YETI Holdings (YETI) engages in the design, marketing, and distribution of products for the outdoor and recreation market. Its products include coolers, drinkware, travel bags, backpacks, multipurpose buckets, outdoor chairs, blankets, dog bowls, apparel, and accessories.
Despite its positives, we are neutral on the stock.
Competitive Advantage
There are a couple of ways to quantify a company’s competitive advantage using only its income statement. The first method involves calculating its earnings power value (EPV).
Earnings power value is measured as adjusted EBIT after tax, divided by the weighted average cost of capital, and reproduction value (the cost to reproduce the business) can be measured using total asset value. If the earnings power value is higher than the reproduction value, then a company is considered to have a competitive advantage.
For YETI, the calculation is as follows:
EPV = EPV adjusted earnings / WACC
$2.787 billion = $223 million / 0.08
Since Yeti has a total asset value of $970 million, we can say that it does have a competitive advantage. In other words, assuming no growth for Yeti, it would require $970 million of assets to generate $2.787 billion in value over time.
Another method to determine if a company has a competitive advantage is by looking at its gross margin, because it represents the premium that consumers are willing to pay over the cost of a product or service. An expanding gross margin indicates that a sustainable competitive advantage is present.
If an existing company has no edge, then new entrants would gradually take away market share, leading to decreasing gross margins as pricing wars ensue to remain competitive.
In Yeti’s case, gross margins have expanded in the past several years, steadily rising from 46.1% in fiscal 2017 to 56.7% in the past 12 months. As a result, its gross margin indicates that a competitive advantage is present in this regard as well.
Measuring Efficiency
Yeti needs to hold onto a lot of inventory in order to keep the business running. Therefore, the speed at which a company can move inventory and convert it into cash is very important in predicting success. To measure its efficiency, we will use the cash conversion cycle, which shows how many days it takes to convert inventory into cash. It is calculated as follows:
CCC = Days Inventory Outstanding + Days Sales Outstanding – Days Payables Outstanding
Yeti’s cash conversion cycle for fiscal year 2021 was 67 days, meaning it takes the company 67 days for it to convert its inventory into cash. In the past several years, this number has trended downwards, indicating that the company’s efficiency has improved.
It’s worth noting though, that the CCC for the last 12 months is actually 108 days. The fact that it’s higher in the last 12 months compared to fiscal year 2021 is not a big deal because this appears to be a seasonal pattern. However, the 108 days is higher than the comparable period’s 92 days.
With inflation continuing to rage on, this may be an early sign that fiscal year 2022 will see a slight increase in the cash conversion cycle, as consumers shift their spending habits towards essential goods. As a result, there might be less demand for discretionary products such as those offered by Yeti.
Valuation
To value Yeti, we will use a single-stage DCF model because its free cash flows are volatile and difficult to predict. As the free cash flow input, we used the average since 2018, which is when the company IPO’d.
For the terminal growth rate, we will use the 30-year U.S. Treasury yield as a proxy for expected long-term GDP growth.
Our calculation is as follows:
Fair Value = Average FCF per share / (Discount Rate – Terminal Growth)
$36.32 = $1.89 / (0.082 – 0.03)
As a result, we estimate that the fair value of Yeti is approximately $36.32 under current market conditions.
Risks
To measure Yeti’s risk, we will first check if financial leverage is an issue. We do this by comparing its debt-to-free cash flow. Currently, this number stands at 4.23.
Overall, we don’t believe that debt is currently a material risk for the company because its interest coverage ratio is 82.5 (calculated as EBIT divided by interest expense). This means that YETI can cover its annual interest expenses 82.5 times over using its operating income.
However, there are other risks associated with the company. According to Tipranks’ Risk Analysis, Yeti has disclosed 54 risks in its most recent earnings report. The highest amount of risk came from the Finance & Corporate category.
The total number of risks has decreased over time, as shown in the picture below.
Wall Street’s Take
Turning to Wall Street, Yeti has a Moderate Buy consensus rating, based on nine Buys and four Holds assigned in the past three months. The average Yeti price target of $72.46 implies 59.4% upside potential.
Final Thoughts
Yeti is a company with good brand recognition that has a measurable competitive advantage. In addition, it has improved its efficiency over the past several years when looking at the cash conversion cycle. Lastly, it has the backing of Wall Street analysts, who see almost 60% upside potential.
Nevertheless, we remain neutral because the cash conversion cycle over the last 12 months compared to the 12 months prior to March 2021 has increased. In the current macroeconomic environment, this may be an early sign that demand may soften in fiscal year 2022.
In addition, the company’s free cash flow is difficult to predict because it is volatile. Thus, when using the average FCF per share on a single-stage DCF, the company appears to be overvalued. As a result, analysts may be too optimistic about the stock.
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