We’re adding YETI to our Best Idea Short list and think that there’s 60%+ downside over a TAIL duration. We’ve been patiently waiting to add this name to our Best Ideas but wanted to de-risk the 4Q print, as we knew the results were tracking well. We were vocal about that even when upping this on our Short Bias list earlier this week. But apparently so was the Street as the stock traded down 8% on a 20% EPS beat and bullish guide. We’re far from too late in elevating this short to our Best Ideas List (first made the call at $68 last month – stock closed at $72 today). The upside catalyst is gone, and it just signaled its 1st lower high with accelerating volume on declines (bearish trading inflection). Importantly, we think that 2H21 will be the beginning of the rate of change that will mark a 1,000bp deceleration in the top line, 500bp erosion in margins over a TAIL duration – at the same time capital intensity in this business is growing (capex up 100% in the upcoming year). Not a good fundamental rate of change cocktail for one of retail’s momo stocks.
Today people view this as a cult brand and value it at a mind-numbing 5x EV/Sales multiple – for a cooler company – a consumer durable business with extremely low barriers to entry. With ROE of 80%, ROIC of 35% and a loyal customer base I kind of get it. Let’s face it, the brand is hot. No question about that. But the reality is that this is an example where the right innovation cycle (hand held coolers) and impressive branding synched with the pandemic (off premise alcohol consumption and outdoor gatherings) which drove the highest margin business to 58% of sales, and did so through the highly profitable DTC channel (53% of sales). So the punchline is that during the pandemic we clocked in at 20% top line growth, a stunningly unsustainable 19.6% EBIT margin, and 56% EPS growth. Does this warrant YETI being valued higher than AMZN (3.4x sales) which might have higher barriers to entry than any company on the planet? I’d argue that the answer is no. But the growth, margin and return on capital characteristics have been downright impressive.
But now things change…
This type of ‘lightning in a bottle’ business is one where it’s critical to model out the margin and capital intensity of the business over time. Again, barriers to entry are low in the cooler business, and the company will have to spend up each year to maintain its share. Keep in mind that the company’s success is drawing steeper competition from branded competitors (Hydroflask), and even private branded product on platforms like AMZN (which accounts for 13% of total sales today). We're also seeing somewhat puzzling product diversification into backpacks, duffels and wheeled luggage. In fact, in looking at the company’s guidance management talks about reinvesting ‘strategic actions’ back into product, strengthening of the Chinese RMB hurting product costs, higher shipping costs, variable SG&A growing faster than sales (implying 20%+), and as noted earlier, a dramatic increase in capex. In other words, it’s spending more to get to a lower top line growth rate and incrementally fewer margin dollars. Wholesale is also likely to rebound in 2H21 upon reopening, which we estimate is at least 1,000bp lower margin than its DTC business. Ultimately, for 2021 we’ve got sales slowing by 400bp, and margins down to 18.7% from 19.6% in 2020. That takes ROE down to 47% and ROIC closer to 30%. Still good, but with a decelerating top line, margin pressure and with greater capital intensity, we think it’s the start of when people begin to value this name on EPS, EBITDA and FCF Yield as opposed to blindly slapping on a nose-bleed EV/Sales multiple.
This ‘spend more to get less’ model should continue in year 2 and 3 of the model. Ultimately, we’re coming out at the business growing globally at a high single digit rate with mid-teens margins – which we think is generous for a hardgoods company – even one with the current brand heat of YETI (the point is that the heat will cool over the TAIL duration, or cost real dollars to maintain). That’s about $2.00-$2.25 in EPS in perpetuity as lower margins clip away incremental top line and keep EPS relatively even. We can debate what the magic multiple is for a consumer durable business with high single digit growth and (pressured) low-mid-teens margins and sub-20% ROIC. We’d get interested in owning it at a low-teens PE, sub-10x EBITDA multiple, or a 6-8% FCF Yield. Any way you cut the math, if our model is right we’re looking at a stock between $20-$30. Far more downside to come with this name.
