Our view: ATZ's unique positioning is the key to strong performance, but investor concerns around sustainability of demand against the backdrop of recession/higher rates/consumer disposable income headwinds, and transient margin pressure are likely to weigh on share price performance until visibility improves. Nonetheless, we maintain our thesis that ATZ has an exceptional growth runway as it continues to seed the US market, grow its omnichannel presence and expand assortment into new categories. SP reflects sector exposure/valuation/relative upside potential.
Key points:
Despite higher than Q-end inventory, mid-way through Q4 management expects FQ4 markdowns to be consistent with pre-pandemic. Inventory at the end of FQ3 +187% reflects very low on-hand inventory last year as most of the committed inventory at the end of FQ3 last year was stuck at factory level due to supply chain constraints. On a total committed basis, including inventory at the factory + in transit + on hand, Y/Y inventory growth was 35.6% and in line with revenue growth. Forecasts assume inventory normalizes by mid-F24, thereafter tracks top line growth.
F24+ forecasts essentially unchanged, adjusting Q4/F23E to reflect better top line growth, offset by transient margin pressure. Our F24E normalized EPS $2.04 implies four-year EPS CAGR +26% since the start of the pandemic. Revising Q4/F23E EPS from $0.44 to $0.34 reflecting: i) higher top line growth forecast to $598 MM (+12% vs prior published, +35% Y/Y) toward the high end of guidance range $580-$600 MM, ii) transient GM % pressure -250 bps Y/Y, in line with revised guidance reflecting higher warehousing costs due to inventory rebuild and normalizing supply chain lead times, and higher SG&A. Importantly, management is not seeing any adverse signals in its core KPIs with sales growth on full price items > merchandise on mark down, which speaks to the resilience of Aritzia's core customer demographic. Calendar and weather effects likely a wash early FQ4, with one extra Saturday leading up to Christmas this year offset by unseasonable weather/precipitation across Canada in December.
Stepping back on the NCIB. ATZ moderated share repurchases in FQ3, buying back 122k shares vs 1.7 MM fiscal YTD (1.5% of total), and ATZ hasn’t filed any repurchases so far in FQ4. Against the backdrop of rising uncertainty over discretionary consumer spending, share repurchases likely to remain highly opportunistic, in our view.
Maintaining SP rating, $63 PT. In our view, the slowdown and uncertainty that surrounds probable recessions on both sides of the border is more likely to impact valuations rather than earnings and demand trends at Aritzia. Target multiples reflect heightened uncertainty and SP rating reflects sector exposure/positioning relative to other SMID-cap names.
Revenue performance/outlook reflects strong/building brand equity, growing TAM
Raising BOTH cost and revenue forecasts for Q4 consistent with guidance resulting in moderated EBITDA growth for the quarter; F24+ EBITDA forecasts largely unchanged. In conjunction with the Q3 release, management provided updated guidance for Q4/F23. While revenue momentum remains strong Q4-to-date with good balance of full price/promo, gross margin and opex pressure in Q4 will be greater than prior forecasts, moderating EBITDA by ~$10 MM (10%).
Q4/F23E outlook vs RBC E:
o Sales ~$580-600MM (RBC E $598MM), partly offset by... o GM compression ~250 bps (RBC E -252bps) and...
o Opex ratio flat y/y (RBC E +7bps).
However, looking ahead, normalizing cost structures and execution of the growth strategy should enable ATZ to remain on its growth trajectory. While a recession and sharp contraction in consumer disposable income could likely moderate organic performance, ATZ’s relative quality/value proposition and extended new opening pipeline should enable the company to continue to generate sector-leading growth. Sector Perform rating reflects current equity market flow of funds/relative upside.