Columbia Sportswear: You Can Buy The Clothes But Not The Stock – Seeking Alpha

Columbia Sportswear (COLM) is a US-based leading manufacturer and distributor of outerwear and sportswear clothing. There is a very good chance that if you have ever engaged in either cool weather or hot weather sports, such as skiing or fishing, you have worn Columbia clothing. Columbia has been a publicly traded company since 1989 and is one of the better known providers of outerwear clothing today in all of retail. Competition in this segment of the retail industry has become fierce in recent years due to a number of factors. Under Armour (UA) has moved beyond the initial stage of being just a provider of athletic apparel as the brand popularity has exploded, with product offerings now encroaching on a segment once dominated by Columbia. Nike (NKE) continues to be the 800lb gorilla in the sports apparel industry, and thus has the ability to offer a value proposition from a pricing standpoint when compared to Columbia. Finally, a number of private companies, such as The North Face, provide significant competition specifically in the cold weather performance apparel segment. There is a reason that the competition in this retail segment is increasing, and it is due to the profitability tied to this type of apparel. Columbia has consistently generated gross margin in excess of 40% over the last 5 years. This is a significant level of profitability in the apparel industry and is partly due to the premium connotation associated with this type of clothing and partly due to a lack of competition. As the competition increases, the outlook for Columbia decreases as the company could be forced to become more competitive from a price standpoint. The company is already seeing top line pressure with revenue declining YoY in 2012 and the company guiding for revenue to decline again in 2013. With the headwinds facing the company, the valuation equation for owning Columbia shares is currently non-existent. Further, the company would appear to be overvalued with at least 18% downside from its current levels using a discounted cash flow analysis.

Company Overview

Columbia Sportswear is one of the largest outdoor apparel and footwear companies in the world. While the US accounts for over 50% of the total sales volume for Columbia, this is very much a global company, with its products being sold in almost 100 countries during 2012. The company reports financial results for two distinct operating segments: 1) Apparel, accessories, and equipment “Apparel” 2) Footwear. The company markets its apparel and footwear under multiple brands, the largest of which is its namesake Columbia brand. The apparel and footwear sold by Columbia is meant to reach a broad consumer group, ranging from extreme outdoor activities requiring cold gear or sun protectant clothing, all the way to apparel for casual or leisure activities.

Financial Overview

The below table provides a quick snapshot of key financial and market data points for Columbia:

Columbia currently trades towards the mid/high end of its 52 week trading range, which is relevant in the sense that the company lowered its 2013 guidance as part of its Q1 2013 earnings report in late April. After a minor sell-off related to the lowered guidance sent the stock down to about $57 a share, it has since rebounded and has continued to push steadily higher since the last earnings report as seen in the chart below:

COLM data by YCharts

Financial Analysis

Columbia saw flat to slightly negative revenue growth in 2012 when compared to the prior year. The company also recently provided guidance during its Q1 2013 earnings call for revenue in 2013 to be slightly negative compared to 2012. The table below shows actual revenue from 2008 through 2012, in addition to projected revenue for 2013 (assuming only a 1% decrease), to determine the CAGR over the 5-year time period ending in FY 2013:

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This historical look at revenue is important for determining a fair value for Columbia’s stock price. The company’s results are heavily influenced by weather, or the lack of cold weather to be more precise. Using a period of time that covers six years worth of revenue history smooths out any positive or negative impacts to operating results in any given year that the company may deem to be weather related. Importantly, the table above shows that over the last five years, the revenue CAGR is ~4.6%. This will come into play later in calculating a discounted cash flow analysis valuation for the fair value of Columbia shares today. Notably, the table above also shows that the company has managed to maintain relative stability in its gross margin % over the five years.

Columbia is a global company, and reports its operating results across the four global regions shown below:

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The above image from the 2012 10-K shows that the US accounted for ~57% of total revenue in 2012. The Latin America Asia Pacific “LAAP” region of the world was the second largest driver of sales for the company. This was also the only region where the company saw growth in 2012. While growth in this region is encouraging, it is to be expected as the company focuses on its international expansion into these emerging markets. The significant decline in sales seen in Europe is a concern, but can ultimately be written off to the macroeconomic issues facing that entire continent. What is most concerning is the trouble the company saw in the US during 2012, with revenue being essentially flat YoY. 2012 was a year that in general was favorable to most US retailers as the economy began to show signs of life and consumer sentiment perked up. It is difficult to assume that the weather was entirely to blame, or at all to blame, for the lack of growth seen in the US market for Columbia. One of the fastest growing performance apparel retailers, and largest competitor for Columbia is Under Armour. In 2012, Under Armour managed to grow its revenue in North American by almost 25%, generating almost double the total revenue in North America that Columbia generated in its US segment. Under Armour has a broader assortment of apparel, but it also has a heavy focus on cold weather apparel, and any weather related impact would also be expected to materialize in its operating results. The fact that this does not seem to be the case presents a concern that Columbia has reached a peak saturation level in its US market and will find it difficult to achieve meaningful revenue growth on its home turf going forward.

Looking at the specific operating segments, the company saw a material decline in its footwear segment and a modest decline in its apparel segment YoY in 2012:

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Here again, the concern is that the results seen in 2012 specifically related to footwear for any number of retailers generally showed positive year over year growth. Consider Foot Locker (FL) as a proxy for how the footwear market performed in 2012, considering the company carries any number of brands or styles and touches a broad range of price points. In 2012, Foot Locker registered growth of almost 10% in sales. This compares to Columbia seeing a 10% decline in sales for its footwear segment. This type of contrast speaks to an issue specific to the Columbia products and brands that should be concerning to investors.

Turning to the balance sheet, Columbia has done a good job of maintaining a healthy amount of liquidity and managing its inventory. As the image from the 2013 Q1 earnings report below will show, the company had over $300M of cash on the balance sheet and also had a material reduction in its inventory on a YoY basis:

In remarks from the company’s CFO that accompanied the Q1 2013 earnings release, it is noted that about 34% of the total cash and short-term investments are held in foreign jurisdictions. The effect of this is that unless the company is willing to incur a significant tax expense to repatriate these funds, a material portion of the company’s cash is not available for use domestically. This could be a reason that Columbia is not engaged in any type of share repurchase program that so many companies are using to boost earnings in this current economic environment.

Also, while sound inventory management is critical to any retailer, a significant drop in inventory can also signal caution as to the future order outlook. Consider that Columbia notes in its 10-K that its business is predominantly tied to the second half of each calendar year, in conjunction with the fall/winter months. By the end of the first quarter, the company would have to be preparing its apparel assortment and orders to have product manufactured and available for sale in relatively short order. The fact that inventories are down over 10% from the prior year is quite possibly a negative signal about how the company really sees the balance of 2013 shaping up. At the very least, the company did confirm on its Q1 2013 earnings call that it was seeing hesitancy on the part of retailers to place orders as far in advance as they had in years past. While the business could still materialize, the company risks not having the inventory available to meet the demand should order suddenly spike to higher levels. History provides a great example of how the inventory level at the end of the first quarter can be a predicative force for the outlook for the balance of the year. Note that previously in the article a table of historical revenue was shown, where you can see that revenue grew almost 15% from 2010 to 2011. Reviewing the Q1 2011 earnings report, we see that the company had increased its inventory balance by almost 35% over the prior year, in anticipation of or because of advance orders already booked. While the growth in inventory did not exactly mirror the growth in revenue, it directionally confirmed the company’s outlook for its business during that particular year. As such, with inventory levels down over 10% YoY, it would seem that the company is at risk of seeing revenues decline by more than the slight amount that the guidance for 2013 would imply.

Valuation

In prescribing a valuation to Columbia, it is helpful to understand where the company is valued today on a PE multiple compared to where it has historically been valued. The chart below shows a historical PE valuation range for Columbia:

COLM PE Ratio TTM data by YCharts

Note that there are only two periods over the last 15 years where Columbia traded materially above a 20x PE multiple. The most recent period shown coincides with the company showing revenue growth of 15% YoY. Considering that the company is coming off a year of negative growth and forecasting another year of the same, it is safe to say that the 2011 time period does not provide a good barometer for a historical PE average. Looking at the chart, it is clear that from 2003 to the current period, the company has generally traded within a range of a 10 – 20x PE multiple. Columbia today trades at over 23x its forward PE multiple as earnings are expected to decline in 2013 compared to 2012.

It is also relevant to compare Columbia to two of its main competitors, Nike and Under Armour, to ascertain whether or not the company is fairly valued today. The following tables compare Columbia to the aforementioned competitors in terms of revenue growth as well as how each company is currently valued from a PE multiple standpoint:

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The first table shows that Under Armour is clearly leading the pack in terms of revenue growth. Compared to Nike this is to be expected as Nike has already saturated the globe with its brand whereas Under Armour still has substantial opportunity ahead of it. The Nike CAGR is also somewhat misleading as the company posted about 10% growth in its last 12 month period, compared to negative growth for Columbia.

Turning to the PE multiple comparison, we see that again Under Armour is afforded the type of multiple you would expect to see with a company growing its top line by 25% annually. The fact that Columbia trades with the same PE multiple as Nike seems to defy reason. Nike is a global brand, in many regards the most well-known apparel brand in the world. It has a diversified base of business globally that insulates it from the ebbs and flows of macroeconomic issues in and around the globe. It also is experiencing material top line growth. Columbia has none of the attributes that Nike has when it comes to growth and a well diversified business. The company’s performance is significantly tied to the US and to a lesser extent Europe. The US appears to have possibly reached an inflection point where growth will be materially lower going forward when compared to its competitors in 2012 who had no issues growing their North American businesses during a period when Columbia struggled.

Target Price For Columbia Using DCF Analysis

Columbia has the type of profile that allows for a DCF type analysis to provide a fairly accurate assessment of what shares should be worth today. The company is not experiencing hyper growth; it has steady free cash flow in terms of cash flow approximating the growth seen in its business, and it is not subject to wild swings in capital expenditures. Candidly, using a DCF analysis for Columbia potentially yields a higher fair value price because the company generated significant free cash flow “FCF” in 2012 as it reduced its inventory balance and increases its working capital.

Columbia generated $98.2M in FCF during 2012, defined as operating cash flows less capital expenditures. The following assumptions were used in the DCF model to determine the fair value for Columbia shares today:

• FCF of 10% from 2014 to 2017, 5% from 2018 to 2022
• Terminal FCF growth of 3% annually
• 12% discount rate
• Gross margin % maintained at current levels as well as outstanding shares

Using the above inputs, and the current cash and other balance sheet items as of the end of FY 2012, the DCF valuation derives a fair value for Columbia shares of ~$42 a share. This is over 30% lower than the shares currently trade for today. If an investor is willing to assign a lower risk to owning Columbia, and thus would accept a lower discount rate, the fair value price would increase. Using a 9% discount rate, shares of Columbia would be fairly valued today at ~$50 a share. This is still an ~18% decline from where the shares currently trade today. Shown below is a summary of the DCF model, using a 12% discount rate and the other inputs previously noted:

Investment Outlook

Columbia is a well-known retailer and brand in many of the countries in which it operates. In the US, the brand has been around for ages, and it is endearing to many consumers. It is the fact that the company does have a loyal following that generates a significant amount of consternation from an investment standpoint. Why, when other retailers are seeing a rising tide lift all boats in the form of an improving US economy, are the results for Columbia not also being lifted by that same tide. Further, even if you assume that the company returns to growth after 2013, its average growth rate over the last five years will still sit under 5%. I very easily could argue that the growth assumptions used in the DCF analysis above were more optimistic than the historical results for Columbia should allow. I give the company credit for additional international expansion, but with its product already being sold in 100 countries, it is not as if international expansion is low hanging fruit waiting to be picked. Columbia is a good company that makes good products and with a solid balance sheet that can support the business in the near term. Ultimately its valuation is stretched, both when compared against a high growth peer and the industry stalwart, and when analyzed using a DCF model. The stock is trading anywhere from 18%-30% above its fair value. Any sign that a return to growth will continue to be elusive for Columbia could potentially sends its shares south in a hurry.

The specific catalyst that should drive the stock lower centers around the guidance the company provided for 2013. It is somewhat lost in the shuffle that the company guided for a material decline in YoY revenues for 2013. Yes, the official guidance called for revenue to be down slightly on a YoY basis. But the company benefited from a strong Q1 in 2013 when compared to the prior year due to a later winter which drove cold weather apparel sales into Q1. The table below provides a look at what the company is actually providing guidance for over the balance of the year, given that Q1 actuals are known and the company guided for a 4-6% decline in revenue for Q2:

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The second half of the year is where the company generates the majority of its revenues and the entirety of its profits. In 2012, you can see that Columbia generated 63% of its revenue in Q3/Q4 and over 100% of its operating income.

Using the actual revenue for Q1 2013, guidance for Q2 2013 to be down ~5% YoY, and for total 2013 guidance to be down slightly YoY (estimated range of 1 – 3%), we can determine that the company is actually guiding for its revenue in the second half of 2013 to be down anywhere from 2 – 5%. This is a significant issue for the outlook around Columbia, and also one that is not evident in the official company guidance due to the strength seen in Q1 2013. With the lion’s share of its revenue and operating income tied to the second half of the year, the fact that Columbia is implying its YoY revenue performance should show a decline in its most important selling season is a concern for investors, as it implies the uptick in Q1 was an aberration driven solely by weather. This also leaves the door open to downward pressure on the stock as expectations are reset, even if the company simply meets its guidance for the year, as the headline commentary turns to the YoY revenue decline in the second half of the year.