Columbia Sportswear Company: Overlooked Mid-Cap Stock (NASDAQ:COLM)

Columbia Sportswear Company (NASDAQ:COLM) is currently trading near their 52-week lows, despite posting strong earnings and guidance on their most recent earnings release. The company is highly profitable and is generating significant free cash flows. Their fundamentals are supported further by a balance sheet that includes cash on hand that nearly exceeds their entire balance of liabilities.

Recent fashion and recreational trends include a movement towards more active lifestyles, to which Columbia is well poised to capitalize on. In 2022, the company expects double-digit sales growth, which will come after a record-breaking year in 2021. The recent pullback in the shares offers investors a compelling opening into a dividend-paying company with upside price potential of approximately 25%.

Business

COLM is a global leader in everyday lifestyle products targeted towards people with an active lifestyle. Their products are principally in two categories: apparel, accessories, and equipment products; and footwear products. These product categories are provided through four well-known brands: Columbia; SOREL; Mountain Hardware; and prAna.

The breakout below, available within the annual 10-K filing, provides a revenue disaggregation for each product category. Additionally, it is summarized by the four geographical segments, which includes the United States, Latin America and Asia Pacific (LAAP), Europe, Middle East, and Africa (EMEA), and Canada. In 2021, COLM reported total revenues of +$3.1B. 65% of those sales were generated in the U.S. Additionally, 76% of total sales were non-footwear related.

Below is a more comparative breakout of sales by geographical segment over the past three years. As can be seen, over 60% of the company’s sales are generated within the United States.

While the U.S. accounts for the concentration of total sales, COLM’s products are sold in approximately 90 countries through two primary distribution channels, wholesale distribution and direct-to-consumer (DTC). In the U.S. and LAAP, over 50% of total sales are through DTC, while wholesale accounts for over 50% in EMEA and Canada. Consolidated, the split is approximately 50/50.

As part of their business strategy, the company outsources their manufacturing processes to contract manufacturers located outside the U.S. In 2021, their non-footwear related products were manufactured in thirteen countries. Vietnam, Bangladesh, and Indonesia together produced 75% of these products, with Vietnam, alone, accounting for 45% of the total. Their footwear products, on the other hand, were manufactured in six countries, with Vietnam and China accounting for 95% of production.

Competition

The market for active lifestyle apparel is highly competitive, and COLM faces competition from numerous companies, both large and small. Larger companies are equipped with significant financial and operational resources with significant scale. One such company is V.F. Corporation (VFC), which owns The North Face. As shown in the peer comparison tool below, available from Seeking Alpha, VFC has a market cap of +$20B with 33K employees versus a +$5B market cap and 8K employees for COLM. In addition to larger competitors, COLM must also compete against smaller companies with similar resources but with deep loyalty in their local markets.

Over the past year, all publicly traded apparel companies have lost significant value. COLM is down 16% over the past six months, while some others are down more than 20%. Recent concerns in the industry are primarily related to inflationary pressures, supply disruption, and geographical exposure risk to war-stricken areas of the world.

The declines have created an attractive entry point for many of these names. COLM, in particular, is trading at a significant discount to their five-year averages on many of the valuation metrics below. For example, the current forward P/E of COLM is approximately 15x, which is lower than both VFC and Under Armor, and also lower than the company’s five-year average of 22x. Additionally, their EV/EBITDA multiple of 8x is lower than most of their peers and their own average of 14x.

One noteworthy statistic is insider ownership. As reported below, over 40% of the company’s shares are held by insiders. This is significant, especially when compared not only with their peers but the broader market in general. The high level of ownership indicates the confidence that management has in the company’s outlook.

Competitive Advantage

COLM has a long history of directly serving people with active lifestyles. Over the lifespan of their business, they have developed themselves into a leading brand with significant awareness among all groups of consumers. Though they specialize in a niche sector of the clothing industry, the diversification of their revenue base minimizes their exposure risk to any one particular product.

In addition, COLM is an industry leader in innovation with over thirty innovative material technologies that keeps their customers protected in all weather conditions. In addition to the innovative nature of their products, their brands are known for their quality and performance, which enables the products to be used in a wide variety of activities in all different terrains and seasons.

Finally, as will be shown later, the company benefits from strong fundamentals and a fortress balance sheet. From 1998-2021, COLM generated 9% net sales CAGR and 11% EPS CAGR. The strong sales figures and earnings potential contributes to significant cash generation that can be used to fund future growth opportunities or returns to shareholders in the form of dividends and buybacks.

Future Catalysts

The COVID-19 pandemic has expanded the addressable market for COLM in two ways. The first is the increase in the number of individuals participating in outdoor recreational activities. For example, visits to National Parks, such as Acadia National Park in Maine and Canyonlands National Park in Utah, were up significantly within a one year reporting period. In addition, recreational activities such as kayaking, backpacking, and camping achieved record-breaking participation over the past two years. As the demand for these activities continues to expand, COLM is expected to benefit from increased sales of the apparel and accessories related to these activities.

The second way COVID has positively affected COLM is though the casualization by customers. For the professional sector, as work has shifted to more hybrid models, the demand for comfort clothing has increased significantly. COLM’s products, by nature, are designed for comfort and the ability to function in diverse environments. The trend is expected to continue being a tailwind for sales moving forward.

In terms of specific product lines, COLM expects their SOREL brand to be their fastest-growing brand in 2022 due to the product’s function-first design. The variety of boots available through SOREL are widely considered to be among the best in the industry. According to one testimonial, some pairs of the boots are expected to last ten years or more, despite daily use. The durability and quality of the product combined with its attractive value continues to appeal to a vast group of consumers.

Another significant growth opportunity is Omni-Heat Infinity. During the fourth quarter of 2021, the company initiated the launch of this product innovation, which was the largest in the company’s history. The innovation has been covered extensively by U.S. media outlets and has received over 700 million impressions. The product is set to receive additional exposure though their partnership with the Nova-C lunar lander and other sporting and media outlets.

Earnings & Outlook

For the 2021 fiscal year, COLM reported net sales that were up 25% from 2020 and record operating income of +$450M that was up 229% and came in at 14.5% of net sales versus 5.5% of net sales in 2020. Even when considering pre-pandemic levels, net sales were still up 3% for the year.

For the quarter, results surpassed their earlier outlook and sales came in at a record +$1.1B, which was up 23% compared to the fourth quarter of 2020. Additionally, operating income also came in at a record +$212M and was up 71% from prior year levels. The strong gains were driven by DTC outperformance and a favorable selling price environment due to low inventory levels and limited promotional incentives.

While disruptions to the supply chain did constrain growth in wholesale, sales for the year still surpassed expectations and margins remained robust, despite inflationary headwinds. For example, compared to the fourth quarter of 2021, margins were up 5.2% due to effective cost control and favorable pricing actions. Moreover, to better support their retail partners during the peak holiday period, the company constrained e-commerce marketing to intentionally slow online demand and prioritize wholesale shipments. This was done to avoid being unable to meet soaring customer demand. Had the company not taken this action, sales would have been even higher

In addition to a blowout quarter and year, COLM repurchased +$166M of common stock during the year, and they also increased their dividend by 15%. One strategic priority is to return at least 40% of free cash flow to shareholders in the form of buybacks and dividends, and thus far, the company has been able to meet that goal and is expected to continue doing so moving forward.

For fiscal 2022, COLM expects sales growth of up to 18% compared to 2021 and an operating margin between 13-13.5%. The outlook includes the benefit of the pricing actions the company took to mitigate inflationary pressures. Still, gross margins are expected to contract by 1.6% to approximately 50% due to elevated freight costs. Despite this, the expected gross margin of 50% represents the second highest performance in the company’s history, just behind the performance in 2021.

Liquidity Analysis

As of December 31, 2021, COLM reported total current assets of +$2.1B and total current liabilities of +$680M. Furthermore, of the total current assets, cash and short-term investments accounted for 42% of the balance, while A/R and inventory made up 53% of the balance.

In 2021, there was a large increase in the balance of short-term investments and inventories, as can be seen below. The inventory purchases were made to get ahead of robust demand. The purchases of the investments, on the other hand, was simply transferring the cash balance to an interest-bearing instrument that is, otherwise, effectively equivalent to cash.

To obtain deeper insight into the liquidity position of the company, it is helpful to analyze the seven liquidity ratios below from the past five years. The first point to note is that the figures are generally consistent from year to year. In 2020, however, there was a slight uptick in the number of days receivables remained outstanding. Additionally, inventory has also remained unsold for a longer period, jumping from 135 days in 2019 to 166 days and 145 days in 2020 and 2021, respectively.

Both operational headwinds can be attributable to the uncertainties of COVID-19 and the resulting supply chain related disruptions. For example, in 2020, at the onset of the pandemic, most companies took drastic efforts to preserve their cash balance. Some cut shareholder payouts. Others stopped production and reduced capital spending. And then there were others, still, that held off payment to their suppliers and vendors. A customer’s decision to withhold payment to preserve cash is likely what COLM experienced in 2020. In 2021, however, collections returned to normal levels.

Similarly, logistical constraints continue impeding the sale of inventory. While there was an improvement in 2021, it still has not returned to pre-pandemic levels.

Another point to note is the strength of the company’s coverage of their current liabilities with their current assets. The current ratio indicates coverage of 3x current liabilities. Furthermore, cash on hand, alone, can pay off 100% of the current liabilities with a sizeable amount still left over. Clearly, there are no concerns on liquidity at present.

Because there is a period of time involved in selling inventory, collecting on A/R, and paying off suppliers, it is important to analyze the relationship between the three business practices to determine the net number of days in which the company requires cash. The summary of the results is shown below. In 2021, it took COLM 145 days to sell their inventory. It then took 55 days to collect on that sale. Therefore, there was a total of 200 days in which cash receipts remained pending. During that period, the company held off payment to their suppliers for 56 days. Thus, there were 144 days in which the company’s operating activities were funded by either cash on hand, their operating cash flows, existing credit lines, or other longer-term financing arrangements. COLM also had 91 days of sales in cash, which effectively would have covered 100% of their working capital needs.

While all metrics on liquidity look impressive at first glance, the days to sell inventory appears high. To gauge whether this is cause for broader concern, it’s helpful to compare the performance with similar competitors in the industry. The results are summarized below. As seen, it’s not unusual for inventories to be held for over 100 days in the clothing industry. This could be partly due to seasonality. COLM’s sales, for example, are heavily weighted towards the third and fourth quarter of the year. It’s likely the company is placing their orders in the spring and summer time and those orders are then sold in the fall/winter months.

COLM’s liquidity position is impressive. They have a significant amount of cash on hand that can cover their entire balance of short-term liabilities, and they don’t have any collection issues on A/R. The company, however, could benefit from improved selling times on their inventory holdings.

Long-Term Solvency Analysis

Below are the results of several long-term solvency metrics for the past five years. As can be seen, the company has effectively no long-term debt. Instead, all their debt is in the form of current liabilities or non-current operating lease liabilities. There was an uptick in the debt ratios from 2019 to 2021 due to a GAAP rule change that required companies to record their operating lease liabilities on their balance sheets. Previously, operating leases only impacted the expense side of the income statement.

The only other item to note is the Z-Score of 6.57, which indicates virtually 0% chance of bankruptcy.

For a comparative look, the summary below from Seeking Alpha provides additional insight into the long-term debt holdings within the industry. COLM is the only one to opt out of holding longer term debt. In one way, this is an advantage in that the company has more cash available to apply to CAPEX or to return to shareholders as opposed to servicing debt. On the other hand, with rates as low as they have been, the company could have benefited from an additional financing source with minimal servicing costs.

From a long-term perspective, there are no concerns on the health of the company due to the lack of debt holdings. This is also a competitive advantage for the company. As such, it is safe to provide a strong rating on this metric.

Profitability Analysis

Despite inflationary headwinds, the apparel industry is still generating strong profit margins. COLM generates margins of 52%, which was higher or in-line with most of their peers. Additionally, they outperform on many other metrics. Compared to VFC, who is significantly larger, COLM is outperforming on several metrics. This is impressive given the fact the company is outnumbered in operational and financial resources.

Additionally, it’s worth noting that revenue per employee is higher than all peers except Under Armor. This is important because in a period with rising labor costs, a more productive workforce is a critical benefit for margin preservation.

As shown below, the company reported double digit net profit margins in 2021 that exceeded pre-pandemic levels. This was despite negative input cost externalities. This outperformance was related to prudent cost management, favorable selling prices, and a productive workforce.

The ability of the company to consistently generate significant net income is a strength that will continue to reward shareholders for years to come.

Cash Flow Analysis

COLM generated +$354M in operating cash flow in 2021. This was 24% higher than 2019 levels. And this was due to higher net income that came in at +$354M for the year versus +$330M in 2019. Furthermore, in 2021, the company reported a net change in inventory of +$100K, which was a negative adjustment to cash from operations. This net change reflects the increased purchases made to meet robust demand. If inventory purchases were in-line with 2019 levels, operating cash would have been approximately $16M higher.

On the balance sheet, one can see that cash decreased by +$27K from 2020.

Further below is a summary of the line items within the cash flow statement that provide further insight to where the company utilized its cash. As stated earlier, the company generated +$354M in operating cash flows. +$163M was then spent on investing activities and +$211M was spent on financing activities. Accounting for +$7K in exchange rate adjustments would thus yield the net change of +$27K.

Normally, investing activities are concentrated on CAPEX spending. In 2021, however, COLM spent +$130M to acquire short-term investments. In essence, this was simply transferring a portion of their idle cash balance to more productive interest-bearing instruments. CAPEX amounted to +$35M, which was higher than 2020, but lower than the +$124M spent in 2019.

Since the company’s long-term debt is negligible, nearly all financing activity is related to share repurchases and dividend payments. Within the summary below, various metrics are included to support the safety of the company’s shareholder payouts.

As indicated in the metrics, COLM has a strong ability to cover both their dividend and their share repurchases. Most of their payouts, approximately 70% of it, are in the form of buybacks. As such, their dividend coverage will typically indicate a high degree of coverage. For example, in 2021, the dividend payout ratio was 19%. But when including share repurchases, the ratio is 66%. Still highly covered, but more reflective of the company’s true ability to cover total shareholder payouts as opposed to strictly the dividend.

Regardless of one’s preferred metric, it’s evident the company’s payouts are safe due to the significant amount of cash being generated by the company.

COLM is well positioned to meet their goal of returning at least 40% of free cash flows to shareholders. Moving forward, shareholders should benefit from steadily increasing payouts. One area that appears lagging, however, is CAPEX spending. Given the company’s significant cash on hand and ability to generate cash flows, it’s surprising the company isn’t using more of it to invest in growth opportunities. Perhaps there are uncertainties due to current market conditions. Nevertheless, it is a concern worth monitoring in future periods.

Intrinsic Share Price (DCF Method)

COLM currently trades at 15x their forward earnings versus a historical average of 22x. Applying their normal multiple to current pricing would yield a share price of approximately $127. The use of a discounted cash flow model, on the other hand, yields an intrinsic share price of $114, as explained below.

For this model, free cash flow was calculated by deducting net new operating capital from after-tax GAAP operating income. Operating capital was assumed to be the sum of total current assets and net PP&E, less total current liabilities. The net new operating capital, then, was simply the year-over-year change. The tax rate used was 22%, which is consistent with the effective rate that is reported within the annual financial statements.

The results below provide calculated FCF for the past five years. Two observations helpful for forecasting is that operating costs are tracking at around 85% of total sales and depreciation is trending at approximately 7% of total operating capital.

The next step in the model was to input various assumptions for future periods. This model utilized highly conservative estimates. For example, management is guiding for sales in excess of 15% for 2022. This model used 10% instead. Sales were also expected to decrease each year thereafter with long-run FCF growth ultimately projected at 2%. Additionally, in order to obtain a more pessimistic estimate, total operating costs and depreciation expense were expected to run higher than historical levels.

The final assumption was the discount rate, which equated to 6.95% when applying the CAPM formula. In the CAPM, the risk free rate used was 2%, which was in-line with reported amounts in The Wall Street Journal. Furthermore, the beta of 0.9 was obtained from Morningstar. Finally, the historical market risk premium is 5.5%. Thus, the expected return on the market was assumed to be 7.5%.

The projections below were prepared upon inputting the assumptions above to the model.

The final step in the model was to calculate the terminal value and combine that value with the sum of the present value of the five-year FCFs. Since the company has no measurable long-term debt, the combination of the two values were then converted into the expected intrinsic share price.

The intrinsic share price above indicates a premium of over 30% to current pricing.

Primary Risks

As a consumer products company, COLM is highly dependent on discretionary spending. In times of economic turmoil with periods of significant stress to household budgets, COLM’s products will be among the first to be cut as consumers reorient a larger share of their budget to more essential items. In addition, the rising cost of food and energy is a further strain on household incomes. As these costs continue to rise, consumers will increasingly cut back on discretionary spending.

Intense competition with larger competitors and smaller private label brands further hinders the company’s ability to retain market share. A larger competitor, for example, may be able to offer more desirable products at higher quality and at a lower cost than COLM. Similarly, private-label brands may also take away market share during recessionary business cycles where consumers are more cognizant of where they spend their money.

In addition to demand-side issues, the company faces supply-side risks as well. Significant supply related disruptions can have a negative impact on future sales if the company is unable to match an increasing amount of demand with associated products. Furthermore, the company does not have long-term contracts with any of their wholesale customers. If there is a significant economic downturn in any of these customers or if the company fails to deliver products to their specifications, these customers can reduce or discontinue future purchases from the company.

Not only is the company subject to macroeconomic risks, but they are also subject to weather related risks. Unseasonable weather conditions may reduce demand for the company’s products, which are inherently targeted to those with active lifestyles. Outdoor activities such as hiking and mountaineering, for example, are limited in periods with heavy precipitation. Thus, demand for the products and gear related to these activities would also be reduced during these inclement periods.

Conclusion

COLM is down nearly 12% over the past month and is trading at a discount to their historical price multiples, despite posting strong earnings growth and record figures for fiscal year 2021.

The company has a superior balance sheet with enough cash on hand to completely cover their total current liabilities. In addition, their financial position is essentially free of any long-term obligations. This level of financial freedom enables the company to return a reasonable share of earnings to shareholders and invest in future growth opportunities.

COLM’s profitability and their ability to generate significant free cash flows is a strength that will reward patient investors with a long-term horizon. At present, an investment in the company offers a shareholder with upside potential of at least 25% and a stable dividend payout that is likely to increase from current levels.