its existing product line and e-commerce capabilities.
While most acquisitions do not go smoothly, this is Aritzia’s first acquisition in over 5 years. I trust that this was a worthwhile use of capital and it could show signs of Aritzia’s intentions to enter men’s fashion.
Section 5 - Valuation and Financials
Aritzia currently trades at a higher multiple than I would like for this business, but not terrible considering the runway of growth and the quality of this business.
Multiples based on consensus estimates:
NTM EV/Sales = 4.38x
NTM EV/EBITDA = 18.67x
NTM EV/EBIT = 29.21x
While these multiples might be considered high for a retail company, I believe that consensus is underappreciating Aritzia’s potential revenue growth and therefore make Aritzia more expensive than it actually trades for.
Lululemon’s multiples based on consensus estimates:
NTM EV/Sales = 7.35x
NTM EV/EBITDA = 29.98x
NTM EV/EBIT = 33.80x
These are 67.8%, 60.6%, and 15.7% higher multiples than what Aritzia trades for. While yes, Lululemon is a more mature and larger company, Aritzia has all the same qualities that Lululemon does such as a dedicated customer base, brand loyalty, and pricing power. Aritzia has a larger runway for growth through men’s clothing, swimwear, store expansion, and e-commerce.
Section 6 - Risks
The major risk for Aritzia is the number of store locations that support the branding and unit economics of the business. Management aims for A+ locations that have both the desired foot traffic as well as the right location suitable for an Aritzia store. You’re likely to find an Aritzia in cities such as New York City, Washington DC, Chicago, and in more wealthy suburbs.
Therefore I worry about the number of store locations that Aritzia might be able to open. While big cities mentioned above might support numerous stores, how many stores can a city fit before cannibalizing sales? If Aritzia were to expand into A- or even B+ locations, would this hurt Aritzia’s brand and bring down important metrics like sales/sqft.
Since I don’t follow fashion trends that closely, the other risk I worry about is Aritzia’s exposure to a certain fashion trend or fad. Aritzia might have inventory that goes stale when a fashion trend turns the other direction. I think Brian Hill has a good sense of what clothing items will work and I’m glad he’s at the helm running this business, but what happens when he decides to retire? Is there a replacement that has the right combination of the business and fashion sense to run this business successfully?
good writing! I really worry about retail in general, especially fashion. For that reason it’s not something i’d invest in. Curious about the comparison to Lulu - is there evidence that customers value the brand and come back for more like they do for Lulu? thanks for your thoughts!