For those who think they’ve missed FNP, you’re getting another shot today. Sound familiar? It should. It’s the second time FNP has revised its F12 EBITDA outlook this year. The problem from our perspective is that they’ve shown us #2 when we thought it was improbable. We can argue until we’re blue in the face that the stock is cheap, but that would be pretty ridiculous when it comes down to one of the real questions to be researched – can #3 rear its’ ugly mug? We think it’s not likely, as this was probably a greater take-down than they needed. But then again McGough, you didn’t expect a press release after the close last night, so why should I believe you now? Excellent question.
Let’s step back, re-evaluate the thesis, and see what’s changed.
Thesis: FNP is an misunderstood, underloved, and grossly undervalued company made up of one power brand, and two call options on value creation. The company will aggressively grow Kate Spade globally while milking Lucky Brand for cash, and fix Juicy Couture or else boot it. This is all on a greatly reduced operating asset base after the Mexx and Liz Claiborne brand sale. In the end, there’s a much higher top line growth rate and a less volatile msd/hsd blended operating margin – and when laid over a reduced asset base the implications for ROIC are not even being considered by 99% of the investing population.
Changes to thesis: There’s no way we’d even attempt to argue that it did not change. But let’s review…
Kate: comps looked great and business is on plan. Check.
Juicy: While continued business ‘bumpiness’ has been feared and rumored for 3-6 months, the conformation is definitely a bad thing.
Management: We’re mixed on this one. We had a meeting with them two months back and learned that CEO and CFO were BOTH spending about 90% of their time on Juicy. Retail is a fickle business that changes daily, we get that. But it bugs us that so much of their effort is going to a division that just missed. To be fair, we said at the time that we did not know if that time ratio was a good or bad thing. Perhaps the same still applies. Maybe it’d have otherwise missed a lot more. Regardless, management is back on the spot with the ‘fix or sell’ decision. The good news is that we have enough confidence in McComb (and we don’t have confidence in most CEOs) that he’ll make the right call.
McGough’s prediction: The good news is that I think that Juicy will be outta here. The recent improvements to the back end of the combined company make it easy to do so. The bad news is that it might take another disappointment before they jettison the division. In addition, the miss is likely to hamper dollar value, as well as any discussions for international JV’s that management hinted will be announced near-term.
The stock had already broken critical TRADE support of 13.21 before the event even transpired, (which is why Keith wasn’t long it in the Hedgeye Virtual Portfolio); TREND support is 11.48; he’d probably buy it if recaptures that level and holds it.
Based on our model and assumptions, we think the impact of the announcement is roughly $26mm in lower FY12 sales as well as a $22mm reduction in Juicy EBIT and additional ~$3mm of DC related costs. In addition, we expect the impact on FY13 sales and EBIT to be $28mm and $10mm respectively. This shakes out at a $0.13 and $0.08 hit to FY12 and FY13 EPS respectively. All in, we’re at $0.54 and $1.03 next year and the year out (FY14). Assuming a high teens multiple for a significantly faster earnings grower, this $0.08 revision equates to roughly $1.50 in value. The market has it about right from a near term trading perspective with a $1.55 draw down.
From a longer-term vantage point, we think we’ll be making a call within six months that they’re finally getting rid of Juicy, with the difference being that it could generate a $500mm sale. You may have to live with the volatility of owning the business for 2 quarters before then. Over a TAIL duration, its well worth it. Else, get ready to buy it, bc the days where it will dip below $10 will not last long – if they ever even come to fruition.
The key delta impacting EBITDA by ~$25mm is impaired profitability at Juicy, which accounts for ~12% of FNP’s equity value. Importantly, results at both Kate and Lucky remain and on track to ahead of expectations.
So what have we learned:
- Juicy has too much high priced product. The only plus here is that they moved up-scale too quickly, which is better than shifting down-scale too fast. However, it also begs the question re the direction that Leann Nealz has taken the brand since coming on 2-years ago, but more importantly, the process put in place to sustain consistent profitable growth. Is the brand more or less uniquely Juicy than it was 2-years ago such that they core customer is willing to pay more for it? It’s difficult to suggest the answer to that question is yes given today’s update. Perhaps there is simply too much product in the ‘Best’ tier of the product pyramid. Either way, we aren’t likely to have clarity here before Spring.
- Also embedded in adjusted EBITDA is $2-$4mm of delay-related DC transition costs as the company looks to outsource its distribution.
- They gave us better disclosure regarding the componentry of FY12 adjusted EBITDA guidance by brand. What jumped out at us was how much Juicy accounted for prior guidance at $45-$48mm (with corporate expense allocated) accounting for 32%-38% of $125-$140mm FY12 adjusted EBITDA. With this hindsight, we had been lower on Juicy and higher on Kate. The new outlook adjusted expectations for Kate higher nearly in-line with our model while Juicy was adjusted sharply lower accounting for the net negative $25mm delta.