How To Be Cool(er)

Yeti is a cooler company. It sells ice-boxes for tailgates and thermoses for coffee. Its value you ask? $2.7 billion. This write-up will be more of an exploration of the business model and strategy of Yeti rather than an explicit buy/sell recommendation. The story of Yeti starts on the Colorado River, near Austin Texas. Two brothers, Ryan and Roy Seiders, wanted to create a fishing rod company to fuel their passion for hooking largemouth bass. But what these Texas boys stumbled into was something grander than they imagined. A staple of the South, Yeti’s products are representative of upper echelon country living. This ain’t no $10 Igloo cooler. This is a whole different beast.

So how did two fishing-loving dudes grow a cooler business to nearly $800 million and will it last as long as your ice can stay cold in a Yeti cooler? One word: brand. Yeti’s brand has become synonymous with cool(ers). I Googled “hunting status symbols” and Yeti popped up as the first one. As a Ferrari is to a Wall Street banker, a Yeti cooler is to hunter/fisherman. You might think, “this is insane,” why would someone, in their right mind, pay $250 for a Yeti cooler when Igloo has the same product for $80? Well, as more evidence of fanfare, in 2015, a year-and-a-half after the company started selling drinkware, sales from that product category grew 14-fold, from $15 million to $225 million. Yeti stays relatively asset-light as well. It outsources manufacturing, logistics and distribution. So, much like most brands today, it focuses on design and marketing. But that raises some questions. If Yeti is so asset-light why did it have 4.4x Debt/EBITDA ratio? Well, the details are a little foggy, but in 2012, Cortec, a private equity fund, bought a controlling stake in the company. And as is the norm, to juice returns, Cortec levered up the firm. Since its IPO last October, Yeti has managed to cut that debt ratio to 1.7x but Cortec still owns 53% of outstanding shares. Having raised about $40 million from going public, the company still has about $290 million of net debt on its balance sheet. At a run-rate of about $30 million in interest expense, the IPO was timely and should enable a few years of growth without diluting existing shareholders. So while many investors stay away from this name because of the debt load, it is probably manageable. What is strange is Yeti’s operational hiccup in 2017. The company, after growing nearly 90% in 2016, saw sales actually decrease 20%. What a reversal! Here’s essentially what happened. To set the scene, Yeti sells two product lines (coolers and drinkware) in two ways: as a wholesaler to retailers and direct-to-consumer (DTC) on its own website and through Amazon. In 2016, the company was growing so quickly that it was routinely having product shortages. Retailers like Dick’s Sporting Goods and Bass Pro Shops couldn’t keep up with demand. So in the first half of 2016, retailers put in BIG orders…too big. Demand slowed and around this same time, a few retailers like Sports Authority and Sports Chalet went bankrupt. That meant huge discounts and excess inventory. Good thing the company wasn’t public, it would’ve been decimated. But things are on the upswing now. Sales grew 22% for 2018 and operating margins widened from 10% of revenues to 13%. Further down the income statement, earnings grew 550% from $15 million to $57 million. This is a function of a terrible 2017, and an easy comp. In context, that’s 11% compounded earnings growth from 2016. A big part of Yeti’s strategy going forward is DTC. In the past year, the company decreased its reliance on wholesalers and now DTC makes up 37% of overall sales versus 30%. At the same time, drinkware has picked up. In 2017, drinkware and coolers each made up 50% of sales. Now, drinkware, having grown 37% versus 6% for coolers, makes up 56% of sales. Therefore, to sum up Yeti’s current strategy, it is to sell more cups and thermoses through its website and Amazon. But some big questions still remain. How sustainable is brand as competitive advantage in this space? And how saturated is the company in its target market? Brand is amorphous. What once was a clear competitive advantage due to lack of transparency is now a question mark. For instance, before the internet, consumers were kept in the dark. There was nowhere to compare prices and features. Therefore, it was all about brand awareness. The companies who advertised the most became known and could demand higher prices, which allowed them to continue advertising and the cycle continued. Now, brand means something different. It is not as much about consistency, it’s about the experience. In today’s consumer-surplus society, there’s so much competition. Don’t like your brand of toothpaste? There are over 4,000 kinds to choose from on Amazon. But it goes deeper. For a category like toothpaste, buying habits differ from something like a car. It’s unlikely that you would peruse 4,000 options to find the “perfect” toothpaste. The incremental benefit by spending a lot of time finding a better toothpaste is outweighed by the inexpensive price. On the other hand, a car is a big decision and importantly, it is a public-facing purchase. Therefore, status matters. Toothpaste status doesn’t matter because most people don’t see inside your medicine cabinet (Seinfeld lovers will know this isn’t always true). This is the crucial hinge for Yeti. It is a status symbol. It is not rational to buy a cooler for $1,300. Sure, buyers of such an item will brag about the features, the durability, the no-sweat surface, the grip on the underbelly, and on and on. But there’s one reason somebody buys a Yeti: status.

But this leads to the next question. Does every hunter/fisher that wants a Yeti already have one? Well, reading through customer reviews, a lot of people say Yeti’s are: “the only cooler you’ll ever need.” The quality is so good you won’t ever need to buy another one. It is even Grizzly-bear proof (even though Grizzlies can’t be found anywhere near the home-base of Texas). To be clear, this is a product company. It’s not an ecosystem. It’s not like Apple, which makes great margins on the service-side of its business. Yeti sells cups and coolers that never need replacement. To get some more insight, let’s do a little math. Since starting to sell drinkware, Yeti has sold $1.4 billion in aggregate. At an average selling price of $35 (reasonable after perusing the website), the company has sold about 40 million cups since Q2 of 2014. Maybe you need a new cup after a few years (dent it, lose it, etc.) and maybe some people buy a few cups (one for coffee at the office, one for home). Let’s assume 30% re-order volumes within that 5 years and each person averages 1.5 cups. 40 million units / 1.5 per person = 30 million unique people before re-ordering 30 million unique people before re-ordering = 23 million unique people * (1+ 30% re-order volume) Therefore, maybe about 23 million people have been serviced by Yeti and won’t need to re-order a cup for a while. It is harder to calculate this for coolers because the data doesn’t go back to the origin, but people are much less likely to re-order a cooler and most people probably only need one cooler (more for avid hunters). Using a similar calculus, I estimate that Yeti has sold no more than 5 million coolers since inception. ($1.9 billion in aggregated sales at an average price of $400). A study pegs the population who participated in hunting/fishing/wildlife activities in the US at about 100 million people. So there is definitely still room to grow, but it is difficult to tell how pervasive the Yeti trend could be. It is obviously huge in the South and the Midwest, the two populations that hold 45% of the demand for this market. So maybe 45 million people in the US is a more reasonable total addressable market. And the company has yet to expand internationally, though I’m skeptical this phenomenon could be replicated abroad. Further, the drinkware market will expand beyond hunters/fishers and the cooler market can easily extend to tailgaters and serious BBQ-ers as well. It will remain to be seen how important status is to these demographics though. My guess is less important but still a purchasing factor. The company has gross margins of 50%, meaning that it sells a big cooler for $400 but it only costs $200 to produce. This is high for a physical product company. In context, Apple’s gross margins tend to hover around 40% and Nike’s around 45%. So the company certainly has pricing power. And when you’re buying a cooler for $500 and a big ole’ thermos for $70, what’s a few more bucks? If I’m honest, before writing this piece, I was pretty negative on Yeti. But as I’ve dug in, I think it will be a battleground stock that will keep rising in the face of negativity. The company’s margin profile will be pushed along by the move to DTC, an inevitable retailing trend. And the company has some optionality. I don’t want to see them move too quickly, trying to create new brand categories, but it sure knows how to scale new products (i.e. drinkware) and it has built incredible brand equity. The company converts about 20% of its sales into free cash flow, meaning it trades for about 5% free cash flow yield, after factoring in debt into the enterprise value. That’s not terrible. For the (grizzly) bear case, on a trailing basis, the valuation looks silly at 30x earnings for an undifferentiated cooler company, controlled by a return-hungry PE firm. But digging in, investors can get a brand powerhouse, in a growing market, with awesome pricing power for 21x forward earnings. To be clear, this might seem like an invalidation of this whole write-up, but Yeti is not a no-brainer at this valuation. Hopefully, the shorts come out and bring this one down, but I’m not touching it yet. Consumer companies are difficult to invest in because consumer tastes can change on a dime. Yeti will be hated/shorted by a lot of smart investors because it is merely a “cooler company” but these situations are fascinating because there is always another side to the story.

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