This morning, Roots reported Q2/F18 results that were below our forecast while maintaining its three-year guidance targets through F2019.
Impact: NEGATIVE
We anticipated a weak top-line performance in Q2/F18 due to the material success of the Canada 150 campaign in F2017, however, we underestimated the full degree of its success including the "halo" effect that resulted in growth above expectations. Admittedly, this is masking/muting the F2018 performance and, as such, we need to reset our near-term financial expectations as this will remain a headwind in Q3/F18 prior to seeing a return to growth in Q4/F18 and a re- acceleration supported by in place initiatives in F2019, in our view.
It appears Roots has placed itself in the near-term penalty box as investors digest and make judgement upon its growth outlook. This is a function of the recent quarterly results and the soft outlook alluded to by management for Q3/F18. That stated, our view is unchanged that the mid-term growth outlook remains in place, supported by the timing of growth verticals currently ramping. This, along with continued benefits from the United Brand Range ("UBR") merchandising strategy, should lead to a material increase in F2019 EPS, in our view.
We reevaluated our investment thesis for Roots in light of the weaker-than- anticipated outlook for F2018. While we contemplated taking our loss and soldiering on, we believe in the growth drivers that are set to materially increase over our investment horizon. We believe that this should result in attractive FCF and a deleveraging of the balance sheet and a return to an attractive EPS growth outlook. As such, we are maintaining our recommendation and believe that the guidance set out by management remains achievable through F2019.
We believe that near-term catalysts for Roots appear elusive as we anticipate a "soft" Q3/F18 period as well. Saying this, it is our view that this has been priced into the shares and that by the Q3 reporting period, management should have a clear understanding of its ability to resume growth in Q4/F18 and the outlook for initiatives set to improve growth in F2019.
TD Investment Conclusion
We are maintaining our ACTION LIST BUY recommendation while lowering our target to $15.00 from $17.00.
Company Profile
Roots is an iconic Canadian retailer with a rich heritage and portfolio of premium apparel, leather goods, accessories, and footwear. Roots operates 122 stores in Canada and the U.S., and 139 partner-operated stores in Taiwan and China.
September 12, 2018
Consumer Discretionary
Brian Morrison, CA Meaghen Annett, CFA
Recommendation: ACTION LIST BUY
Risk: MEDIUM
12-Month Target Price: C$15.00 Prior: C$17.00TD