FNP: Something to Chew On

Takeaway: We expect FNP to undergo meaningful structural change in 2013 that will continue to unlock shareholder value.

Dinner with a management team rarely (if ever) shifts ones’ investment thesis on a stock, and our’s with FNP last night was no exception. But we definitely walked away with confirmation that the management team is deploying assets to the areas that will fuel growth, and will do what it needs to do in order to purge parts of the portfolio that are simply not working. The bottom-line is that we expect FNP to undergo meaningful structural change in 2013 that will continue to unlock shareholder value.     

 

The only negative point we could really think of is that with a ~20% hit to EBITDA guidance (Juicy plus general conservatism) and a resulting 12% increase in the stock price, it would be flat-out dishonest of us to not admit that this latest update started the clock and set expectations that something strategic will, in fact, happen this year. Fortunately, we think it will happen, and when it does the path to a $20 stock will be apparent.


In the process of reflecting on his current “State of the Industry,” CEO Bill McComb highlighted that apparel is becoming increasingly commoditized requiring brands to become more differentiated in a consumer-direct format with a focus in part on accessories to shape how he runs each of his portfolio brands for tomorrow. In listening to McComb talk strategyvabout the future of the business, he most similarly sounds like Dick Hayne of URBN. Not a bad stock chart overvthe past year to follow.

 

Here are a few musings from last night:      

  • As for branded commentary, while Kate continues to be the fastest growing, Juicy remains the most dynamic. McComb put new Juicy CEO Paul Blum in place to set a path for the brand’s approach to market and its product allocation/mix across categories. This leadership has been sorely missed in recent years, which has lead the brand to run astray under Chief Creative Officer Leann Nealz in 2012. Simply put, a creative designer has been running the brand, and our opinion is that she had too much latitude to skew the brand up and down in price point and age. The brand needs a business person to instill a process to methodically target a consumer and procure product accordingly. We’re not declaring victory for Juicy. But we think that it has more going for it today as it relates to touting leadership to make it salable.
  • The upshot is that Paul is setting the course, but that’s just the start. In order to execute effectively, 1) the role of Chief Merchant still needs to be filled, and 2) the chief creative visionary has to be onboard and willing to follow the course set before her. Any deviation there would likely result in a replacement.
  • At Lucky, it’s clear that the focus beyond core denim (i.e. more fashion product) is critical to driving store productivity from $460 up to and beyond management’s $650 per sq. ft. target. In addition, e-commerce will be the primary driver of comp over the next 12-months as the team integrates successful initiatives at both Kate and Juicy.
  • As for Kate, there’s a ton of moving parts over the next year or two that drive brand growth, but McComb remains focused on the bigger picture – investing to ensure the Kate Spade business achieves a critical mass not necessarily managing to profitability. We’re not talking about a $460mm brand at 10% margins getting to 12% overtime, but a path and vision for sub $500mm brand to ultimately achieve $3Bn in revenues at margins over 20%+. We don’t think that investors are looking at the big picture here with what this brand can become. Focusing on the baby steps is an opportunity cost.

 

As we look ahead to the upcoming catalyst calendar, we expect confirmation shortly that a Kate Spade analyst day will take place over the next 3-months. Given the transformation and multitude of moving pieces underlying Kate’s growth trajectory, the added detail and visibility will be a net positive in light of the discounted multiple the market assigns to this brand.


Prior to then, we wouldn’t be surprised to see the addition of a Head Merchant at Juicy. Beyond 3-months is when we suspect more significant divestiture events are most likely. Among the assets likely to be monetized first are the Adelington Group and then Juicy.


The impact of these events on the balance sheet and P&L would be substantial and set free FNP’s most important asset i.e. Kate Spade. Keep in mind that a 0.5x sales multiple on Juicy Cotoure would net $250mm, which would eliminate 65% of debt, and leave FNP with debt to total capital of under 15%. That’s definitely consistent with what investors want to see from an early cycle high growth story. A better informed market following a 1H analyst day is more likely to reward the remaining business with an appropriate market multiple, which could in turn reward investors with a 40%-65%+ return from current levels and a stock worth $20-$24 per share. FNP remains one of our top longs for 2013.



 

 


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