Established in 1973, Roots Corporation (TSX: ROOT) is a premium outdoor lifestyle brand. The group unite the best of cabin and city through unmistakable style built with uncompromising comfort and quality. The group offers a broad range of products designed for life’s everyday adventures, including women’s and men’s apparel, leather goods, footwear, accessories, and kids, toddler, and baby apparel. Starting from a little cabin in Algonquin Park, Canada, Roots has grown to become a global brand. As of January 30, 2021, the group operated 111 corporate retail stores in Canada, two corporate retail stores in the United States, 117 partner-operated stores in Taiwan, 26 partner-operated stores in China, two partner operated stores in Hong Kong, and a global eCommerce platform, roots.com.

Revenue Mix

Business Segments

Source: Kalkine Group, Refinitiv (Thomson Reuters)

Investment Rationale

• Available at a Discounted Valuation: From the valuation standpoint, ROOT shares are trading at a discounted valuation to the industry peers. As, from the NTM EV/EBITDA standpoint, shares are trading at a multiple of 5.7x, whereas the industry (specialty retailers) average multiple stood at 8.4x, implies a discount of 32% against the industry average. Also, from the NTM Price-to-Earnings multiple standpoint, its shares are trading at a multiple of 8.8x, whereas the industry average multiple stood at 15.6x, implies a discounted valuation of ~44%. Given the gradual recovery in the apparel sector, we believe the valuation gap to bridge over in the next few quarters. Therefore, the current valuation level seems to be a good entry-level for long-term investors.

Source: Kalkine Group, Refinitiv (Thomson Reuters)

• Strong Free Cash Flow: The company is having solid free cash flow, which is a strong fundamental metrics and provides a margin of safety to existing as well as potential shareholders. At the end of FY20, the company’s free cash flow position stood at CAD 47.50 million, which is decent given the market cap. Moreover, Root’s market cap is approximately CAD 137 million, and the group is sitting on CAD 47.50 million of free cash, which implies that Market Cap to TTM Free Cash Flow ratio of 2.88x. This is a single strong fundamental measure for investors as generally a market-cap to free cash flow ratio below 4x considered to be a value opportunity. Also, the availability of free cash flow ensures that the company has adequate liquidity to meet its obligations and handle business during tough times.

• Relying on eCommerce to tap the US Market: The company continue to believe that the U.S. market offers ample opportunities. However, the Adjusted EBITDA loss and the increasing challenges in the discretionary retail environment resulting from COVID-19 led them to believe that the permanent closure of these New U.S. stores was their best option. In the near term, the group believe a principally eCommerce-based distribution model is best to serve the U.S. customer base. The company would also continue to operate its two longstanding stores in Michigan and Utah, as both locations play important roles in their heritage and have well-established customer bases.

• Solid Jump in Margin Profile: The company reported solid margin expansion in FY20, led by a significant reduction in the operating overheads. Further, the company turned positive at the operating level and at the bottom line as well.

Source: Kalkine Group, Refinitiv (Thomson Reuters)

• Industry Leading Financial Performance in FY20: The group reported decent financial results and outperformed the industry median on various financial metrics, which is evident from the below chart.

Source: Kalkine Group, Refinitiv (Thomson Reuter)

• Shares Hovering above the Crucial Support Levels: At the last traded prices, its shares traded well above the crucial long-term support level of 200-day SMA of CAD 1.95 and traded decently above the crucial short-term support levels of 50-day SMA, which implies that long-term bullish trend is largely intact despite few corrections witnessed in the counter over the past few trading sessions.

Technical Price Chart (as on April 20, 2021). Source: Refinitiv (Thomson Reuters)

• Risk Associated with Investment: Consumer demand would be the most significant issue amidst the uncertainty in the global economy, negatively impacting the group’s corporate retail stores, as well as the businesses of their international operating partner and their North American wholesale and retail partners. Also, cases of COVID-19 infection that arise at their corporate retail stores, leather factory, distribution center, or head office may disrupt the company’s operations, which could lead to lost sales and/or additional costs.

Financial Highlights: Q4FY20 and FY20

Source: Company Filing

Q4FY20

• Total sales decreased by CAD 28.056 million, or 22.0%, to CAD 99.397 million in Q4 2020, from CAD 127.453 million in Q4 2019, led by 22.9% decline in the DTC sales and 9.1% decline in the Partners and Other Sales.
• Gross profit decreased by CAD 10.436 million, or 15.1%, to CAD 58.854 million in Q4 2020, from CAD 69.290 million in Q4 2019. This was mainly on account of the 16.5% reduction in the DTC segment gross profit. However, DTC gross margin increased to 59.8% in Q4 2020, from 55.2% in Q4 2019.
• The company recorded no goodwill impairment in Q4 2020, compared to a goodwill impairment of CAD 44.799 million in Q4 2019.
• SG&A expenses decreased by CAD 30.436 million, or 43.8%, to CAD 39.009 million in Q4 2020, from CAD 69.445 million in Q4 2019. SG&A expenses includes a fixed asset impairment of CAD 0.886 million in Q4 2020 and CAD 19.183 million in Q4 2019.
• Adjusted EBITDA increased by CAD 0.038 million, or 0.1%, to CAD 26.091 million in Q4 2020, from CAD 26.053 million in Q4 2019.
• Net income increased by CAD 56.921 million to a net income of CAD 12.344 million in Q4 2020, from a net loss of CAD 44.577 million in Q4 2019.
• Adjusted Net Income increased by CAD 3.003 million to CAD 16.272 million in Q4 2020, from CAD 13.269 million in Q4 2019.
• Basic earnings per Share increased to CAD 0.29 in Q4 2020, from a loss of CAD 1.06 in Q4 2019.

Full-Year Performance

• Total sales decreased by CAD 89.359 million, or 27.1%, to CAD 240.506 million in F2020, from CAD 329.865 million in F2019, driven by 27.6% sales reduction in the DTC segment, and 23.3% sales declined reported in the Partners and other segment.
• Gross profit decreased by CAD 36.450 million, or 20.7%, to CAD 139.739 million in F2020, from CAD 176.189 million in F2019.
• SG&A expenses decreased by CAD 73.501 million, or 39.0%, to CAD 114.807 million in F2020, from CAD 188.308 million in F2019. SG&A expenses includes a fixed asset impairment of CAD 0.886 million in F2020 and CAD 19.183 million in F2019.
• Adjusted EBITDA increased by CAD 12.680 million, or 48.6%, to CAD 38.748 million in F2020, from CAD 26.068 million in F2019. Adjusted EBITDA was 16.1% of sales in F2020, increasing from 7.9% of sales in F2019.
• Net income increased by CAD 75.109 million to a net income of CAD 13.080 million in F2020, from a net loss of CAD 62.029 million in F2019.
• Adjusted Net Income increased by CAD 12.493 million to CAD 16.511 million in F2020, from CAD 4.018 million in F2019. Adjusted Net Income was 6.9% of sales in F2020, increasing from 1.2% of sales in F2019.
• Basic earnings per Share was CAD 0.31 in F2020, up from basic loss per Share of CAD 1.47 in F2019.

Top-10 Shareholders

The top-10 shareholders are holding approximately 53.6% stake in the company, with Searchlight Capital Partners UK, LLP and Manges (Daniel) are the top investors, holding 48.63% and 4.12% stake, respectively. The institutional ownership in the company stood at 48.81%, whereas strategic holding stood at 4.83%.

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Valuation Methodology (Illustrative): EV to Sales

Note: Premium (discount) is based on our assessment of the company’s growth drivers, economic moat, competitive advantage, stock’s current and historical multiple against peer group average/median and investment risks.

Stock Recommendation: The company witnessed many challenges due to COVID-19 led distortion; however, since March 2020, they have implemented many strategies to reduce costs and manage liquidity to overcome the negative impacts of the pandemic. The company substantially reduced selling, general and administrative expenses (“SG&A expenses”), capital expenditures and discretionary spending across all areas of the business. The company also reduced and adjusted forward inventory purchases. As a result, the group has reduced and managed the costs across all areas of the business. The group has been able to effectively manage the liquidity with a 53%-year-over-year increase in available liquidity as at the end of F2020 and a reduction of the leverage from 3.7x Adjusted EBITDA in F2019 to 1.6x Adjusted EBITDA in F2020. The group also reported a decent improvement in its financials since the last three quarters on a sequential basis. Further, the strong free cash position of the company provides a sense of margin of safety to the investors. Market Cap-to-TTM Free Cash Flow ratio is below 4x, which is making it a good value investing opportunity at the current level. Also, its shares are available at a discounted valuation to the industry average, which sets it as s good bet for bargain hunters.

Going forward, we expect the situation to return to normal as the vaccine rollout is in progress, which should result in higher footfall at the stores. However, recent spikes in COVID-19 cases pose a short term challenge.

Therefore, based on the above rationale and valuation, we suggest a “Speculative Buy” recommendation at the closing price of CAD 3.18 on April 20, 2021.  

1-Year Price Chart (as on April 20, 2021). Source: Refinitiv (Thomson Reuters)

*Recommendation is valid at April 21, 2021 price as well.

Disclaimer

The advice given by Kalkine Canada Advisory Services Inc. and provided on this website is general information only and it does not take into account your investment objectives, financial situation and the particular needs of any particular person. You should therefore consider whether the advice is appropriate to your investment objectives, financial situation and needs before acting upon it. You should seek advice from a financial adviser, stockbroker or other professional (including taxation and legal advice) as necessary before acting on any advice. Not all investments are appropriate for all people. The website www.kalkine.ca is published by Kalkine Canada Advisory Services Inc. The link to our Terms & Conditions has been provided please go through them. On the date of publishing this report (mentioned on the website), employees and/or associates of Kalkine do not hold positions in any of the stocks covered on the website. These stocks can change any time and readers of the reports should not consider these stocks as advice or recommendations later.