Goose is Loose!

This year I started a position in Canada Goose. Here is my thesis!

Investment Overview

Canada Goose is a performance-luxury winter wear brand, with 60+ years of history as an expedition parka manufacturer. Management is fantastic. They are long-term oriented brand custodians who are making the right investments to strengthen the company. CG has multiple levers for growth: increasing brand penetration in the US, Asia, and Europe; mix shift to DTC, driven by solid online channel and growing physical presence; plans to monetize brand sensibly by entering adjacent product categories.

Business Overview

History

Canada Goose (originally Metro Sportswear) was first founded by Sam Tick, an immigrant to Toronto, Canada, in 1957. Canada Goose’s products have a long history of being used for Arctic and Antarctic expeditions, stemming from Metro Sportswear’s original specialty in woolen vests, raincoats, and snowmobile suits. Sam Tick was eventually succeeded in 2001 by Dani Reiss, who stimulated growth, committed to the Made in Canada cache, and rebranded the business as Canada Goose. Over time, CG has reduced its dependence on department stores and pivoted towards DTC channels (online is particularly big). In 2016, CG opened its first two flagship stores in Toronto and New York City. They are also in the process of launching a winter footwear product line-up to complement their existing winter jacket and knitwear (started in 2017) business segments.

Business model

Canada Goose operates in a subset of the winter outerwear market, selling parkas costing over $800. Authentic, superior-quality, function (rather than fashion) oriented products are the core of CG’s long- term brand strength. CG’s products, given their bias for function over fashion, are evergreen and so they can follow a strict no-discounting policy which adds to the brand image and maintains the value of their products. Sustainability is also a key consideration that underpins CG’s image. They always use 100% responsibly sourced down and reclaimed fur, are committed to carbon neutrality by 2025, and have launched a new parka, which has a 30% smaller carbon footprint, compared to in-line Expedition Parkas.

More recently, CG has started to monetize its brand sensibly by entering the related product categories including knitwear and footwear. To gain manufacturing expertise to guide the upcoming launch of a CG-branded footwear product, the company acquired Baffin, a specialist brand with Arctic heritage and best-in-class functionality synonymous with CG’s brand, at a cost of USD 32.5 million in 2018. They also recently hired Adam Meek, who has over 20 years of global footwear experience with prominent global brands including Sperry, Nike, and Lacoste Footwear, to head this business line.

Under-penetrated brand

North America

CG’s US operations now generate 30% of revenues, similar to the 35% generated by Canada operations. Given that the US has almost 9x the population that Canada does, there is clearly potential for the US business to grow substantially. CG is strong in Northeast USA but has yet to make entries into the Midwest and Northwest. They should succeed in all markets except LA, which is more fashion oriented.

Europe & Asia (China)

Europe and Asia together account for c. 33% of revenues. Although some countries in this region have milder climates, the brand remains in the early stages of its entry into key geographies. Specifically, future sales growth should be turbocharged by the opening of stores and a growing DTC presence in China. Popularity of CG brand in China is evidenced by the proliferation of fakes. Note also that c.30% of sales in North America and Europe are driven by Asian (primarily Chinese) tourists and travelers.

Key Industry Insights

Outerwear market is large and growing

The global winter wear market is worth USD $290B, of which 50% is jackets and outerwear. The overall winter wear market is expected to grow at just under 5% CAGR between 2020-2025. This is being driven by a fashion trend towards increased casualization as well as increasing business & leisure travel. Key mid-to high-end players in this category include North Face, Arcteryx, Patagonia, Columbia, Marmot, and the like. These players’ products typically cost less than $600.

Luxury outerwear is growing even faster

As mentioned above, Canada Goose operates in a subset of the outerwear market, selling coats costing upwards of $800. This segment has only really become a category in the last ten years and was worth approximately USD 11B in 2019. Luxury outerwear has fast rates of growth, driven by: (i) increasing consumption by young HENRY’s (High Earners, Not Rich Yet), with over USD100,000 in annual income, who account for c.50% of global luxury spending; (ii) an increase in the wealth and number of HNI’s, who’s total wealth has increased by a CAGR of 8.9% since 2011; (iii) the rise of the Chinese luxury consumer.

CG & Moncler lead in fragmented industry

Key players in this new high-end, luxury winter outerwear category include Mackage, Moose Knuckles, PJS, and Moncler. Specifically, Moncler has 16% and CG a 6% share of this USD 11B market. CG and Moncler, which have been growing revenues at 15-20% p.a., are growing faster than the luxury segment and consequently gaining share. This is driven primarily by their DTC efforts.

Moat Sources

Strong performance-luxury brand

CG has 60+ years of history as an expedition parka brand. As mentioned above, authentic, superior-quality, function-over-fashion products are at the core of CG. Brand strength and functional, evergreen products allow CG to operate a strict no-discounting policy which preserves brand equity. For me, brand strength is best evidenced by the strong presence of CG’s trademark Arctic patch at some colleges.

Existing distribution channels

Distribution channels are the second notable entry barrier in the luxury outerwear industry. Most brands start by selling through department stores and then develop the DTC channel, which entails more branding and customer experience management. CG has strong, long-standing relationships with its wholesale partners who extend the brand’s reach and influence. Good sell-in/sell-out helps sustain and cement these relationships.

CG also has a notable DTC presence. Brands typically maintain an online and brick-and-mortar presence. Early recognition of the potential of ecommerce and a subsequent willingness to make strategic investments means that CG over-indexes on ecommerce and has 51 national ecommerce markets. The company also has a small but expanding physical presence with 28 stores vs. Moncler which has 282 stores. Although smaller brands will undoubtedly try to move into the DTC channel, they may struggle to successfully grow DTC as CG already has.

Investing in moat asset

In-house manufacturing strengthens brand

CG has doubled down on the “Made in Canada” cache and is increasingly taking manufacturing in-house. They have gone from 33% in-house in 2018 to c. 50% today and are targeting 70% in-house. The “Made in Canada” cache assures consumers of authenticity and in-house manufacturing allows for greater quality controls. As a result, their commitments bolster their image as a superior-quality specialist brand with Arctic heritage and best-in-class functionality. As a testament to management’s long-term orientation, CG will reinvest savings from bringing manufacturing in-house to keep strengthening the brand.

DTC strengthens brand and improves unit economics

CG sells its winter apparel through (i) DTC and (ii) Wholesale channels. Consistently faster DTC growth (double wholesale growth) means there has been an ongoing mix-shift towards DTC. This is being catalyzed by CG’s rationalizing its wholesale presence and expanding its physical presence. DTC went from zero in 2015, to being a roughly equal revenue contributor pre-covid. Covid-19 resulted in a big drop in wholesale sales and an acceleration of DTC growth. In Q4 2020, 80% of sales were from online DTC channel alone. For FY21, 70% of sales are expected to be through the DTC channel (Moncler stands at c. 75% DTC).

CG has a two-pronged DTC strategy, combining an ecommerce-first business with a strategic brick-and-mortar presence. The company’s physical presence has been increasing. Having opened their first two stores in 2016, CG now has 28 stores, and plans to have 40-50 stores, with a particular emphasis on China going forward. Going DTC allows for a superior customer experience and more careful brand management; fewer clearances help preserve brand equity.

Note also that DTC is a higher margin channel. Luxury winter wear segment is a high margin category with COGS being approximately 25% of the retail price of goods. In the traditional department store channel, brands sold to department stores for half the retail value and so made a 50% GPM. Meanwhile, in the DTC channel, revenues are double, and GPM rises to 75%, meaning gross profits can be 3x normal. Indeed, in the most recent period CG’s wholesale GPM was 35.3%, about half of its DTC margin of 72.8%. There are, of course, higher SG&A costs associated with running stores, advertising, and maintaining an online presence. Nevertheless, this channel mix shift has boosted CG’s operating margins.

Building an emotional link b/w products & customer

Historically, CG struggled to build an emotional link with customers. In fact, they received flak for their use of real fur, with some falsely stating that ‘they trap and kill wildlife for an unnecessary, decorative fur trim.’ There have been significant positive developments on this front, with several non-fur products being launched (fake fur would be contrary to brand image). I believe this brand-image issue is mostly in the past as CG announced it would stop purchasing fur by 2021 and stop manufacturing using fur by 2022. CG is also a pioneer in its promise to source 100% RDS-certified (responsibly sourced) down by 2021. Note also that CG’s DTC push gives them more control over the customer journey and allows them to build a deeper emotional relationship with buyers.

Goose Black Label makes the brand more aspirational

Given high demand, CG can comfortably increase prices slightly when they bring new products to market. They are also using Goose Black Label to serve a slightly more premium ($1200+ vs. 800+), more fashion-oriented customer. These moves create interest in CG, make it more aspirational, and boost profitability.

Entry into adjacent verticals to monetize brand

CG’s transcendental parka brand is being leveraged to enter new adjacent product categories. The company has been expanding its offering of related products to include lightweight down-jackets, knitwear, and rainwear, to sensibly monetize their brand and reduce seasonal fluctuations in their sales. Most importantly, even as they seek to enter new categories, the company is careful to stay true to its DNA. This approach is, for me, epitomized by the way in which CG acquired Baffin – a specialist brand with Arctic heritage and best-in-class functionality synonymous with CG’s brand – for its manufacturing expertise to prepare for the upcoming launch of its new winter footwear line. 

Stewardship

Great brand custodians

CG is a family run business. Dani Reiss and team are great brand custodians. They understand that authentic, superior quality winter wear is at the core of CG. Given the company’s manufacturing roots, they place outsized importance on product quality. Additionally, they abide by a strict no-discounting policy. It is hopefully evident that management has a long-term mindset towards preserving the brand and growing sustainably through small, deliberate investments which can be scaled as things work. Incentives of common stockholders are well-aligned as promoter Dani Reiss has 18% ownership.

Innovation (but not newness)

CG is not a fashion company and does not launch new products at a rapid pace. Instead, they innovate whilst staying true to their DNA. New concepts are typically rolled out slowly and allowed to scale as they show signs of success. Therefore, it can take multiple seasons for concepts to become significant. That said, the pace for products in new categories has accelerated slightly, and there has been a greater attention to making sure products are aesthetically pleasing, in addition to being functional. One new initiative that stands out to me is the cold room (five currently exist) where customers can try on a parka in a store and go into a virtual Arctic experience in a giant refrigerator room.

Key Risk

CG is a fad. Company has over-invested and expanded. Growth runs out of steam. Poor profitability ensues. Although this has the appearance of a fad, I believe it is not. CG’s products are at their core function-oriented, as any CG parka-owner who has endured a Chicago winter will attest.

Play your own game

I recently read Morgan Housel's short and insightful article titled Play your own game. I think this article is a must read for all investment professionals and asset allocators.

Every trade has a counter-party and consequently involves an implicit declaration: "I'm right you're wrong." This declaration of one's superior insight is frequently stretched beyond individual decisions to encompass investment strategies. Deep value investors might shit on quality growth ones and vice versa. 

Such arrogance pervades through investment business. This is wrong.

Housel explains that just as athletes competing in different sports must train differently, equally smart and talented people invest very differently depending on what game they’re playing. His key messages are:

1. Judge less.

At least half the people doing things with money that you disagree with are playing a different game than you are. You probably look just as crazy in their eyes. 

2. Figure out what game you’re playing, then play it (and only it).

So few investors do this. Maybe they have a vague idea of their game, but they haven’t clearly defined it. And when they don’t know what game they’re playing, they’re at risk of taking their cues and advice from people playing different games, which can lead to risks they didn’t intend and outcomes they didn’t imagine. 

“That’s how I played the game,” Jordan said. “If you don’t want to play that way, don’t play that way.”

Moats as assets

I was incredibly lucky to be a summer research analyst at WCM Investment Management this summer. At WCM, there is a belief that a company’s moat trajectory is more important than its existing moat. This post, inspired by WCM’s concept of moat trajectory, will reflect on how a moat may be thought of as an asset. 

Before I apply the language of assets onto WCM’s framework, I want to outline first the origin story of moat trajectory. 

A moat, in common parlance, is a deep, wide water-filled ditch surrounding a castle. In investor-speak, a moat refers to a business’ ability to protect its long-term profits by maintaining its competitive advantages. A business’ economic moat, a term popularized by Buffett, works just like a medieval moat, which protects those inside the castle from attack. Following in Munger and Buffett’s footsteps, fundamental investors have gravitated towards investing in fairly valued businesses with large economic moats. 

However, in keeping with one of the foundational tenets of microeconomics, competition, drawn by the potential for supernormal profits, often erodes away the competitive advantages enjoyed by such superior companies. The result is that business’ moats may shrink over time. Once great businesses become simply good ones. Returns in such cases are less than spectacular. The WCM team’s key realization was that it is not just the existing but the future moat that really matters. Enter moat trajectory.

Having explained the importance of investigating the moat trajectory of a business, I will now make the case that the language of assets can be used in relation to moats. 

An asset, broadly defined, is something of value which can be converted into cash. As a company generates cashflows, a part of this asset may be used up. Take for example a luxury brand which overexposes itself and so generates outsize profits today. Here, the extra cash generated is really from the sale of an asset: the brand equity or intangible moat. In other words, the company divested an asset.

 
Just as companies can divest part of the moat, they can also invest to create and grow it. For example, a luxury brand may forego some cashflows today by hiring the best designers, spending on brand advertising, and curbing sales to maintain scarcity. These moves may be thought of as investments in the intangible moat. Preserving brand equity will lead to sustainable, strong performance and vice versa.

 
It may be said, then, that the future moat drives future cashflows, which ultimately determine how much a business is worth. Thus I believe the moat is an asset. Thinking like this will help us (i) reduce the risk of buying optically cheap businesses which are selling assets to generate outsize profits today, but will have less future cashflow; and (ii) identify companies which, although they might appear expensive, are really great businesses that are under-earning because they are constantly investing in their moat-asset.

To end I will return to the image of a medieval castle, one that is constantly under attack. As enemies fill the moat with dirt in a bid to make it crossable, one must spend on digging to maintain and grow it. Similarly, companies too must invest to create and expand their economic moats.

The Art of Worrying Productively

Worrying is an often unproductive activity. I certainly am guilty of worrying about tasks for longer than it eventually takes to complete them. In investing, too, worrying can breed doubt and become paralyzing (for no company is perfect).

But, worrying is not all bad. Worrying can induce a desirable level of stress which is, in fact, conducive to productivity. Similarly, in investing, too, worrying can be an incredibly productive activity — perhaps even more so than in any other field. Worrying is doubly useful. First, worrying about all the ways you might be wrong allows you to discover what you don’t know. Secondly, worrying in this way leads one to work harder, dig deeper, and become more vigilant, enabling a more thoughtful view on the range of potential futures a business might face. 

Long-term investment success probably relies on a mastery of the art of worrying productively.