Kits Eyecare FY24Q3 Earnings
Accelerating Revenue Growth, Optionality, Recurring Revenue, and Valuation
Kits Eyecare price today (Nov 7, 2024): $9.79 CAD
My cost basis: $4.40 CAD
Market cap: $309M CAD
Looking at the bigger picture, our presence in the optical industry still represents less than 1% of total market. With a $70B category still left to address and 7 out of 10 individuals who rely on vision care, we believe we’re just beginning to scratch the surface of this opportunity that’s in front of us.
— Roger Hardy
Kits reported Q3 earnings today and their press release can be found here: https://ir.kits.com/news/news-details/2024/KITS-Eyecare-Reports-Record-Third-Quarter-2024-Financial-Results/default.aspx
This was another great quarter with 34% YoY revenue growth and they guided for an even stronger 39% YoY revenue growth in Q4 (at the mid-point).
In my first post on Kits (Mar 4, 2023), I pointed out that “as eyeglasses make up a larger portion of revenue, overall revenue growth % could accelerate” and I believe we are starting to see a bit of that, but I don’t want to minimize the incredible growth in contact lenses either (33% growth YoY). Kits’ marketing strategy is obviously working and the company continues to exhibit operating leverage as they grow.
It feels like I go into every quarterly earnings thinking there won't be much new going on, I think to myself "this is a simple recurring revenue business," and the team surprises me again and again. Here are a few of the new products they've released in the last few months:
Coloured contact lenses: Founder Joe Thompson says they are "off to a strong start."
Kits PIXA personalized glasses: think Crox Jibbitz for glasses.
Pangolin smart glasses: sold out in one quarter - no idea on volume.
Kits+ Subscription Membership: Joe says off to a "blazing start."
The one I'm most interested in is the Kits+ $50 annual membership. When I thought about a subscription membership to an eyeglass store that won't be deductible under insurance I was initially skeptical. However, the more I think about it, the more I like it:
This will entice members to shop with Kits exclusively when they may shop around otherwise.
There is an obvious initial value proposition with up to $100 in savings off the first offer and savings of 40% on lens upgrades, offsetting the entire cost of the first years' membership.
The membership is a no brainer for someone without insurance coverage, although I'm not sure if the 50% discount on the first order will be renewed every year.
For someone with insurance like me -> typically glasses cost me $0 a year because I can claim them. With this membership my annual glasses cost will be $50, but I will get considerably more value with my insurance dollars. I think the benefits they've included are enough to make the purchase worthwhile.
Overall, I have a good feeling about membership adoption rates.
This seems like a low risk bet with potential for a big payoff if it gains traction.
Regardless of the actual performance of any of these products, none of them required significant upfront investment. This is a strategy out of Amazon's playbook (albeit on a more narrow vertical) -> try a bunch of initiatives that require little upfront investment and see what works. These are asymmetric bets and investors can view these products/services as free options.
Thoughts on Recurring Revenue
Most wouldn’t consider a company selling eyeglasses a recurring revenue model. Most recurring revenue models are subscription or license-based with annual contract terms. So it makes sense companies measure their net revenue retention on a year-over-year basis, if a customer cancels (churns) then they are unlikely to provide revenue to the company in the future.
If you look at Kits’ 12-months retention of approximately 50% you may not be impressed, but unlike subscription/licensing revenue, there is no annual contract with customers → customers can come back and spend after 1 year, 2 years, and so on. Per the slide below, customers are spending >100% of their initial purchase by 36 months post-sale. These numbers are impressive and give the company more predictability than the average retailer.
Paper-napkin Valuation
Some of the analysts on the call were most concerned with updating the next two quarters in their models rather than inquiring about the subscription membership. Instead of building a complex model which will inherently require a lot of assumptions anyways, I have provided a high-level valuation model below.
Assumptions:
Estimated FCF margin at maturity = 10% (this estimate has been provided in the past and makes sense for a company focusing on a low-cost competitive advantage. Note that subscription revenues typically attract higher margins)
Estimated valuation in 10 years: 15 times FCF (average)
TTM Revenue = $146M
Current Market Cap = $309M
Minimal dilution
In order for us to achieve a 15% return based on the above assumptions, the company would have to grow revenue by 19% on average over the next 10 years (calculation below).
$309M * (1 + 15%) ^ 10 = $1,250M market cap in Year 10
$1,250M / 15 FCF multiple / 10% FCF margin = $833M Revenue in Year 10
($833M / $146M) ^ (1/10) - 1 = 19% required revenue growth
If FCF margins are higher at maturity; if the market applies a higher multiple of FCF; or if revenue growth is higher than 19% then our return could be even higher than 15%. Of course the inverse would lead to a lower return so it is up to you to decide if these assumptions are aggressive or conservative.
One thing I’ve noticed is that disruptors tend to surprise to the upside. So I’ve bought more shares and Kits now makes up approximately 10% of my portfolio.
Here is a link to my full public portfolio in Google Sheets, including all of my buy and sell activity: Curious Investing Portfolio
Disclosure: As of November 7, 2024, I am a shareholder of Kits Eyecare Ltd at an average cost base of $4.40. My plan at the time of writing is to hold these shares long-term, but I may have sold my position by the time you’re reading this. This is not a purchase recommendation and I can only hope that I’m right on 3 out of 5 (60%) investments I make — this could be one I’m wrong on. Please do your own research and double-check my data & findings.
Read disclaimer here: Disclaimer & Process