Yeti Hits the Market with a Cool New IPO

Lifestyle products company Yeti (YETI -2.49%) exploded in popularity in the last few years, and so has its growth. In this week's episode of Industry Focus: Consumer Goods, host Vincent Shen and Motley Fool contributor Asit Sharma take a closer look at the company's financials and game plan, and tell investors what they need to know before buying in.

With big growth comes some big caveats, and a few risks that you'll definitely want to keep an eye on. Can the company sustain its popularity without jacking up its marketing spend? Could expansion be the key to new growth? Tune in to learn more about this new initial public offering.

A full transcript follows the video.

This video was recorded on Nov. 27, 2018.

Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. I'm your host, Vincent Shen. Joining me today via Skype is senior Motley Fool contributor, Asit Sharma. Hey, Asit! Thanks for being here, man!

Asit Sharma: Hey, Vince! Thanks a lot for having me on!

Shen: Do you know why today is special?

Sharma: Let me guess... because you are going to give me a Yeti product, maybe?

Shen: No. Not quite. But you did hint at the reason why. It involves three letters -- IPO. Today, we have a new story and stock to introduce to listeners. This brand, Yeti, might mean a lot to some of you, if you've heard of it, encountered it in your leisure time, maybe at the beach or camping out in the wilderness. Yeti Holdings makes coolers, drinkware, and other accessories for the outdoor enthusiasts, and also a bunch of college kids, too.

Asit, I'm curious, had you heard of Yeti before you started researching the company for the show?

Sharma: I had, Vince. I'm in the South, as are you, which is the major market for this company. I have an Ace Hardware very close to where I live. I'm often popping in there for different things. Yeti has a very beautiful display in my local Ace Hardware. Many times, I have stopped at that display and gazed upon these extremely nice coolers and tumblers and other merchandise. Have not purchased anything yet, but I'm familiar just from seeing these products quite frequently. How about you?

Shen: Yeah, absolutely. It feels like the company has absolutely exploded in the past few years, in terms of popularity. That would match pretty closely the growth that the company's enjoyed. I feel like the first time I saw a Yeti cooler was on someone's fishing boat a couple of years ago. At that point, it was still something new and novel. I actually got to check out the company's single brick and mortar location when I was in Austin this past March. I was thinking myself, holy cow! I didn't realize that they were at the point where they were opening physical stores. I didn't realize until doing the research for the show that that was their single location. We'll get more into that later.

At this point, you see the Yeti logo on a pretty regular basis, even living in an area like D.C. I was rummaging through my brother's kitchen, looking for something last week, and boom, right there, I see a Yeti water bottle in the cabinet that belonged to my sister-in-law. It really is growing its presence. This is a very interesting consumer business. The growth is especially impressive given how focused its product portfolio is.

Roy and Ryan Seiders founded the company in 2006 in Austin, Texas. This started as a pretty niche cooler company marketed to avid hunters and anglers. It's grown into a much bigger company since then. A big driver of that was Yeti's takeover by Cortec [Group]. This is a private equity firm. They took it over in 2012. We've seen firsthand how Cortec has taken the Yeti brand and expanded the product line from those core coolers to other accessories, cups, tumblers, water bottles, soft coolers. Most importantly, they've also broadened the target market for these products to everyday users. In the prospectus, Yeti shares some interesting data from customer studies that highlight this strategic change. First, from 2015 to 2018, the customer base shifted from 69% hunters to just 38%. In that same period, women grew from 9% to 34% of the company's customer base.

Under Cortec, Yeti went from a company with $90 million in revenue in 2013 to $640 million dollars in 2017. On the surface, that's 60% plus compound annual growth. THat's crazy for any company, let alone a consumer one churning out coolers and tumblers. There are also some gray areas working through Yeti's recent results that we'll get to.

I'll pass the baton to you, Asit. Can you walk us through any key numbers that stood out to you? Anything with profitability and other longer-term prospects? Where do you want to start?

Sharma: I want to walk back briefly to one more comment about Cortec making this into a more viable operation for larger-scale business. They also brought in more seasoned management. The two Seiders brothers are still with the company. Roy Seiders owns 10%, Ryan Seiders owns 9%. After this IPO, Cortec still retains a majority 52% of shares, but they brought in a CEO, Matt Reintjes, and, more important to me, a new CFO this year, Paul Carbone. Those of you who are familiar with Dunkin Donuts, he was their CFO and left to join this company. Leaving a great outfit like Dunkin, which itself is growing, and coming to this, maybe tells you something about the opportunity.

Let's dive into some top-line numbers and talk through those. I think that'll frame a lot more of this discussion for us. We have from their prospectus the first six months of net sales. This is about $342 million worth of sales. On that, the company has a gross profit of $158 million. All the way down to the net income line, net income is $15.5 million. Rough numbers. Net profitability is about 5%.

This is a function of the product line that this company sells. We were talking before the show about one of the phrases in the prospectus, which mentions that Yeti has a product line from a $20 tumbler all the way up to its top-of-the-line $1,300 Yeti cooler. When you have such a wide variety of price points -- listeners, you can build in your head -- you can sell more of those high-end products and up the margin or you can sell the lower-end products, which hurts your margin but helps that revenue growth. In fact, as we'll talk about later in the show, drinkware products are really leading sales for the company over the last year.

One more point to mention about the financial statements. I talked about $15.5 million in net income. Interest expense on the company's debt is $19.6 million -- even more than final net income. We'll return to that thought.

Vince, I was curious, we've talked a lot about distribution strategies on other IPOs we've covered. I noticed that Yeti has a very interesting one. It's split up between a direct channel and a wholesale channel, which involves a lot of major retailers. I wanted to talk about that following these numbers.

Shen: Absolutely. The way Yeti splits up its product categories and its distribution, the coolers category that I think they're most famous for, in terms of the product line, made up 45% of top line in the first half of 2018. The drinkware, some of the lower-priced products that you mentioned, Asit, those came in at 52% of revenue. That product category is growing quite a bit faster than the coolers line. The company distributes its products through wholesale and direct-to-consumer channels, with about a 70-30 split, respectively, between the two. For wholesale, Yeti's biggest partners include chains like Dick's Sporting Goods, Bass Pro Shops, REI, and also about 4,800 smaller independent retailers. For the direct-to-consumer part of the business, these include Yeti's own online stores. They also sell through Amazon and that flagship store location that they have in Texas. We see this for a lot of consumer and retail companies, that DTC business is growing faster than wholesale, 75% year over year in the first half of 2018. The tailwind for the company is that there are higher profit margins for DTC that they enjoy over wholesale.

Something else that I think is worth mentioning in recent results. We talked about pretty solid growth in the first half of 2018. Revenue growth came in around 34% year over year. But there's a blip, also, in 2017 that I think really worried investors looking at the story, evaluating its long-term prospects. We saw the company putting up these incredible growth numbers, but at the same time, the revenue was down in 2017 for Yeti about 22% as a result of what the company describes as multiple factors coming together as headwinds. Can you tell us a little bit about that, Asit?

Sharma: Sure. One of the first problems that hit the company was, it has been doing so well that many of its partners built up excess inventory. On top of that, there was a delayed merger between Bass Pro Shops and Cabela's, which didn't help. And, the negative retail trends, if you think back to just a year ago, we used to talk on the show in the 2016, 2017 timeframe about Amazon's effect on retail outlets. So, there was positioning there.

And then, there were lawsuits against some competitors who were essentially mimicking the Yeti product line. What happened for Yeti in terms of enforcement is, it was able to successfully sue some of its competitors. But, the courts ordered these competitors to liquidate inventory, so there was a fire sale on competing products, which hurt Yeti's own sales. In response to that, Yeti in its prospectus has listed a number of initiatives that it's undertaken to restabilize and regrow sales, including pricing actions. You can read that as discounting its own products. That's to make sure that they restimulate the demand. But they've said that they've done that without hurting their premium positioning. Focusing, as Vince mentioned, this DTC channel, especially the digital channels which are associated with that.

The company culled about 1,100 underperforming retailers to get to that 4,800 number that Vince told you about, in terms of retailers today. Cut out the inefficient ones who weren't that profitable for it. And, increased engagement with Dick's Sporting Goods, which is the country's largest sporting retailer.

A couple more I'll mention that were listed in the prospectus. Rationalizing the manufacturing base. That simply means they cut down on the number of manufacturers to get better production deals out of the ones that were remaining. Adding those executives we talked about, as well as more employees, including those that work on product developments. One of the things that's really characteristic about this company over the last year is, it's really ramping up the number of products it offers, especially in the drinkware and other categories. The other category includes T-shirts, hats, and even pet bowls.

Shen: I saw that in the prospectus, too. I mentioned this before, I think management does their best trying to explain for 2017 why, all of a sudden, this incredible growth trajectory really just flips like a switch and goes in the opposite direction. But for any young company that's going public, you're going to have a hard time building as much confidence in investors when your most recent full-year results show a double-digit revenue decline, net income down 69%. And, at the same time, some investors are already going to be feeling worried or concerned that the company's riding a wave of fad-like popularity, and there's no guarantee that it's going to have staying power being this top-of-the-line cooler and drinkware brand.

That was ultimately reflected in the initial public offering process itself. We haven't talked as much about this. Cortec first filed to take Yeti public back in 2016. After two years of sitting on the shelf, the deal was pulled earlier this year, only to be refiled. Eventually, they were able to price the deal in late October at $18 per share. That was below the range of $19-21. Following in that vein, the company's first day of trading was October 25th. Shares closed at $17, below the offering price. As of this recording, shares still haven't managed to clear that original $18 pricing level.

That weaker IPO performance, downtrading, it really does, I think, serve to reflect the concerns investors have about long-term growth and positioning for Yeti. Keep in mind that with this IPO, the deal size was $280 million, but Yeti itself only pocketed about $37 million of that, in terms of the proceeds. The remaining proceeds went to Cortec, which reduced its ownership from originally around 70% to about 55%. I found a source that Cortec acquired its initial stake back in 2012 for $67 million. At the IPO valuation, that $67 million investment became $1 billion of holdings. A pretty solid return for Cortec in six years' time.

Going back to the use of proceeds that are going to Yeti, the company said they would be using them to pay down debt. Asit, we've talked a little bit about revenue. We've talked about profitability. How about the balance sheet? I know there was something that raised both of our eyebrows and came up as a red flag. Could you go into that?

Sharma: Sure. One of the things that's really important to do, investors, if you're looking at an initial public offering, this is a pro tip -- not that I claim to be a pro -- is to go straight to that use of proceeds section and see why a company is coming to market. Most of the time, the reasons will be obvious if you know even a little bit about the company. It needs capital to grow, it's going to invest in research and development, etc. The total $37 million of net proceeds that was raised, as Vince mentioned, has gone to debt service.

If we look at the balance sheet, Yeti has long-term debt of about $428 million on its books. That's divided between two term loans. They call it term loan A, which is $356 million outstanding, and term loan B, which is about $78 million outstanding. The first loan that I mentioned has an interest rate of 7.6%. The second loan that I mentioned has an interest rate of 6%. Yeti obviously wants to pay down some of this debt. It also has access to $100 million more in terms of a revolving credit facility that's currently untapped.

I crunched some numbers. The debt load is moderate. It's not terribly excessive. I got roughly 3.5X annual EBITDA -- earnings before income, taxes, depreciation and amortization -- which is a middle-of-the-road, creeping up toward higher leverage. But what concerned me -- I think I had dyslexia earlier. That interest expense wasn't $19.6 million. It was closer to $16.7 million. Still, to my point, that's more than net income that was generated in the first reporting period.

With this kind of debt load, slim margins, high interest expense, if some of this revenue generation and revenue acceleration is due to a fad that's going to wane, as Vince has posited -- let's talk about that for a second. One of the things that a company like this may run into is a cash crunch down the road. Adjusted EBITDA numbers are higher. You do want to look at that. But I like to look at the full GAAP numbers -- generally accepted accounting principles. I think those numbers really tell you, over the long-term, what a company needs to generate to stay profitable, have strong cash flow.

Just curious, Vince. To me, this a little bit of a yellow flag, not necessarily a red flag. What are your thoughts?

Shen: Maybe a lowercase, small r, red flag. Looking at that debt load, for a company that's looking to invest and grow, based on what they described as their long-term growth opportunities, $350 million net debt. And I got the same number, about 3.5X debt to adjusted EBITDA. Not outlandish for a company at this stage of its life. At least that debt balance is down from its peak in 2016, when it was over $500 million.

Next up, we're going to look more into the breakdown of this business, particularly with its expansion and some of the other risks that we see with the business.

We've covered the big picture for this company, what they're selling, who they're selling to, some of the things that jumped out to us in the financial statements. Let's turn our attention to what lies ahead for the company. For example, part of that direct-to-consumer distribution, Yeti has that single flagship store that I mentioned in Austin. Management indicates that they plan to gradually open more brick and mortar locations over time. Even though Yeti's popularity has really jumped recently, management paints a picture where the brand is still most prevalent in the United States, and within the U.S., only the South and Southeast regions, what it calls its heritage markets. That presents a runway for growth, with the big outdoor recreational markets that remain in the West Coast, the North, the Northeast. What do you think, Asit? My concern for any company like this always revolves around the idea of how big you can ultimately become. Yeti is selling $700-800 million of coolers and tumblers and water bottles right now. How much bigger kind of business like this realistically get? What do you think?

Sharma: I think it has a chance to keep growing at a good clip. Some of the markets that are open to it -- say, the Northeast -- aren't quite as conducive to the hunting and fishing ethos which fueled its first line of growth. But as you pointed out, more sales to women, more non-traditional customers are buying the products. If you look at this map of the Southeast and picture all the blank space that exists in the Midwest, the West Coast, there is a large westward and northward expansion that the company has available to it.

One of the strategies that it's trying to use is to expand drinkware sales. As I mentioned before, drinkware sales increased by $58 million, or about 49%, to $177 million in the first six months of this year compared to the prior year. But the flip side of that is, those are presumably much lower-margin sales than those $1,300 coolers. It's also trying to increase corporate branded sales in this direct channel. And, also, international markets. This is something that most investors wouldn't natively think, myself included, about Yeti, but it's already established markets in Australia and Canada in 2017. It entered Japan in 2018. Listeners, I mentioned a few times on different shows that unique culture in Japan of liking nice things and acquiring great products. We talked about this in relation to Sonos when it had its IPO. I think that's a smart market. It's looking at Europe. It's also looking at Asia, particularly China, outside of Japan. If we consider all that together, I think there is a pretty good market for this company to expand. I do like the strategies that it's putting forward.

However, I'm concerned, Vince, with what you mentioned. So much of this has been fueled by the desirability of the Yeti brand. We were chatting with our producer Austin before the show, and he was telling us how popular it was on Instagram last year. How sustainable is that advantage? Will other competitors come, especially in this drinkware portion where it wants to expand, and take some market share? What do you think?

Shen: I'll just say, with the international expansion, which I thought was really interesting, going to Canada and Australia last year, then going to Japan. Something I will play a little bit of devil's advocate with is that these are still very early efforts. Yeti themselves say they're just trying to get their name out there, build up brand awareness. It's likely to take at least a few more years before the company sees any kind of material contribution from that international segment.

On the flip side, in terms of being more of a supporter of this possibility, I'm usually pretty skeptical of international expansion as a source of significant long-term growth for a company that doesn't have any kind of proven track record yet outside of its home market. But I also think that Yeti is a company that has proven itself very savvy with marketing, with establishing what they've described as an aspirational nature of their brand. They have these Yeti ambassadors, famous hunters and fishermen, even surfers and barbecue pit masters. I thought that was really cool. They have a really big social media following, which you mentioned.

I think that leaves us with these overall themes. They have a strong brand. They have this premium positioning. Their growth seems to be recovering from the pretty significant hiccup that they encountered in 2017. So, the question is, does it have that staying power? Or is this another single-focus company that is able to create a market and dominate it, has a status symbol sort of brand? When they encounter significant competition, is that going to erode their margins, hurt their market share, and hurt the momentum for the company? Are you a buyer?

Sharma: My opinion is, don't buy this stock just Yeti, if I can make a bad joke, a lame joke.

Shen: [laughs] Oh, God! That's good! I hated it, but it was pretty good.

Sharma: [laughs] Thank you! This one needs some seasoning, a few quarters of looking at financials. Listeners, we've given this advice with a number of IPOs that we've discussed over the past couple of years. I think it's sound advice. When there's a really compelling company that you just have to get into, you can see all numbers soaring, market demand is shooting up, management's hitting everything, the company's going on all cylinders. This is not really one of those scenarios. To give you one key number, if you look at marketing spend, they spent about cumulatively $156 million between 2013 and 2017. $50 million of that was spent just in 2017. That tells me that this relationship between needing to market and generate sales with an acceptable margin is questionable, perhaps. I would wait a few more quarters and look at that marketing expense as a total of sales. That will give you an indication of many of the pieces that Vince has talked about why this might not be a fast-moving company out of the gate after its IPO. My opinion is wait on it. Look at these next couple of quarters. It's really very close to the situation it had in 2017, which it's still recovering from. I say wait. There's no hurry to buy this. Buy one of their products, enjoy it at the beach in the meantime. What about you, Vince?

Shen: That's our usual disclosure that we have when we talk about IPOs, especially when it's soon after the company has priced. Some listeners, I'm sure, are probably getting sick of hearing this kind of cautionary advice that we give. But with any new public company, I think it's smart to give them at least six months, maybe a year, to get their footing, release some quarterly results. Even get a feel for management during their earnings calls, how they present the results, respond to analyst questions, how much they disclose and how transparent they are with that kind of information. Thinking about all that before taking a position.

I was looking at the current trading level, about $17 per share as of this recording. That puts the company trading at over 40X trailing earnings. First half of 2018 saw 34% year over year top line growth, 73% adjusted EBITDA growth. It does explain why expectations are high. People are excited about the opportunity that the company brings.

Making my call now for Yeti, as fellow Industry Focus host Nick Sciple put it once, I'm neither overwhelmed nor underwhelmed. I'm just whelmed by this story. I love the branding and the tailwinds in some of these new target markets and new geographic markets, but we've also learned some pretty hard lessons over the years in consumer and retail for similar stories. I mentioned GoPro earlier, but you think about also Fitbit or Groupon, Blue Apron, even Under Armour, which had a pretty long, strong run. These companies soar on a nascent trend, on this brand prestige, but they start to stumble once they face more serious competition or the fad burns out. I still have to ask myself how many $500-1,300 coolers can the company sell? How many of those are people looking to buy? When you buy one, I can't imagine you replenishing this on a yearly basis. That gives me some pause. But I'm actually pretty excited to follow this company. I think there's a lot to support the story.

Any final thoughts from you, Asit?

Sharma: Look at the debt, as well. Earnings are coming out shortly. Take a look at the marketing expense in relation to sales, as I said, and look at that debt load, any changes to that, and any indications for management of where they want to be in terms of leverage. Those would be the two most crucial points, along with the usual color on where the company wants to expand and how well it's doing.

Shen: Great! Thanks for joining us!

Sharma: This was a really fun conversation, Vince! I appreciate it!

Shen: Thanks, Fools, for tuning in! People on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. Fool on!