Dr. Martens is a shoe brand operating in the global footwear market, which sells to consumers in more than 60 countries. The brand began with the creation of its first boot, the 1460 (seen below), on the 1st April 1960, and since then the brand has built a defined presence in the footwear market that is synonymous with British youth and music subcultures.
The Group reported its Q3’22 results on 27 January 2022. The results were met poorly by the market with shares falling c.12% on release despite Group revenues rising by 11% YoY and DTC revenue growth of 33%.
Recent Results: Q3 Report
In Dr. Martens' recent Q3 report, CEO Kenny Wilson reiterated problems that had been facing the Group in its interim report earlier in 2021: the closing of three of its third-party factories in South Vietnam, which represented a third of the Group’s production capacity. The Group had entered the current financial year with relatively high inventory levels. However, the closures of the Vietnam factories alongside extended shipping times resulted in constrained inventory levels during the third quarter. This led Dr. Martens to prioritise the inventory it had for its DTC channels (as Q3 is its key DTC trading period), which resulted in its wholesale channel being down 14%.
Kenny Wilson was clear that the poorer performance in Dr. Martens’ wholesale channels was entirely down to lack of inventory rather than any drop in consumer demand and that there had not been any significant cancellations of orders in the Group’s wholesale channel despite delays. This reassurance came after Wilson was asked whether there was a pricing or demand problem for Dr. Martens’ products that may lead to a drop in management’s confidence in its long-term targets, he stated that the Group had achieved what it had set out to do at IPO — to grow the brand high teens this year despite the headwind of its largest manufacturing country, Vietnam, being closed for three months.
I think from our perspective as management, we don't control the share price, what we control is performance, and we will deliver exactly what we said we would do 12 months ago. And we feel very confident as we look at the guidance we've given for the outlying years. The Dr. Marten's brand is strong with huge potential around the world. — Kenny Wilson, Q3 earnings call
Regional Performance in Q3
EMEA results were strong in the quarter with good growth across all channels. Italy was converted to a directly owned and operated country at the start of the financial year with three stores in Milan opening in December. Management were pleased with the progress that they were making in the Italian market.
Asia Pacific was weaker with revenue down year-on-year. The biggest impact here was seen in distributor markets, namely Australia, and specifically third party operated stores in China as the impact of renewed COVID restrictions and concerns were felt in these two markets.
However, management noted that the vast majority of Q4 wholesale pairs have been manufactured and they're in transit by sea to distribution centres in preparation for shipping to wholesale customers.
In H1’22, the Group’s biggest operational challenge was the aforementioned closing of three of its third-party factories in South Vietnam, which represented 33% of the Group’s production capacity. Luckily, the Group had built inventory levels in anticipation that it may face issues with supply chains, and so were able to cover much of the shortfall from these factory closures and from shipping delays.
Dr. Martens’ story begins in 1901 with the Griggs family, who were known for making boots in the small town of Wollaston, Northamptonshire in the English Midlands. For six prior decades, Griggs’ footwear had earned a solid reputation as sturdy, durable work boots.
Then in 1945, Dr. Klaus Maertens, a 25-year-old soldier from Munich, created a unique air-cushioned sole to aid his recovery from a broken foot. He made a prototype shoe and showed it to a university friend and mechanical engineer Dr. Herbert Funk. The two went into partnership, and by 1947 they had begun formal production. In 1959, they decided to advertise the footwear invention in overseas magazines.
This invention was picked up in 1960 by the Griggs family. An exclusive license was acquired and a few key changes were made, including the distinctive yellow welt stitch that is still a key part of the brand’s design today. The first eight-holed Dr. Martens boot took its name from the date of its inception, April 1st 1960, named the 1460.
The boot was originally worn by postmen, factory workers and other members of Britain’s working class. However, the 1960s brought with it a wave of social and cultural change, and this radical atmosphere aided the uptake of Dr. Martens by early multicultural ska-loving skinheads who proudly championed British working class style. Shortly after, Peter Townsend of The Who became the first high profile individual to wear the boot as a symbol of his own working class pride and rebellious attitude. The boot began to become a subcultural essential.
Over the next decades, the boot was adopted by various British subcultures (glam, punk, goth, grebo) and was particularly championed by young people. The brand also made its way across to the US when hardcore musicians touring the UK took DMs back to the west coast, thus inadvertently starting American subculture’s adoption of the brand.
In 2000, shortly after the brand’s fortieth birthday, sales declined so dramatically that all but one of the UK factories had to be closed to stave off bankruptcy. Then, in 2003, the revitalisation of the brand began with high fashion designers reinterpreting and customising the classic 1460 boot.
At present, Dr. Martens has a well established brand and core following that has been further curated over the last decade. However, the company's brand and relationship with core customers has faltered in the past, primarily due to poor management of the business in the early 2000’s.
Dr. Martens has always had a unique brand character. They are an iconic name, with a strong UK history, associated with music and rebelliousness. However, as product lines and markets grew, some of this heritage was lost.— Permira Advisers
Now, Dr. Martens aims to implement their brand custodian strategy at the heart of everything they do. This strategy is consistently repeated throughout Dr. Martens’ results literature and in publications by its largest shareholder (Permira Advisers). Wholesale relationships are now agreed upon the criteria of whether a retailer will uphold Dr. Martens brand values.
Our product durability and timeless design are rooted in a sustainable, long-term approach, and our brand custodian philosophy continues to guide the decisions we take. — Dr. Martens
Dr. Martens Business Model
Dr. Martens’ business consists of a simple product range with a high-level of non-seasonal continuity lines. The Group operates with a low markdown percentage, only using markdowns to clear seasonal stock.
The 1460 is Dr. Martens’ most iconic product, maintaining the same style and design today as when it was first created in 1960. Its ‘Originals’ category is made up of its ‘big three’ products, the 1460 boot, the 1461 shoe and the 2976 Chelsea Boot. Originals sit at the core of Dr Martens’ product strategy and represented 57% of the Group’s revenue in FY21.
Dr. Martens’ major focus since its IPO in January 2021 has been to grow the brand through its own direct-to-consumer channels to enable control of brand engagement and drive greater profit margins. The focus of this DTC offering is the Group’s e-commerce channel, which offers consumers an extended product range on its own website drmartens.com
Dr. Martens has rapidly grown its DTC channels to comprise 64% of revenue in Q3’22 (up by 24% from H1’22, when DTC represented 40% of revenue). Prior to releasing its Q3’22 report, Dr. Martens stated that it was targeting a 60% DTC mix over the medium-term, with a target for e-commerce to grow to at least 40% mix of the Group’s revenues. Ecommerce growth was up 16% in Q3’22 versus Q3’21, representing 39% of revenues in Q3 and 30% of revenues year to date.
Dr. Martens’ e-commerce platform is complemented by the Group’s retail channel, comprising 158 own-retail stores at 31 December 2021. The Group’s retail strategy focuses on building profitable stores with short payback periods with small footprints and relatively short-term leases in brand appropriate locations. The Group’s directly operated stores act as brand beacons and as drivers for e-commerce growth, as new stores increase brand awareness.
The Group’s wholesale channel provides physical distribution via third parties in locations or markets where the Group typically has a smaller number of stores or no stores. It has historically been the channel representing the largest proportion of the Group’s revenues. Dr. Martens’ wholesale customers are now largely limited to best-in-class retailers, who act as custodians of the brand. The wholesale channel also plays a significant role in increasing brand awareness globally, in particular in new markets. The Group has focused on optimising its wholesale account base, closing approximately 1,190 accounts from FY18 to FY20.
The Group’s footwear is manufactured in the UK, Vietnam, China, Thailand, Laos and Bangladesh, but its shoes are mainly manufactured at third party factories in Asia. (The business continues to produce its “Made in England” range at Dr. Martens’ original manufacturing site in Wollaston.) In Asia, the Group’s footwear is manufactured at 13 sites, mainly located in China and Vietnam, under ‘arm’s length’ arrangements.
Dr Martens’ boots are still worn as a symbol of uniqueness and subversion; one of the brand’s taglines states ‘we stand for nonconformity’. However, Dr. Martens aims to appeal to a broad customer base. While the Group’s marketing strategy is influenced by alternative consumers who have their own individual style, the brand resonates with and is worn by a much broader audience of footwear consumers. This is reflected in the demographic mix of the Group’s customers across all metrics including gender, age, income level and region shown in the tables and figures below.
Potential for Growth
The Group’s current geographical footprint, in terms of total Group revenue, is 85% represented by the US and EMEA. However, given the attractiveness and high growth rates of the APAC region, the Group believes that Dr. Martens’ relative under-representation in this market represents a strong future growth opportunity for the Group. Dr. Martens is aiming to target Japan and China in particular.
Dr. Martens has been operating in Japan since 1998 and in China since 2007. A new release, Dr. Martens “Year of the Tiger” collection, is geared particularly towards its Chinese market; the “Year of the Tiger” 1460 and 1461 designs are shown below.
Dr. Martens stated in its half year report that its growth in its APAC segment was particularly hit by revenue decline in Japan, as there was a State of Emergency throughout the period that resulted in a decline in retail sales. In its recent Q3 report, the Group expressed weakness in Australia and China where third-party stores were impacted by renewed restrictions. Revenue declined by 28% in Q3 (constant currency 24%).
China is the world’s leading consumer of footwear according to Statista, with around 3.94 billion pairs of shoes bought in 2020. Dr. Marten’s ability to crack the footwear market in China is therefore key to its future growth. In China, and across the wider APAC region, the Group stated that it was yet to fully execute its “DOCS” strategy (D — DTC acceleration; O — Operational Excellence; C — Consumer Connection; S — Sustainable Global Growth).
Leading the business in the APAC region is Derek Chan, who has been President of the Asia Pacific region since 2019. Chan’s experience has consisted of Vice President/General Managers roles for Amazon, Nike and Levi Strauss & Co.
At a glance, Dr. Martens’ financial metrics seem relatively impressive. Revenue growth has been superb in the last five years for the footwear retailer, especially in 2019 and 2020. Covid-19 related issues have caused lower sales growth in 2021 and 2022’s expectations. However, with growth of 15% in 2021, we can begin to understand how resilient Dr. Martens’ business is in an economic downturn.
Gross margins for Dr. Martens are also very high for a footwear manufacturer — at roughly 60%, Dr. Martens outstrips the profitability of Nike and Adidas at 45% and 50% respectively. Dr. Martens does a good job of converting this into operating profit, and operating margins have grown over the past 3 years to 23% expected in 2022.
Whilst the business is fairly new to the stock market and will need some time to establish a track record of sustainable return on capital (ROCE), it is pleasing to see that in some years ROCE has achieved levels of 27%, which suggests Dr. Martens has the ingredients to be a good quality business.
Looking at the balance sheet, Dr. Martens IPO'd with a fairly high level of debt, showcased by the debt to equity ratio of 8.3 in 2020. However, this ratio has since been reduced to 3.33. Dr. Martens has £300m of bank debt (long term) and £100m of lease liabilities offset by £113m of cash as of September 2021. I would expect Dr. Martens’ leverage to reduce over the next few years as the company matures on the stock market post-IPO.
Management and Significant Shareholders
Dr. Martens was subject to a private equity buyout in 2014 by Permira Advisers LLP. Permira still holds c30% of the share capital. Reading Permira’s reports, it could be suggested that Permira added significant value to Dr. Martens over their holding period, by revitalising the strategy and adding a new management team.
Dr. Martens was already an international player when the Permira funds invested, but when sales were audited, it was found that the mix was far from ideal, with almost half the sales being derived from two key markets alone. With the funds’ support, a new management team reviewed the company’s international approach and helped set new targets for each region. They researched the best way to achieve their new sales objectives by reviewing the benefits of the own-store model versus the franchise model, as well as establishing the optimal number and location of the stores. Today it is all about sticking to this chosen strategy and executing it with precision. — Permira Advisors
In 2018, Permira added Kenny Wilson as the CEO of Dr. Martens, who now owns 1.12% of the share capital (£30m). Kenny Wilson has extensive experience leading high-profile consumer brands, including Levi’s where he spent 19 years and rose to become President of the Brand in Europe. Prior to Dr. Martens, Kenny was CEO of Cath Kidston, a role he held since 2011. During that time, he doubled its sales and transformed it into a global brand with more than 220 stores worldwide and diversified its product range to broaden its customer base.
Most recently in 2019, the Group was awarded “Best Place to Work Award” by Drapers, “Business Culture Achievement Award (Medium Business)” at the Business Culture Awards and “Employee Engagement and Experience Award” at the HR Distinction Awards.
With Permira’s 30% share ownership, there is a risk that selling pressure could ensue should Dr. Martens largest shareholder wish for an exit. However, with such a large holding, it is unlikely this would be done quickly and Permira is likely to act in the interests of protecting the share price.
Summary and Valuation
Dr. Martens certainly has some quality aspects to interest prospective shareholders. It's popular cult-like following and rebel image has created a powerful brand personified by the timeless yellow embroidery on its core range of boots and other products. Dr. Martens brand strength, alongside well thought out strategies such as a non-seasonal mix and minimal discounting allows for premium pricing reflecting in gross margins of 60% (Dr. Martens' unit profitability is higher than Nike and Adidas).
I also like the fact that Dr. Martens has navigated some operational challenges in the past. The business and management have learnt from these challenges and now their 'custodian' ethos reflects the lessons management have learnt in protecting and growing an international brand. Direct to customer sales strength also reflects this ethos, and Dr. Martens should reap the benefits of vertical integration both from a brand strength standpoint and through increased profitability.
The business is expected to earn 16p in earnings per share in 2022, followed by EPS of 19p in 2023. The resultant valuation puts Dr. Martens on a P/E of 17x 2022 estimates and 14.6x earnings in 2023.
If Dr. Martens can continue executing the current revenue growth trajectory (15-20%) and expand successfully into Asia, I think the price today, having fallen c.40% from IPO levels (brought on by short term issues such as supply and logistics challenges), looks very attractive as an entry point into a quality business.
At the time of writing, James did not own shares in Dr. Martens.
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