Introduction

Dr. Martens plc (OTCPK:DOCMF) (LSE:DOCS) is a British footwear company founded in 1960. Its best-known product, the 1460 AirWair boot, was honored as a British cultural icon in 2006, alongside of the Aston Martin DB5, Concorde and Jaguar E-Type, to name a few.

The company only went public in January 2021 and the stock is down about 50% from its post-IPO record high. At current prices below 270 pence per share, I believe it is undervalued by at least 40%. Strong finances, growth prospects and brand-friendly management make Dr. Martens a sound investment and potentially a long-term preparer.

Dr. Martens over the years

Klaus Martens, a German doctor during World War II, injured his ankle in a skiing accident in 1945. He then found his standard military boots too uncomfortable on his injured foot, prompting him to bring improvements. He added softer leather and air-cushioned soles. These improvements resulted in what would later become the 1460 AirWair boot icon.

Dr. Martens boots first found popularity with housewives and women over 40, who found them very comfortable. Later British police officers and skinheads began to wear them, although for different reasons. What has really made the brand iconic, however, is its popularity among musicians and celebrities.

From punk to rock to grunge to all things Miley Cyrus, the original Dr. Martens boots have always found a devoted fanbase. The company has somewhat of a cult following among rebels of all ages and nationalities. A quick Google search turns up images of dozens of celebrities, from Avril Lavigne, Gwen Stefani and Orlando Bloom to Jessica Alba and even the Kardashians wearing Dr. Martens. Apparently, the boot suits more than one clothing style or personality type. More importantly, famous people wear Dr. Martens because they like it, not because the company pays them. This shows how strong the brand is, which gives the company great pricing power, which in turn leads to high profit margins.

Despite his history of success and recognition, Dr. Martens has also had his fair share of problems. For example, sales dropped nearly 70% between 1999 and 2006 due to poor brand management. R. Griggs Group, the company that bought the patent rights for the boots in 1959, nearly went bankrupt in 2003 and was forced to lay off more than 1,000 people and move production from the UK to China and the United Kingdom. Thailand to cut costs in order to survive.

But he survived. In 2012 R Griggs was the eighth fastest growing UK company. In 2013 it was acquired by private equity Permira for £300m. Permira did a great job as owner of Dr. Martens, as sales continued to grow rapidly over the next eight years. Revenue nearly doubled between 2018 and 2020 alone, from £349m to £672m.

Despite supply chain difficulties and Covid-19 restrictions, sales still increased by 15% to £773m in the financial year ending March 31, 2021. That brings us to today today and why I think Dr. Martens’ future is just as bright. like the best part of his past.

Financial overview and valuation

Dr. Martens released its annual results for the fiscal year ended March 31, 2022, June 1. The company sold more than 14.1 million pairs last year, up from 12.7 million the year before. Revenue rose 18% to £908m, free cash flow approached £150m and EPS was 18.1p per share. Net profit margin and FCF margin were 20% and 16.4% respectively. These results would have been even better at constant exchange rates, with revenues up 22%. Importantly, excessive debt is not driving Dr. Martens’ growth, as net debt was just £53m at the end of the financial year.

Looking ahead, analysts expect FY2023 sales to exceed £1.05bn and result in 19p per share of earnings. I consider these estimates to be overly conservative as they projected 15.5p in EPS for 2022, missing the actual result by 2.6pa or 16.7%. Given Dr Martens’ growth profile, I expect EPS to approach and possibly exceed 21p this year. With stock currently at 260p, this translates to a forward P/E of less than 12.5. For a 20% producer, that’s a very cheap valuation.

My discounted cash flow calculations also suggest the stock is undervalued. Using EPS of 20 pence as a base, a discount rate of 10%, a growth rate of 13% for the first ten years and a terminal growth rate of 4% for years 11 to 20, the fair value for Dr. Martens is about 430 pence per share. This translates to a safety margin of around 40%, which is more than enough for such a quality company. Looking at it from another angle, a realistic EPS number of 27p for FY2025 and a more decent P/E of 20 makes Dr Martens a double at 540p three years from now.

In fact, given management’s ambitions for geographic and direct-to-consumer expansion, I might as well undervalue the company. DTC, both in-store and online, is the first pillar of the company’s “DOCS” strategy. The other three letters stand for organizational and operational excellence, consumer connection, and supportive brand expansion with B2B.

By cutting out the middleman, Dr. Martins was able to increase its EBITDA margins from 17% to 29% and better control its brand image. While the company has no plans to move to 100% DTC, it plans to continue to increase the DTC channel as a percentage of sales to at least 60% from the current 49%. That means profit margins have more room to grow from here, so profits should grow faster than sales for at least two or three years. In other words, despite the company’s decision to increase its marketing spend by 0.5 revenue points per year, this should also drive sales growth.

Risks

I consider the Dr. Martens brand to be its greatest and most important asset. Without it, it’s just a company selling winter boots. The period 2000-2006 has already demonstrated the extent of the damage that poor brand management can cause to this company. The good news is that the current management is fully aware of its responsibility to preserve the brand. The people at the helm are experienced veterans, who never miss an opportunity to call themselves “the brand keepers”. The management team has over 60 years of experience in other brand-conscious companies like Levi Strauss (LEVI), Lacoste and Nike (NKE), to name a few.

Another risk that has only been made more evident by China’s zero-Covid-19 policy and resulting lockdowns is the localization of manufacturing in a single country. Dr. Martens has managed this risk through diversification. In addition to its own factory in the UK, the company also relies on manufacturers in Vietnam, Laos, Bangladesh and Thailand. China represents only 10% of production.

But the risk I was most worried about initially was that Dr. Martens boots would still be more or less a fashion item, subject to changing consumer moods and tastes. In this regard, I was pleasantly surprised to find that the original three models still account for more than half of the revenue. Imagine that a product that has barely changed since the 1960s is still a bestseller in 2022. How many companies can say that?

With that in mind, I’m much less worried about Dr. Martens going out of fashion. Additionally, company research shows that the brand has never been more popular. However, this strong popularity does not mean that there is a risk of market saturation. The company only operates in around 60 countries and sells just over 30 pairs per 1,000 people in its native and most saturated market – the UK. There is plenty of room to expand globally. On page 41 of Dr Martens’ prospectus, management’s theoretical projections point to the possibility of £6 billion in annual sales over the long term. But the key word here is “theoretical” and there is no need to rely on this number yet.

Conclusion

With its intentions to increase the marketing budget, expand its geographic reach and strengthen its DTC channel, while preserving its valuable brand, I believe Dr. Martens’ prospects are brighter than ever. At less than 12.5 forward earnings, the stock looks undervalued by at least 40%. Given its timeless product, cult following, track record of profitable growth, and capable management, I believe the stock can rise well beyond my current estimate of long-term fair value.