Roots Corporation (TSX: ROOT) is a publicly held Canadian brand that sells apparel, leather bags, small leather goods, footwear, active, athletic wear, and home furnishings. The company was founded in 1973 by Michael Budman and Don Green. In 2015, Roots was sold to Searchlight Capital Partners LP, an American investment firm. The company’s design centre and leather factory are in Toronto, Ontario. Roots employ 2,000 people in Canada. As of May 2013, Roots was operating 210 stores in Canada.

Revenue Mix

Source: Annual Report, Kalkine Group

Investment Rationale

• Solid YoY Performance: On YoY basis, the company reported solid financial performance with revenue jumped by 24.7%, Direct-to-Sales segment revenue nudged by 27.6%, Partner segment sales improved by 11.3%, gross margin improved to 57.5% versus 54.9% in the previous corresponding period (pcp) backed by lower COGS as a percentage of revenue, operating losses also narrowed by lower selling and general administrative and other expenses as a percentage to revenue.

• Expanding eCommerce Reach: Retail apparel industry is going through a paradigm shift after business badly jolted by the COVID-19 pandemic. Traditional Brick and Mortar retailers are focusing on increasing their reach and footprint in eCommerce sales. In the first quarter of fiscal 2022, ROOT has increased eCommerce sales by approximately 50% year-over-year, partially offsetting store sales declines during periods of closure.

• Higher Institutional Ownership: Despite the penny cap market categorization of the company, institutional holding in the company is quite high at 51.06%. Moreover, recently institutions have increased their holding in the company with Invenomic Capital Management LP bagged 0.48 million shares, Timelo Investment Management Inc. added 0.44 million shares, and Acadian Asset Management LLC increased its position by adding 0.01 million shares. A higher concentration of institutional holding, especially in a penny cap stock, bolsters investors confidence and increases confidence in the company's books of accounts.

• Planning to Combine Online and Mall Shopping: According to the latest industry report, the eCommerce sales in Canada jumped by a whopping 75% in last fiscal to USD 77.25 billion, and the eCommerce market would continue to rise. To capitalize on the same, Roots launched virtual shopping appointments in April 2020, connecting customers with staff by phone, live chat and video while Roots locations were closed. Some staff have now been permanently moved into that function, and while the company is expecting fewer virtual appointments as customers come back to stores, it is considering how to continue merging online shopping with in-person service. Roots chief executive officer Meghan Roach said, "It's really about taking that next step."

• Increasing Demand Offtake: Led by the easing lockdown restriction along with more people getting inoculated against the deadly virus, and an increase in discretionary spending has boosted demand dynamics. It can also be gauged by seeing the topline performance of the company, which jumped by 24.7% on a YoY basis.

• Increased Brand Portfolio: The company has amplified the brand with the launch of multiple collaborations, including Révolutionnaire x Roots, Roots x and ROOTS X AVENGERS S.T.A.T.I.O.N.

• Available at a Discounted Valuation: From the TTM Price to Earnings multiple standpoint, ROOT shares are available a steep discount to its competitors, with ROOT's TTM P/E multiple of 9.32x whereas median industry peers are trading at the multiple of 17.85x, which implies a valuation discount of 48%. We believe this valuation gap to close in the future on the back of a strong brand portfolio and future growth strategy, which the company is adopting to position itself strongly in the geographies it operates in.

• 14-day RSI Indicates Potential Uptrend in the Near-term: In the below chart, we notice that 14-day RSI is consistently taking support near 40, which indicates that the stock is not turning into a downtrend. Moreover, after taking support at the lower Bollinger Band©, the stock has registered a trend reversal and moved towards its 20-day SMAs with above-average volume and a long Candle Stick indicates that bulls are getting control in the stock backed by a sharp surge in 14-day RSI. These technical indicators are indicating a potential upside in the stock from the current trading levels.

Technical Chart (as on August 03, 2021). Source: REFINITIV, Analysis by Kalkine 

• Prices are Taking Support of the Horizontal Trend Line: On the weekly chart, ROOT stock prices are trading above the horizontal trend line support level of CAD 2.82 and continuously taking support of it. After taking the support of its horizontal trend line, the price has witnessed the sharp upside move. The momentum oscillator RSI (14-Period) is trading at ~55.24 levels, indicating bullish momentum. Moreover, the stock is trading above 50-period SMA, which may act as a crucial support level for the prices.

Technical Chart (as on August 03, 2021). Source: REFINITIV, Analysis by Kalkine

• Risk Associated with Investment: The company is exposed to variety of risks ranging from supply chain risks, resurgence of Delta variant of COVID-19, a fresh lockdown and travel restrictions, intense competition, forex risks, credit risk, higher leverage position exposed it to interest rate risks, and investors in this company are exposed to credit risk, liquidity risks and steep volatility in the stock price because of the penny cap market categorization of the company.

Financial Highlights: Q1FY22:

Source: Company Filing

• Company reported stellar performance in the first quarter of fiscal 2022, with total revenue surged by 24.7% to CAD 37.3 million as compared to CAD 29.9 million in the same quarter of the previous financial year. This was primarily driven by 27.6% jump in the Direct-to-Customer sales to CAD 31.4 million versus CAD 24.6 million reported in the same quarter of the previous financial year.
• Q1FY21 Partners and Other sales (wholesale Roots-branded products, royalties on partner retail sales, licensing to select manufacturing partners and the sale of certain custom Roots-branded products) were up 11.3% from in Q1FY20. The year-over-year improvement primarily reflects an increase in the Company's partner business, which was significantly impacted by temporary store closures and reduced traffic in Q1FY20 because of COVID-19.
• First quarter Gross Margin also nudged by 260 bps to 57.5% against 54.9% reported in pcp, driven by 250 bps reduction in the cost of Revenue as a percentage of Total Sales to 42.5% versus 45% in year over period.
• On absolute basis Gross Profit surged by 30.7%to CAD 21.47 million as compared to CAD 16.43 million reported in pcp.
• Selling, general and administrative expenses of CAD 25.9 million were down from CAD 27.8 million in pcp. Selling and Distribution costs as a percentage to revenue also reduced significantly to 68% from 86% in pcp.
• Total operating costs as percentage to revenue also narrowed by 10 percentage points to 112% against 122% reported in the same period of the previous financial year.
• Operating losses narrowed to CAD 4.41 million against CAD 6.60 million reported in the pcp.
• Net loss per share of CAD 0.12 improved from a net loss per share of CAD 0.18 in the same quarter of the previous year.
• Adjusted Net Loss per Share of CAD 0.10 improved from net loss per share of CAD 0.22 in pcp

Top-10 Shareholders

Top-10 shareholders together holds approximately 55.86% stake in the company, with Searchlight Capital Partners UK, LLP and Manges (Daniel) are among the major shareholders with an outstanding position of 48.61% and 4.12% respectively. The institutional ownership in the company stood at 51.06% and Strategic shareholding stood at 4.84%.

Valuation Methodology (Illustrative): Price to Earnings based Valuation Metrics

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 covid-19 pandemic has forced Apparel and footwear players to accelerate digitalization to remain competitive. ROOT has taken the necessary steps to bolster its digital reach. Moreover, the company’s E-commerce sales have increased by approximately 50% year-over-year. Moreover, faster eCommerce penetration also helped the company to reduces its operating expenses, which lead to narrowing of operating losses.

Further, the company’s liquidity position has also bolstered in the latest quarter, with a Current Ratio of 1.05x at the end of the Q1FY22 improved from 0.95x in a quarter over period and 0.98x a year over period. This implies that the company’s short-term assets are adequate to cover its short-term expenses.

ROOT shares have delivered a stellar return to its shareholders, and despite the recent downtrend in the stock, its shares are still hovering in the long-term bullish zone, with stock traded well above the crucial long-term support level of 200 days SMA. However, a highly leveraged balance sheet is a concern and expose the company to interest rate risk.

Therefore, based on the above rationale and valuation, we recommend a “Speculative Buy” rating on the stock at the closing price of CAD 3.47 on August 03, 2021.

*Depending upon the risk tolerance, investors may consider unwinding their positions in a respective stock once the estimated target price is reached.

Technical Analysis Summary

1-Year Price Chart (as on August 03, 2021). Source: REFINITIV,  Analysis by Kalkine Group

*The reference data in this report has been partly sourced from REFINITIV.

*Recommendation is valid at August 04, 2021 price as well.

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Disclaimer

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