Dr. Martens plc (OTCPK:DOCMF) reported the company’s H2/FY2024 results on the 30th of May, ending the year with expected, priorly guided weakness. The FY2025 outlook, also previously hinted at, shows a belief of continued weakness in wholesale revenues.
I previously updated my thesis on Dr. Martens in a previous article on the stock, published on the 17th of April in 2024 after the company’s trading update publishing regarding FY2025. The article was titled “Dr. Martens: Weak FY2025 Outlook Due To Continued Challenges, A Cautious Buy”. In the article, I noted the company’s continued weakness also considerably weakening the investment case, but remained at a Buy rating due to the share’s sell-off still creating a seeming undervaluation. Since the prior article, Dr. Martens’ stock has recovered by 26% compared to S&P 500’s return of 8% in the same period. From my initial article, the stock has still lost 5% of its value.
H2 Results Ended FY2024 As Expected
The H2 results ended FY2024 with earnings that were previously hinted at in the April trading update. Dr. Martens’ EBIT ended up at £122.2 million in FY2024, down -30.6% from FY2023 as sales declined by -12.3% into $877.1 million. Sold pairs declined by -16.7% into 11.5 million. Dr. Martens’ DTC-based strategy progressed as owned stores increased into 239 from 204 in FY2024, while wholesale accounts declined to 1600 from around 1900. Owned stores are targeted to grow by 25 to 30 in FY2025.
With the H2 results, Dr. Martens also announced a cost savings plan, intended to achieve £20-25m in annual cost savings through reduced organizational costs. The cost initiative isn’t expected to have a notable effect to FY2025 results, but to notably increase FY2026 earnings.
The report showed expected weakness, not showing a significant variance from estimates. I believe that the initiated cost reduction program is great, though, elevating earnings considerably if successfully implemented well.
The FY2025 Outlook Is Still Weak
As expected, Dr. Martens’ headwinds are still looking to deepen in FY2025. The company foresees a group revenue decline of -20% in H1, led by a wide wholesale decline.
While growing DTC sales in the US are targeted in H2, the whole FY2025 outlook remains the same from what was communicated in the April trading update – Dr. Martens’ FY2025 is still highly uncertain and could turn out in multiple ways. An EBT decline into a third of the achieved FY2024 level is the worst-case scenario in the company’s words as US wholesale revenues drag, cost inflation can’t be pushed into pricing, and additional temporary inventory costs of £15 million are expected to repeat in FY2025.
A return to growth is targeted from FY2026 forward, coupled with a decreased cost base and better IT systems.
The US Recovery Plan
The largest factor in the FY2024 decline in performance has been the United States, especially wholesale decreases as already previously discussed. Total revenues in the US declined by -20% in constant currency in FY2024, with the struggles expected to continue deep in FY2025 as well. Dr. Martens is working extensively to turn around the sales trajectory in the country, being critical as 37% of sales were still generated in the US in FY2024.
In Dr. Martens’ US turnaround plan, the company intends to expand marketing in the country, focusing on social media marketing to draw demand from younger people. The digital experience is also targeted to improve. Notably, the company also plans to push efforts to improve sell-through in wholesale stores, but the measures to improve sell-through aren’t very well mentioned. I believe that increased marketing spend should ultimately elevate sales in all channels, but at the cost of elevating expenses.
Dr. Martens told in the H2 earnings call that very little DTC store openings are planned for the United States in FY2025, but the company still sees a long-term DTC opportunity in the country.
While worldwide Google searches for Dr. Martens seem to be stable year-over-year, the United States’ searches still seem to be trailing from previous year’s levels by a wider margin; I don’t expect a very significant return into growth as a base scenario for the US before better demand is showcased. Some of Dr. Martens’ other markets, such as Italy and Japan, still show growth though.
Footwear Market Weakness Piles Onto US Pressure
Behing the weakness, a weak footwear market plays a part in addition to Dr. Martens’ not-as-hot brand. In the United States, most other footwear companies also experienced a decline in sales in 2023 – for example, Steve Madden’s (SHOO) revenues declined by -6.6% in 2023, Designer Brands’ (DBI) by -7.3% in FY2023, and Rocky Brands’ (RCKY) by -25.0% in 2023 including a divestment.
A relation completely to a current weak industry doesn’t really hold ground with Dr. Martens’ US revenues declining by -20%, but a notable effect from the macroeconomic backdrop should still be noted.
The Valuation Doesn’t Have Great Base Scenario Upside Anymore
I updated my discounted cash flow [DCF] model estimates to account for the given financials, outlook, and cost savings plan – I now estimate a revenue decline of -6% in FY2025, driven by the weak H1 outlook. Afterwards, I anticipate a return to some growth, representing a total 3.9% CAGR from FY2024 to FY2034. After FY2034, I now estimate perpetual growth of 2% instead of 2.5% previously.
Due to the newly announced cost savings plan, I now estimate the EBIT margin to recover into 15.0%, up from a previous estimate of 14.0%. Inventory management looks to improve FY2025 cash flows above my previous estimate.
The estimates put Dr. Martens’ fair value estimate at $1.21, 13% above the stock price at the time of writing. While the stock still has some upside with the estimates, the upside isn’t sufficient to really provide a highly attractive risk-to-reward.
A better recovery into growth and higher margins could make the stock attractive again at the current level, but I don’t believe such a scenario to be likely anymore.
A weighted average cost of capital of 11.16% is used in the DCF model. The used WACC is derived from a capital asset pricing model:
In FY2024, Dr. Martens had £19.4 million in interest expenses related to bank debt, making the company’s interest rate 6.58% with the current amount of interest-bearing debt. I continue estimating a 20% debt-to-equity ratio in the long term.
To estimate the cost of equity, I use the United Kingdom’s 10-year bond yield of 4.21% as the risk-free rate. The equity risk premium of 5.48% is Professor Aswath Damodaran’s latest estimate for UK, updated on the 5th of January. I have kept the beta and liquidity premium the same at 1.44 and 0.3% respectively, creating a cost of equity of 12.40% and a WACC of 11.16%.
Takeaway
Dr. Martens reported H2 results in line with expectations and continues foreseeing a weak FY2025 especially in the first half. The FY2025 outlook is still turbulent, but earnings are highly likely to take a large hit. As Dr. Martens plans a return to growth in FY2026, the company has announced a £20-25 million cost savings plan, and extended marketing and other efforts in the United States to improve demand in the weakly performing market. The valuation now has very little upside in my base scenario, and as such, I downgrade my rating on Dr. Martens into Hold. I have personally sold my previous small position in the company after the stock’s short-term recovery, and bought a pair of Dr. Martens shoes instead.
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