Why Aritzia Remains A Buy In Today’s Market (ATZAF)

Aritzia’s business fundamentals have improved since my previous analysis in March 2023 and its 2027 expansion plan is being well executed so far. I will evaluate in more details below how Aritzia has performed financially and in each of Aritzia’s core strategies in the past year. However, Aritzia’s valuation has declined significantly by over 18% compared to a 20%+ gain by the S&P 500 Index. Despite some lingering inventory risk and higher general and administrative expenses, Aritzia stands as a solid fashion powerhouse. As such, I continue to recommend “Buy” for Aritzia at this time.

Introduction

Aritzia, established in 1984 and headquartered in Vancouver, has evolved from a single store into a global fashion entity with 117 boutique stores across Canada and the U.S. as of November 2023. With a market capitalization exceeding $3.8 billion and annual revenues above $2 billion, Aritzia has solidified its position in the industry by specializing in women’s clothing in the Everyday Luxury segment, with plans to expand further into men’s wear.

Firstly, let’s review how Aritzia performed financially in the past year.

Financial Performance

Net revenue grew by 5.9% to $1.7 billion in YTD 2024 from YTD 2023. For full year 2024, Aritzia is expected to generate $2.33 billion revenue.

Revenue generated from the United States continues to increase but at a slower pace for now. For the nine months ended November 26, 2023, the revenue from the United States represented 51.9% of its total revenue, compared to 50.3% in the same period last year. Aritzia has only 52 stores in the U.S., which represents about 44% of the total store count.

E-commerce revenue currently represented about 31.5% of total revenue for the nine months ended November 26, 2023, compared to 31.8% in the same period last year.

E-Commerce revenue increased 4.9% in YTD 2024 compared to YTD 2023.

Gross margin in YTD 2024 declined by 4.5% to 38.6% from 43.1% in YTD 2023. This is primarily due to markdowns on older inventory. However, with the opening of the Vaughan distribution facility in Q2 2024 and a lower inventory level, the gross margin is expected to improve in the coming quarters.

Inventories as of November 26, 2023, were $397 million compared to $508 million on November 26, 2022, reduced significantly in the past year.

Aritzia delivered record cash from operations in Q3 2024 of $241 million. Of cash generated, Aritzia used $44 million to invest in facility expansion and $130 million to repay debt. This should help reduce interest expenses in the coming quarters.

Aritzia also increased its share repurchase volume. In Q3 2024, it repurchased $10 million worth of stock.

SG&A expenses increased significantly by 18.7% in YTD 2024 compared to YTD 2023 largely due to expansion project costs and increased number of support office employees. However, this increase in SG&A should slow down in the coming quarters, given that the major expansion of the Vaughan distribution facility has been completed.

Overall, fiscal year 2024 appears to be a year of transition, executing to expand its distribution facilities. Financial results are relatively positive, but not something to be excited about. However, the financial results are trending in the right direction as inventory risks are easing.

Growth Strategy Evaluation

Key growth strategies contributing to Aritzia’s success include its portfolio of exclusive brands, vertical integration, e-commerce, and geographical expansion.

Let’s now review how Aritzia performed in each of the core strategic areas in the past year.

Exclusive Brands

Aritzia has continued to focus on generating revenue from its exclusive brands. Currently, in Q3 2024, Aritzia generated 97% of its revenue from its exclusive brands, increased from 95% in Q3 2023. Aritzia’s exclusive brands continue to gain popularity as some more celebrities (Kendall Jenner, Ariana Grande, and Meghan Markle) are seen wearing Aritzia’s famous products.

Vertical Integration and Geographical Expansion

Aritzia has continued to consolidate its distribution operations to further vertical integration. In Q2 2024, the 550,000 square feet distribution facility in Vaughan began its operations, which is fully run by Aritzia replacing the previous distribution facility in Mississauga run by a third party. This distribution facility is the largest in Aritzia’s network.

In addition, Aritzia has begun construction of the 380,000 square foot distribution facility in Delta, British Columbia. When completed in fiscal year 2026, this facility will also be fully operated by Aritzia rather than a third party.

Aritzia plans to expand its warehouse in Columbus, Ohio from 255,000 square feet to 560,000 square feet in fiscal year 2025 doubling its distribution capacity in the United States.

Below is a summary of Aritzia’s distribution facilities before this round of expansion and after.

Click to enlarge

In fiscal year 2027, Aritzia will have 1,713,000 square feet from 4 distribution facilities compared to just 628,000 square feet before this round of major expansion. Out of the 1,713,000 square feet of distribution facilities, 67.3% will be operated by Aritzia furthering vertical integration compared to 35.5% before.

Aritzia currently has 52 stores in the United States, while it has 65 stores in Canada. The population per store in Canada is about 0.6 million, while the population per store in the U.S. is at least 3 million. As a result, there is significant potential for Aritzia to expand in the U.S.

By 2027, Aritzia wants to increase the store count in the U.S. to 90, which is an increase of 73%.

Although the % of distribution capacity in the United States is decreasing to 33% from 41% despite the expansion of the Columbus facility, as Vaughan and Delta are all bordering the United States, these facilities located in Canada should also be able to support the geographical expansion in the United States. After all, the operating costs in Canada should be relatively lower compared to the United States.

As the Canadian economy is weaker at the moment compared to the U.S., Canada is expected to cut interest rate slightly sooner than the U.S. resulting in Canadian Dollars getting cheaper. As Aritzia is a net exporter from Canada to the U.S., this trend should help Aritzia improve its margin from the sales in the U.S.

In summary, Aritzia is also trending in the right direction in terms of vertical integration and geographical expansion.

E-Commerce

Aritzia continues to invest heavily in its e-commerce capabilities as part of its core focus toward 2027.

Aritzia’s website has seen some major upgrades recently and is quite outstanding compared to other e-commerce sites.

For example, if you get on Aritzia’s website from Canada in February or March, which is quite cold, you may be presented with Aritzia’s Super Puff collection immediately.

In addition, on the front page, while other e-commerce sites are still showing each product with images, Aritzia has leaped into short videos that give you a quick overview of how each product looks on the model. This feature seems incredibly smooth on mobile phones. Wish I had a way to show you how it appears. I am not a frequent visitor to Aritzia’s website, but I am impressed from the most recent visit.

Also, if you click on a specific clothing item, it is quite easy to find available items by size and pick-up store. When you scroll down, you will be recommended to other products that are similar or will match the style of the clothing item you are interested in.

These features help create a very personal and smooth e-commerce shopping experience on Aritzia.com.

In addition, Aritzia plans to launch a client app to further the tailored approach to engage with its loyal customers.

Overall, it seems that Aritzia has been following through in the past year on its strategic initiatives with increased brand awareness, vertical integration, geographical expansion, and e-commerce.

What to Watch Out for Q4 2024

Given further vertical integration, investors may expect the gross margin to improve slightly in Q4 2024, likely over 40%.

Q4 2024 revenue may increase significantly compared to Q4 2023 with the opening of the Vaughan distribution facility. Investors may also see a slight decline in the % of revenue coming from the United States as a result of Vaughan serving mainly Canadian consumers.

E-commerce sales may increase in terms of % as part of total revenue thanks to heavy investments in its e-commerce site.

Valuation

Aritzia is currently valued at $3.88 billion in market capitalization as of April 18, 2024.

In fiscal year 2023, Aritzia reported an EBITDA of $337 million. For the fiscal year 2024, Aritzia is on track to match last year. If using $337 million, Aritzia’s valuation is about 11.5 times EBITDA. For a company that has been investing heavily in its infrastructure and is on track to grow at a 15% annual growth rate to an annual revenue between $3.5 billion and $3.8 billion, 11.5 times trailing EBITDA appears to be quite cheap.

In addition, Aritzia’s EV/Forward EBITDA is 12.1 while Lululemon is at 14.9.

If we just look at business fundamentals, Aritzia’s fiscal year 2024 revenue is expected to be $2.33 billion, Lululemon’s current year revenue was $12.9 billion. So, Lululemon is about 5-6 times the size of Aritzia currently. However, Lululemon is trading at $61 billion, which is over 15 times more than Aritzia.

One may argue that Lululemon has a higher gross margin than Aritzia. However, it is a bit unfair to compare Aritzia’s gross margin with Lululemon at this time given Lululemon’s economies of scale. Back in 2015 when Lululemon’s annual revenue was just over $2 billion, Lululemon’s gross margin was around 50%, much lower than 58% in the most recent year.

As Aritzia achieves more economies of scale, I expect its gross margin to increase as well.

Overall, I think the thesis that Aritzia may be the next Lululemon still stands, with its core strategies trending in the right direction.

Risks

Despite Aritzia’s growth potential and solid business fundamentals, there are some inherent risks for consideration.

The expansion of distribution capacity may not translate into increased revenue immediately. If the growth in store opening and consumer demand doesn’t align, there may be wasted distribution capacity, resulting in high SG&A expenses and potential layoffs.

Aritzia’s success also relies on its ability to anticipate and adapt to changing fashion trends. If the company fails to adapt quickly enough to consumer preferences, Aritzia may have excess inventory and markdowns again, negatively impacting profitability.

Aritzia’s success is significantly influenced by macroeconomic factors such as consumer spending patterns. Canada still represents about half of Aritzia’s total sales. Given the relatively weak economic conditions and a housing crisis in Canada, Canadians may cut back on discretionary spending at Aritzia and purchase clothing from cheaper options, including second-hand clothing.

Conclusion

Despite facing some challenges, Aritzia has demonstrated resilience and continues to strengthen its position in the fashion retail industry. While its valuation has experienced a decline compared to the S&P 500 Index in the past year, the company’s core strategies, including increased brand awareness, geographic expansion, e-commerce enhancements, and vertical integration, are moving in the right direction. Although there are inherent risks associated with the fast-evolving fashion industry and economic conditions, Aritzia’s proactive approach and strong financial performance support a positive outlook. Therefore, a “Buy” recommendation for Aritzia seems justified at this time.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.