HZO beat its fiscal 3Q by 22 cents, the company narrowed the year, taking up the midpoint by a bit less than the beat. Revenue came in well ahead of expectations, with same store sales inflecting positive vs down 13% in the prior Q. Management keeps highlighting demand strength, though without detail on demand comps or orders. We think demand for boats remains in decline, and the recent reads in US luxury brand trends suggest that the high income consumer is slowing. Rather revenue growth is coming from satisfaction of backlog and acquisitions. Management’s commentary doesn’t match up with the reality in the numbers. Take for example this line from the CFO’s prepared remarks “Customer deposits continue to be historically very high at $98 million, showing the strength of demand for the boating lifestyle. We expect deposits to gradually decline over time as inventory modestly builds allowing us to more quickly meet customer demand.”
Yes, customer deposits are well above normal levels, but they were down $16mm sequentially, and have fallen from $164mm just over a year ago to $98mm. So revenue is most likely running well ahead of orders/demand. If we assume 10% to 20% deposits on these boats, then backlog satisfaction could be contributing as much as 10 to 20 points in comp, its not the boating lifestyle demand driving top line, and falling customer deposits are not a read on strong demand. Next the company implies that deposits fall as inventory rises to meet demand, yet inventory this Q was up 98% yy, with DIH back around pre-covid levels. Meanwhile gross margins were weak, incremental gross margin was only 22% vs the full year guide of mid 30s, and that’s with $25mm of the revenue growth coming from the “high gross margin” IYG acquisition. Comparable gross margins were probably down 100 to 150bps. That’s with inventory up, so if it needs more inventory to satisfy the backlog, it would seem it has a lot of the wrong inventory, making for further cost risk. Within another 6 month to 9 months, lapping the backlog satisfaction will be a huge comp pressure if demand isn’t ramping (which we think is unlikely given the abnormally elevated demand during the pandemic). On the consumer slowdown, we think op margins are heading to mid single digits and earnings are headed back around $3 or lower (street at $5) taking the stock to the low to mid 20s. Sticking with this Best Idea Short with 35% to 50% downside.
