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FNP: Juicing Kate

Takeaway: Incrementally juicing Kate Spade’s hyper-growth status is good for FNP. We see significant upside over the intermediate-term.

FNP’s preannouncement earlier this month leaves little to report on the quarter, but today’s call included a few juicy takeaways for investors. The bottom-line, we think there’s still a very positive asymmetric setup for this stock. This was a ‘back up the truck’ call on the pullback and we still have it as a top long even after today’s 11% move. Here are the key takeaways from today’s call:

  1. Sq. ft. growth is going materially higher. We expected discussion of sq. ft. growth opportunities to surface last quarter. As it turns out we were a quarter early, but it was worth the wait.  
    • Last quarter management spoke to 40-45 new stores between 2H and 2013. Kate opened 9 in Q3, expect 6 in Q4 and now 40+ domestic stores alone in 2013. That’s before adding another 25 stores internationally (mostly Japan). With this type of store growth, mid-to-high teens comps next year and the Japan business adding an incremental $100mm+, investors will start circling Kate revenues approaching ~$800mm next year. For a brand that represents ~75% of FNP’s equity value and we expect to book ~$465mm in revenues this year – that’s a material increase.
    • Lucky is also going to see accelerated growth with 12-15 stores planned compared to our expectation of 10. Solid. But this pales in comparison to the acceleration at Kate and impact on the stock.
  2. A Kate Spade investor day coming in 1H 2013. We’ve seen it from other companies with multiple brands (e.g. VFC), but an analyst day outlining all of the moving parts of the brand and opportunities ahead makes a ton of sense. The reality is that as much as this stock is transforming, so too is the company’s most important asset. Detailing the visibility and economics behind the aforementioned ramp in revenue growth is absolutely a net positive given the discounted multiple the market assigns to this brand. The timing here is unknown, but sounded like a 1H event.
  3. The least desirable outcome for Juicy just got halved. Of the three potential outcomes for Juicy (#1: business improves – FNP keeps it, #2: business erodes – FNP sells it, or #3: business sputters along – FNP keeps it) we think the odds of the least favorable (#3) have just been reduced from ~20-25% to maybe half that. October-to-date comps are up +MSD and initial markdown activity has been met with healthy sell-throughs. This turn will require more than a month’s worth of results to sort out, but we still think the odds are in favor of a monetization
    event by next summer here.

All in, incrementally juicing Kate Spade’s hyper-growth status is good for FNP. To put it in perspective, Kate’s adjusted EBITDA margin is nearly 20% today. In looking at a $800mm revenue base assuming similar (should be higher) margins we’re talking $160mm in adjusted EBITDA for Kate alone. Corporate overhead is expected to come in around $60mm next year. Assuming Lucky, Juicy, and Adelington all come in at the low end of their respective brand profitability ranges provided by the company earlier this month and zero growth, or change in profitability, that suggests another $80mm in adjusted EBITDA. That’s $180mm in adjusted EBITDA in FY13. We think the real number will be closer to $200mm.

Now is that where we expect the company’s initial 2013 outlook to shake out? No. We expect more conservative guidance given the company’s track record. But more importantly the commitment to growing Kate suggests this will be a $1Bn+ brand by FY14. That suggests well over $1.00 in earnings power and EBITDA approaching $300mm by FY14. That’s clearly not reflected in the stock here at $11. With greater clarity regarding the fate of Juicy and visibility of Kate Spade’s growth trajectory coming in 1H, we see significant upside over the intermediate-term.