Dr. Martens Gets the Boot: An Update on the Recent Profit Warning

Following the unexpected profit warning on Tuesday, 16 April 2024, Dr. Martens' share price dropped by 30%. Investors were informed that U.S. wholesale is likely to be double digits lower and profit may be down by two-thirds from the 2023 level for the period ending March 2025. The business is struggling with sluggish sales in the USA market, and additional investments into the supply chain and customer data platform will be required. These are unlikely to be offset by price increases.

At the same time, CEO Kenny Wilson announced that he will be stepping down at the end of the fiscal year and will be replaced by the current Chief Brand Officer, Ije Nwokorie.

Following this announcement, the stock took a significant hit, dropping by 30% to ￡66 per share. This is its historical low and 10% below the low of January 2024.

In December 2023, when the stock was trading at around ￡90 per share, I concluded that the business was undervalued. I assumed that its strong brand would allow it to grow, albeit experiencing a 10% revenue drop in 2023. This has not played out well due to the 2024 reforecast. Since my article, the share price is now down by 27%.

Dr. Martens' share price continues its downward trend from its peak in June 2021, losing close to 90% of its stock value from the peak. The burning question for investors is whether Dr. Martens' stock price is accurately reflecting its bleak future or if the business has just become more undervalued and is offering an even better entry point to buy its shares.

One way of looking at this is by using the well-known, albeit simplistic, Gordon valuation model.

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P = D1 / (r - g)

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Where:

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P is the estimated value of the business, which will then be compared to the business's current market cap of ￡643 million.

r is the required rate of return/WACC, with 10% seeming appropriate.

g is the expected growth rate in perpetuity, for which I will use 2.0% applied from the reduced revenue base.

D1 is the free cash flow, the amount distributable to investors, usually assumed in the form of dividends.

In this scenario, I will assume only minimal future growth. As a result, I will set distributable cash flow to equal net profit (Capex investment is offset by depreciation), net of interest. This should be a conservative assumption, as in the case of low growth in a mature company, depreciation will typically exceed capex investments, and free cash flow will exceed net profit.

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The net profit for the period ending March 2023 was ￡129m from revenue of ￡1 billion. LTM net profit was ￡103m (prior to the profit warning announcement) from revenue of ￡978m. Dr. Martens GPM is about 62%. Assuming limited opex savings from the revenue decrease, I will estimate 50% operating margin and a 38% after-tax margin reduction of the reduced revenue. This would result in a net profit reduction by ￡38m for each ￡100m revenue reduction.

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At a base of ￡1 billion:

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A reduction of 10% would mean revenue of ￡900m and a net profit of: ￡62m

A reduction of 15% would mean revenue of ￡850m and a net profit of: ￡42m

A reduction of 20% would mean revenue of ￡800m and a net profit of: ￡24m

At a discount rate of 10%, the net profit could drop to ￡60m and the business value would still be above the current market price. At ￡40m, which would represent the announced 66% drop, it would be lower.

The table below illustrates range of scenarios using different net profit value and discount rate. Highlighted in green is when calculated business value exceeds current market cap.

However, it is important to recognize that this assumes ongoing 2% growth from the depressed revenue base. In reality, investors will expect that such a dip in profit would be only temporary and that a rebound in the following years would bring the profits closer to and above ￡100 million.

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There is, of course, an additional management risk. The management may, in pursuit of growth, further engage in expensive yet unsuccessful expansion. The free cash invested would deliver returns below the cost of capital and further reduce the business value while limiting dividend payouts or buybacks.

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In summary, if you believe in Dr. Martens' strong brand and its management making the right decisions, then there is a high probability that the share price is presenting a very interesting long-term investment opportunity, even though things may get even worse in the meantime.

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My opinion is that Dr. Martens' share price decrease is overdone, and it is now offering a much better purchase opportunity than it was just a week ago.

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As with most investing, we are playing a game of probabilities rather than certainties, and the reality may prove to be worse than expected.

My view should not be taken as investment advice!

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Dr. Martens announcement HERE