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KITS Eyecare Ltd. Canadian Equity Research Consumer Products 7 February 2021

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Initiation of Coverage KITS Eyecare Ltd. Canadian Equity Research Consumer Products 7 February 2021 Derek Dley, CFA | Analyst | Canaccord Genuity Corp. (Canada) | [email protected] | 1.416.869.7270 Rating Price Target Luke Hannan, CPA | Associate | Canaccord Genuity Corp. (Canada) | [email protected] | 1.416.869.6618 BUY C$17.00 Price Growth clearly in focus KITS-TSX C$8.20 Investment Recommendation We are initiating coverage of KITS Eyecare Ltd. with a BUY rating and $17.00 target Market Data price. We believe KITS offers investors attractive exposure to the highly fragmented, 52-Week Range (C$) : 7.55 - 10.20 Market Cap (C$M) : 254.2 high-margin eyecare market. The company’s unique, 100% online-only business Shares Out. (M) : 31.0 model should allow KITS to exceed the average industry growth rate, as e-commerce Dividend /Shr (C$) : 0.00 eyecare penetration is set to accelerate, in our view. The company is run by a Dividend Yield (%) : 0.0 seasoned management team, which together owns ~74% of the shares outstanding Implied Return to Target (%) : 107.3 and has demonstrated prior success in the online eyecare market. We believe the Net Debt (Cash) (C$M) : (36.9) current valuation of 1.3x our 2022E revenue estimate, vs. peers which trade at 2.9x, Enterprise Value (C$M) : 217 represents an attractive entry point. FYE Dec 2019A 2020E 2021E 2022E Revenue Investment highlights 36.9 74.9 116.2 162.2 (C$M) • We believe KITS is well positioned on the precipice of what will be an acceleration EBITDA (C$M) 3.6 6.1 6.1 16.9 of the penetration of e-commerce within the retail eyecare market. KITS operates EPS (C$) 0.02 (0.10) (0.07) 0.10 a unique, 100% online-only business, selling both private label and well known EV/Sales (x) 5.9 2.9 1.9 1.3 third-party branded contact lenses and eyeglasses. While the eyecare market is EV/EBITDA (x) 59.7 35.8 35.7 12.9 highly fragmented, only 13% of eyewear sales in North America during 2020 were generated through online channels. This is well below other discretionary retail 9.5 categories, which tend to have online penetration of 25-35%, a gap which we expect to close over the course of our forecast period. 9 • While growth in e-commerce penetration should help drive a larger TAM for KITS, we believe this will be further augmented by aging population demographics in the US and Canada. As consumers age, the need for vision correction increases, with over 8.5 75% of the population eventually needing some form of vision correction. Adding to this secular tailwind is that many people are now spending more time in front of computer, phone, and TV screens, particularly given the new work-from-home trends, 8 which has helped drive a greater need for vision correction products. • We believe KITS in particular is set to achieve an inflection in revenue growth and 7.5 margin expansion, as the company increases its exposure to higher-margin eyeglass revenue, which on average carries almost double the gross margin of contact lenses. Currently, eyeglasses represent only 2% of KITS revenue, but following an expansion Feb-21 KITS of the company’s optical lab this year and next, we believe KITS eyeglass revenue S&P/TSX Composite Index (rebased) will grow toward 25% of consolidated revenue, helping drive EBITDA margins Source: FactSet higher. With growth ready to accelerate, KITS is well capitalized to make incremental Priced intraday 5 February 2021 investments to improve brand awareness and add production capacity. We estimate the company will have a net cash position of $37 million at the end of Q1/21, leaving KITS is a rapidly growing digital eyecare platform KITS well positioned to invest in organic growth opportunities. founded in October 2018, operating as a platform of optical e-commerce websites including • We expect revenue to grow to $116 million in 2021 (reflecting YoY growth of 55%) KITS.com, KITS.ca, OptiContacts.com and and $162 million in 2022 (YoY growth of 40%) as KITS ramps up production of ContactsExpress.ca. eyeglass products. We also expect improving product mix as KITS increases its eyeglass product exposure. Coupled with a larger marketing budget and increased public company costs, we expect the company to generate $6 million of EBITDA in 2021 and $17 million in 2022. Valuation Our $17.00 target represents 3.0x our 2022E revenue estimate of $162 million and 29.1x our 2022E EBITDA estimate of $17 million. While there are no perfect public comparable companies to KITS, we believe the broader eyewear retail peer set is an appropriate barometer, with the group trading at an average of 2.9x 2022 sales. In our view, KITS should trade at a premium to these peers, given its earlier stage in the growth cycle, higher expected revenue growth, healthy balance sheet, and strong management team. Canaccord Genuity is the global capital markets group of Canaccord Genuity Group Inc. (CF : TSX) The recommendations and opinions expressed in this research report accurately reflect the research analyst's personal, independent and objective views about any and all the companies and securities that are the subject of this report discussed herein. For important information, please see the Important Disclosures beginning on page 29 of this document. KITS Eyecare Ltd. Initiation of Coverage Table of Contents Executive Summary .................................................................... 4 Company Overview ..................................................................... 7 Investment Thesis ....................................................................... 8 Competition ............................................................................. 18 Financial analysis and outlook ..................................................... 19 Valuation ................................................................................. 23 Appendix A: Key risks to our investment thesis ............................. 27 Appendix B: Management team .................................................. 28 Appendix C: Board of Directors ................................................... 28 2 Buy Target Price C$17.00 | 7 February 2021 Consumer Products 2 KITS Eyecare Ltd. Initiation of Coverage Figure 1: Company snapshot COMPANY DESCRIPTION CASH FLOW ANALYSIS KITS is a rapidly growing digital eyecare platform founded in October 2018, operating as a Year end Dec (C$mm) 2019 2020E 2021E 2022E platform of optical e-commerce websites including KITS.com, KITS.ca, OptiContacts.com and ContactsExpress.ca. Cash flow from operations 3.4 2.8 6.8 15.7 Cash from operating activities 4.1 1.8 7.7 16.8 SHARE INFORMATION Capital expenditures, net (1.0) (0.2) (15.0) (2.0) Free cash flow 2.4 2.6 (8.2) 13.7 Ticker KITS-TSE Free cash flow (inc. wc) 3.2 1.6 (7.3) 14.8 CG rating BUY Cash flow from operations per share 0.34 0.69 0.22 0.51 Target price $17.00 Cash flow from operating activities per share 0.41 0.45 0.25 0.54 Free cash flow per share (exc. wc) 0.24 0.65 (0.26) 0.44 Current price $8.20 Free cash flow per share (inc wc) 0.32 0.41 (0.24) 0.48 Dividend per share $0.00 Dividend yield 0.0% FCF yield 2.9% 7.9% (3.2%) 5.4% Total return to target 107.3% FCF yield including working capital 3.8% 5.0% (2.9%) 5.8% Shares O/S f.d.(mm) 31.0 Market cap (mm) $254.2 YEAR-OVER-YEAR GROWTH ANALYSIS Net Debt (mm) -$36.9 Year end Dec 2020E 2021E 2022E Enterprise Value $217.3 Revenue 103.1% 55.0% 39.7% CONDENSED INCOME STATEMENT Gross profit 106.4% 49.6% 57.4% Year end Dec (C$mm) 2019 2020E 2021E 2022E SG&A 178.8% 7.4% 29.7% Adj. EBITDA 120.0% 116.6% 28.9% Revenue 36.9 74.9 116.2 162.2 Adj. EPS, FD -503.6% 65.5% -150.4% COGS 26.1 52.6 82.8 109.7 Gross profit 10.8 22.3 33.4 52.5 VALUATION Gross margin 29.3% 29.8% 28.7% 32.4% Year end Dec 2019 2020E 2021E 2022E SG&A 7.5 17.1 29.0 38.1 as a % of revenue 20.2% 22.8% 25.0% 23.5% At current share price: Adj. EBITDA 3.6 6.1 6.1 16.9 Enterprise value/Revenue 5.9x 2.9x 1.9x 1.3x Adj. EBITDA margin 9.9% 8.1% 5.2% 10.4% Enterprise value/EBITDA 59.7x 35.8x 35.7x 12.9x SBC - 0.9 2.9 4.1 Depreciation 1.3 2.0 3.1 4.6 At target share price: Interest 1.8 2.6 2.9 4.1 Enterprise value/Revenue 13.3x 6.5x 4.2x 3.0x Earnings before taxes 0.1 0.1 (2.8) 4.2 Enterprise value/EBITDA 134.5x 80.6x 80.5x 29.1x Taxes 0.0 0.5 (0.7) 1.1 Adj. net earnings 0.1 (0.4) (2.0) 3.1 LEVERAGE RATIOS Adj. net profit margin 0.1% (0.5%) (1.8%) 1.9% Year end Dec 2019 2020E 2021E 2022E Basic shares outstanding 4 4 31 31 FD shares outstanding 10 4 31 31 Net debt/Equity 3.3x nmf -3.9x -2.1x Adj. EPS, FD 0.02 (0.10) (0.07) 0.10 Net debt/Total capital 0.4x nmf 1.5x 3.1x Debt/EBITDA 8.8x nmf 1.6x 0.6x CONDENSED BALANCE SHEET Net debt/EBITDA 7.6x nmf -3.9x -2.1x Year end Dec (C$mm) 2019 2020E 2021E 2022E Interest coverage 0.9x nmf 1.5x 3.1x Cash 3 3 46 61 PROFITABILITY RATIOS Other current assets 4 7 13 17 Year end Dec 2019 2020E 2021E 2022E Long-term assets 46 46 58 56 Total assets 53 56 117 134 Return on equity 0.9% -5.1% -2.9% 3.8% Return on assets 0.1% -0.7% -1.7% 2.3% Current portion of long-term debt 23 3 3 3 Return on invested capital 9.1% 13.3% 3.7% 11.1% Current portion of lease liabilities 0 0 0 0 Other current liabilities 7 10 17 22 Long-term debt - 18 10 10 Lease liabilities 1 1 1 1 Other long-term liabilities 16 17 17 17 Shareholders equity 6 8 71 82 Total liabilities & S/E 53 56 117 134 Source: Company Reports, Canaccord Genuity estimates 3 Buy Target Price C$17.00 | 7 February 2021 Consumer Products 3 KITS Eyecare Ltd.
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  • See Through This Optical Illusion Warby Parker Inc

    See Through This Optical Illusion Warby Parker Inc

    IPO RESEARCH 9/8/21 Warby Parker Direct Listing: See Through This Optical Illusion Warby Parker Inc. (WRBY) is set to debut as a public company via a direct listing on September 29. For its last round of funding, the firm fetched a roughly $3 billion valuation. At this valuation the stock earns our Very Unattractive rating. At first glance, it may seem like Warby Parker is a highly profitable company, given its well-known brand and early entrance into the ecommerce eyewear space, but we urge investors to see through this optical illusion, as the company wasn’t profitable in 2020 and barely broke even in 2019. With an expected valuation of $3 billion, we don’t think investors should expect to make any money in this stock. We believe the stock is worth as little as ~$600 million. A $3 billion valuation implies that Warby Parker will achieve some very optimistic milestones, including reversing a downward trend in profits, growing revenue by more than 600%, and generating more revenue than the current eyewear market leader, Vision Source. Despite a strong brand and visibility in the marketplace, Warby Parker maintains a very small share of the highly fragmented eyewear market and to make matters worse, consumers are reluctant to purchase eyeglasses online, instead favoring in-store purchases. Our IPO research aims to provide investors with more reliable fundamental research. Learn more about the best fundamental research Ecommerce Strategy Is Flawed Warby Parker’s initial focus on ecommerce-based eyewear may have been novel in 2010, but this concept hasn’t lived up to the success ecommerce has seen in other industries.