4. Iconic Brand, Inflated IPO: Dr. Martens's Journey Through Market Misjudgements

1. SUMMARY

This report presents a valuation of Dr. Martens Plc. Based on forecasting future cash flows, its intrinsic value is calculated. The estimated equity value is ￡1.2 billion, a figure 43% above the current market capitalization of ￡0.86 billion, indicating a potentially attractive buying opportunity.

Note: This is NOT a financial advice or recommendation.

2. INTRODUCTION

Dr. Martens, an iconic British brand, traces its origins back to 1945 in Germany. Known for its durable boots originally designed for workers, the brand has been widely embraced by various youth subcultures, eventually becoming globally recognized across diverse age groups and fashion styles.

Despite facing bankruptcy risks in the early 2000s, the company successfully turned around by moving production to China and Thailand, focusing on its most iconic shoe models, and repositioning the brand to capture a wider audience.

Acquired by Permira in 2013 for ￡300 million, Dr. Martens achieved rapid revenue growth, with sales reaching ￡1 billion in the year ending March 2023 and a Compound Annual Growth Rate (CAGR) of 23% over the past eight years.

Dr. Martens went public on the London Stock Exchange in January 2021 with a valuation of ￡3.7 billion.

3. FINANCIAL PERFORMANCE

Despite its success, Dr. Martens's share price has declined significantly, down over 80% since its IPO peak in February 2021. This was largely due to overhyped expectations and the reality of slowing growth. The company's expansion into Asia and the US, in particular, has been met with operational challenges, brand recognition issues, and increased competition.

Moreover, there have been criticisms regarding the quality of its boots, claims the company refutes. Notably, Dr. Martens issued a profit warning in November 2023, causing a significant drop in its share price, closing down 22% on that day.

Despite these challenges, the company maintains a healthy balance sheet and positive cash flow.

Share price of Dr. Martens:

Revenue:

The brand image remains strong and is being embraced and promoted by young users. Recently, the company claimed, “Each member of the K-pop girl group sensation NewJeans has been seen sporting some variation of Doc Martens, making Docs a fashion statement in trendy global teen culture.” This solidly cements Docs as a fashion statement in Asia.

It is highly likely that the company will continue growing in Asia as well as in its most troubled US market. It is reasonable to assume that after the current year's revenue decrease, forecasted to be 7%, sales will recover and start growing again.

I will assume a conservative 5% average revenue growth, slowly decreasing to 2% at perpetuity.

Gross Margins:

The gross margin remains high at around 63%, although not at the level of some other top-tier fashion shoe brands. Considering the leather materials used and the complexity of the production, this seems to be a healthy and competitive margin.

Unfortunately, it is likely to be under downward pressure due to inflation and customer complaints about the decreased quality of boot leather, both of which will drive costs higher.

Some of this will be at least partially offset by the increasing benefit of scale, and I will assume that gross profit will stay at 60%.

Source: Invisible, yet Invaluable: Valuing Intangibles - The Birkenstock IPO

https://aswathdamodaran.substack.com/p/invisible-yet-invaluable-valuing

Operating Margin:

The company is highly profitable with a high Pre-tax Operating margin (EBIT), although decreasing in recent years.

As revenue has decreased, the overhead costs have continued to rise as management has kept investing in international expansion and new infrastructure to support it.

Addressing this, it is probable that the company will succeed in consolidating its operations and become more efficient.

I will assume that this will enable it to maintain a 22% EBIT over the next 10 years and 20% EBIT at perpetuity. That is above its current and last year levels, but below levels achieved in 2021 and 2022.

Reinvestment:

The growth of Dr. Martens hasn’t required large capital investments.

Although they have established branded stand-alone stores, they have mostly used outlets of their partners as their main sales channels. This model delivers lower margins due to commission sharing, but it is significantly faster to roll out and less capital expenditure-heavy.

Required investment into working capital has been relatively consistent at approximately 20% of revenue. In recent years, we have seen a significant increase in inventory caused by optimistic managers maintaining high production levels despite decreasing sales, but this will likely sell through, albeit at a discount.

Considering both, a ratio of 2.5 revenue growth to investment seems to be reasonable and in line with the industry.

Risk:

The business is undoubtedly facing a number of risks that will impact its performance. Considering its trading history, brand name, and balance sheet strength, it is highly unlikely that any of these will pose an existential threat. The company is a going concern for the long-term future. I will assign only a 1% probability of a default.

Cost of Capital:

Taking into account current market conditions (high interest rates, risk of recession, etc.), I will use a 13% cost of capital for the next 10 years. This is approximately 1.5 x beta x market premium (6%) + risk-free rate (4%).

At maturity, I will use an 11% cost of capital in perpetuity, assuming lower interest rates and a larger business size.

4. THE VALUATION

Input Variables and Valuation: Dr. Martens Copr.:

Using the earlier defined variables, the equity intrinsic value calculated is ￡1.23 billion. This is 43% above the current market value of ￡0.86 billion.

5. CONCLUSION

The business, as it stands, seems to offer an interesting investment opportunity, providing a 43% margin of safety based on the forecast made. This positive view is further encouraged by the management's commitment to paying out dividends and implementing share buybacks.

It seems that investors suffering three years of stock price decline have finally given up on Dr. Martens. There is a high probability that the stock price will recover at some point in the future and rise close to the calculated intrinsic value.

However, it is impossible to determine the timeframe of the recovery and any further decrease the stock may experience beforehand.

This is an investment ideally suited for an investor with a long-term investment horizon who believes in the future success of Dr. Martens and is able to cope with potential further stock decline.

*Note: This is not investment advice and expresses only my personal opinion.