Aritzia Inc.: Its Profits Are Lacking

Since its first day of trading October 3, Aritzia Inc. (TSX:ATZ) is up 6%. Before you go buying the specialty retailer’s stock, you might want to consider if it makes enough money to justify its valuation.

| More on:

While Aritzia Inc. (TSX:ATZ) had a strong first day as a public company closing October 3, trading up 11%, I personally thought it would do much better.

In an article leading up to its IPO, I predicted that Aritzia would open at $22, well above its $16 pricing; it actually opened trading at just under $19, moved up a nickel, and then slid back below $18 by the end of the day. Given how little IPO action there’s been in the past year, I was convinced that investors would be sucked in by its “Made in Canada” growth story. I was wrong.

Is it simply that investors loathe retail right now? Or is there something else that keeps people from doubling down on Aritzia stock? I believe it’s a little of both.

But for the purposes of this article, let’s look at Aritzia’s profitability and why that may be causing second thoughts among investors.

Aritzia delivered its second-quarter results October 12; they were generally quite impressive, led by 16.9% same-store sales growth that followed on top of even stronger growth (up 20.8%) a year earlier. Meanwhile, net revenue increased by 30.1% year over year. The top line was certainly buzzing.

Even the bottom line appears to be healthy at first glance with adjusted EBITDA and adjusted net income up 20.4% and 42.5%, respectively. A closer look, however, should cause you to pause.

As Fool.ca contributor Demetris Afxentiou pointed out in his recent article, Aritzia’s gross margin in Q2 2016 was 35.9%—160 basis points higher than in Q2 2015. That’s the good news. The bad news, as I see it, is they should be higher.

In the past three fiscal years—chronologically from oldest to newest—Aritzia’s gross margin has been 40.5%, 37.3%, and 36.6%, respectively. So, even though sales have increased by 44%, or $166 million, gross margins have declined by 390 basis points.

Lululemon Athletica Inc.’s (NASDAQ:LULU) gross margins in the three fiscal years leading up to its IPO in July 2007 were 52.3% (2004), 51.1% (2005) and 51.0% (2006)—a decline of 130 basis points, or about one-third the decline experienced by Aritzia.

Comparing LULU to ATZ is a bit of an apples-to-oranges exercise because Lululemon only sells its own brand, while Aritzia sells clothing made by other popular apparel manufacturers; naturally, its margins are going to be lower.

Fair enough.

So, let’s consider Buckle Inc. (NYSE:BKE), a Nebraska-based specialty retailer that sells a little of both, just like Aritzia, only at lower price points. Its gross margins are in the mid to low 40s despite double-digit same-store sales declines. Even farther down the income statement, Buckle’s operating margin (19%) is double Aritzia’s fiscal 2015 operating margin of 9.7%. Despite opening nine stores in fiscal 2015, that’s the same number as Aritzia did this past year.

Sure, Aritzia spends more money on its stores than Buckle, not to mention it locates in nicer malls, so the opening costs are a lot higher, but you’d think they could at least get operating margins into the mid teens after 32 years in business.

Aritzia’s growth story is a good one. However, it’s profits are lacking. For this reason, as Kevin O’Leary would say, I’m out.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Will Ashworth has no position in any stocks mentioned. The Motley Fool owns shares of Lululemon Athletica.

More on Investing

Train cars pass over trestle bridge in the mountains
Dividend Stocks

Is CNR Stock a Buy, Sell, or Hold for 2025?

Can CNR stock continue its long-term outperformance into 2025 and beyond? Let's explore whether now is a good time to…

Read more »

engineer at wind farm
Energy Stocks

Invest $20,000 in This Dividend Stock for $100 in Monthly Passive Income

This dividend stock has it all – a strong outlook, monthly income, and even more to consider buying today.

Read more »

Hourglass and stock price chart
Stock Market

It’s Not Too Late: Invest in These TSX Growth Stocks Now

Solid fundamentals of these top TSX growth stocks could help them maintain strong upward momentum in the years to come.

Read more »

coins jump into piggy bank
Dividend Stocks

The Smartest Dividend Stocks to Buy With $500 Right Now

These top dividend stocks both offer attractive yields and trade off their highs, making them two of the best to…

Read more »

stocks climbing green bull market
Stocks for Beginners

3 TSX Stocks Soaring Higher With No Signs of Slowing

Don't ignore stocks just because they look like they're at a high price. Instead, see exactly why they've driven so…

Read more »

dividends can compound over time
Bank Stocks

Is TD Bank Stock a Buy for Its 5.2% Dividend Yield?

TD Bank stock offers a rare 5.2% dividend yield—can it rebound from challenges and reward contrarian investors? Here's what to…

Read more »

chart reflected in eyeglass lenses
Investing

How Should a Beginner Invest in Stocks? Start With This Index Fund

This Vanguard index fund is the perfect way to start a Canadian investment portfolio.

Read more »

analyze data
Bank Stocks

Is BMO Stock a Buy for its 4.7% Dividend Yield?

Bank of Montreal is up 20% since late August. Are more gains on the way?

Read more »