S&P Global Ratings raised its credit ratings on Canada Goose as it sees a continued focus on the higher-margin, direct-to-consumer (DTC) segment and recovering sales in China helping the outerwear maker’s performance going forward.
“We expect the company’s strategy of expanding its DTC network while focusing on cost efficiencies should continue to support EBITDA growth and maintain leverage,” said S&P.
S&P said that as a result, it raised its issuer credit rating on Canada Goose to ‘BB-‘ from ‘B+’ and its issue-level rating on the company’s senior secured term loan to ‘BB+’ from ‘BB’. The ‘1’ recovery rating on the term loan, indicating S&P’s expectation for very high (90 percent to 100 percent; rounded estimate: 95 percent) recovery in a default scenario, is unchanged.
“S&P said in its analysis, “The upgrade reflects our projections that Canada Goose’s revenues and EBITDA will increase through fiscal 2025 (ending April). Although the company’s fiscal 2023 operations in mainland China were soft following the lifting of pandemic-led closures earlier this year, recent data indicates that consumer spending has rebounded. Canada Goose’s growth prospect is also attributable to the company’s presence in the higher-margin, DTC (mid-70 percent gross margin) channel, constituting about 70 percent of total fiscal 2023 revenues, up from 60 percent two years ago, and its well-developed e-commerce channels. We expect the company will continue to increase sales through the DTC channel such that it generates mid-to-high 70 percent of its 2024 revenues. Canada Goose operates in a global e-commerce business and 54 stores (at the end of first-quarter 2024), with plans to open 16 more stores in fiscal 2024. With a target to double its brick-and-mortar footprint in the next five years, particularly in North America and mainland China this year, Canada Goose will continue to drive customer penetration and increase customer lifetime value from its expanding offerings. As a result, we expect revenue and EBITDA growth, higher than the luxury goods sector, over the next 12 months. In addition, the continued favorable shift in increasing DTC and minimizing wholesale will support higher gross margins.
“Pricing actions continue to mitigate pressures from higher input costs and expansion plans.
“We forecast Canada Goose’s average selling price will rise due to a combination of increased pricing actions (mid-single-digit percentage area) and the company reducing its exposure to the lower-margin (mid-to-high 40 percent gross margin) wholesale segment. The company’s higher-income customer demographic has also made it easier to take pricing actions without seeing a decline in demand. Recovery in retail sales in China is also supporting revenue growth. As a result, we expect the strong revenue growth and expanding gross margin will more than offset wage increases, higher costs to support new store openings, and other strategic measures (IT, marketing) that will reduce annualized operating expenses by C$150 million in the longer term. Nevertheless, we believe the company will sustain EBITDA margins in the low-20 percent area through fiscal 2024. With EBITDA growth, we expect leverage will remain at about 3x through fiscal 2024.
“Store expansion will increase capital expenditure and restrain free operating cash flow.
“We expect the company will continue to generate positive free operating cash flow (FOCF), albeit similar to that of the previous year. During fiscal 2023, Canada Goose had significant working capital investments owing to inventory build-out but also curtailed its capital expenditures (capex) during the year. As a result, the company exited fiscal 2023 with FOCF of about C$70 million. To fund its DTC and retail network expansion, the company plans to increase capex in the C$70 million-C$80 million range to build new stores. As a result, we expect FOCF will be modestly higher than 2023. In addition, capital lease liabilities associated with the new stores will limit any material improvement in leverage for the next 12 months. However, considering cash on hand of C$48 million as of July 2, 2023, and C$517.5 million of borrowing capacity (June 1 to November 30; C$467.5 million for the rest of the year) available under the revolving facility, we expect the company has adequate financial flexibility to mitigate temporary headwinds.
“A niche market, narrow product focus, and high seasonality and geopolitical risks constrain the rating.
“Still, we view Canada Goose’s small-scale, limited product and brand diversity, and the highly seasonal nature of the business as factors that could lead to greater volatility in EBITDA margins and credit measures. We believe that within the broader global designer apparel and footwear market, the company has created a niche position and has a limited scale as a performance luxury outerwear apparel manufacturer. However, we assess Canada Goose’s single brand and narrow product focus as key credit risks to the company’s business risk profile. The company has high product concentration with most of its revenues generated from its highly seasonal parka category (about 75 percent of revenues was generated in July through December; target to reduce to 65 percent), which exposes it to significant revenue volatility should seasonal sales weaken. A small but growing portion of revenues is composed of non-parka products such as apparel and cold-weather accessories. The company has recently launched footwear and plans to expand into travel retail. We believe the company is still in the early stages of product diversification and these efforts would only show material benefit to its operating performance beyond the next 12 months. Finally, although we assess geopolitical risk as low, it could still limit the company’s geographic expansion and revenue growth outside of North America, particularly in Asia.
“The stable outlook reflects our expectation that a growing DTC network combined with cost efficiencies should lead to EBITDA growth and stable leverage of about 3x for the next 12 months. We expect the company will exhibit resilience against macroeconomic uncertainties and continue to execute its DTC strategy. Revenue growth should be spurred by the growth in e-commerce channels, new store openings, increased consumer penetration, and product expansion.”
