We think that FNP investors debating the fate of Juicy Coture, or whether Kate Spade will be a stand-alone entity ‘is so 2012’. At $17 you need to believe that the company’s real earnings power can be well north of $1.00 over 2-3 years. We happen to be in that camp, with an estimate of $1.15 vs. the Street at $0.39 in 2015.
Exhibit 1: FNP EPS ESTIMATES. HEDGEYE VS. CONSENSUS
FNP might seem expensive at 15x our estimate, but the reality is that if our estimates are correct, the company will be putting up triple digit growth rates (see assumptions below), which can sustain a multiple at least what we’re seeing today. In fact, we question how some Analysts could possibly have ‘Buy’ ratings while suggesting that the company’s earnings power is only $0.30-$0.40. They’ll be taking up numbers.
Interestingly enough, when we look at the sum of the parts, we get to a value based on current year earnings of only a buck or two above where it’s trading today. That’s just 10%, and hardly anything to write home about given FNP’s more volatile style factors (not to mention short interest at the lowest level in four years and a beta of 1.8x).
Exhibit 2: SUM OF PARTS ANALYSIS
But when we use our significantly higher 2014 estimates, we get to a value of $28 (60% above current levels), and a year later we’re at $38 using our 2015 model.
When the stock was at $10, we said specifically that 'it would double, and then would double again'. And we completely agree that the stock has far less room for error given the recent run. As such, throwing out a $38 value in 2-years is not thesis morph for us. It’s sticking to the same story. We’d be concerned if there was a tight gap between us and consensus. But as long as we’ve got the growth trajectory and earnings upside in Exhibit 1 above, we’re cool with the valuation.
Here are some of the key assumptions behind our model.
1) Juicy: For modeling purposes, we assume that it is in growth purgatory for the foreseeable future, with EBITDA bottoming at $10mm and rising to $16mm (less than a 3% EBITDA margin) over 3-years.
a) That’s probably not the best way to look at it, because the reality is that if it turns in such performance, the division will be history. If it improves slightly, then it’s still likely gone. If it improves dramatically, then our numbers go up.
b) Actually, even if FNP divests at current levels, we think it’s reasonable to assume that FNP strikes an arrangement for something in the 0.5x sales range. That sounds rich at a mid-teens EBITDA multiple, but we think a buyer would be rational enough to assume that the real earnings power is higher (else they would not touch it). The key to that transaction, we think, would be that it would allow better than 60% of net debt to go away.
c) Our analysis of FNP using Sum of Parts only assumes that debt comes down as a result of cash generated by the company’s own free cash flow (i.e. from divisions that are actually throwing off cash). Anything else would be gravy.
2) Lucky: This is one where the number of growth initiatives in the pipe has caught us by surprise. Admittedly, out of the three divisions, this has garnered the least attention. It’s never been a problem child – at least not lately. But it’s never been a rock star, either.
a) Yet suddenly, the company’s assortment seems to be more fashion forward, with two major innovations (that management was tight-lipped on). They are also taking what is working from Kate and applying it to Lucky – with a handbag line, for example, which makes perfect sense. It is also expanding geographically – into six new territories starting in 3Q.
b) With all of this, the company put out mid-high single digit comp guidance for the year, which is the most upbeat we recall in a while. We have comps at 7% for the year, but driven by a back-end loaded 8% and 10% in 3Q and 4Q, respectively. Then we’re got 10% in 2014. Through all of this, we’re giving zero EBITDA margin improvement in our model, which seems like a conservative assumption to us.
3) Kate Spade: Kate just put up a whopping 27% comp on top of a 58% comp a year ago. That momentum won’t continue forever. Management knows it, and they don’t want to step in front of the freight train of missing an ambiguously aggregated consensus estimate by a point and having people get bent out of shape by asking ‘why is Kate slowing?’. That’s why they put out a ‘low teens’ comp rate.
a) We look at it by pegging an appropriate sales productivity rate, and then backing into what comp rate will get it there. After all, that’s how the company manages its business.
b) Right now, productivity at Kate is running at about $1,100. That might seem like a lot. It is. But KORS is running at about $1,700 this year, and if you believe in consensus estimates over the next 2-3 years (which we are inclined to believe) then they’ll approach $2,400/square foot.
c) Never in a million years will we suggest that Kate is KORS. But even Coach is at about $1,800/sq ft in the US, and is pushing $2,800 in Japan.
d) Something to keep in context is that the Kate Japan license that FNP just brought back in house is running at about $1,400/sq ft in productivity. Yes, this is a higher-end market and almost always commands higher prices. But this is a business that FNP has not even directly controlled. When RL took in its geographic licenses it saw sales lifts of 40-50%.
e) We can go on with this exercise for a while, but the point is that it is that $1,100 in productivity does not seem maxed out to us by any means, especially with 45% of the stores having come on to the P&L within the past 3-years – and they reach peak productivity in between 4-6 years. If Kate put up a low teens comp for 3-years, it’d still be below $1,600 in productivity. We’re closer to 20% in our model.
f) We’re modeling margins down 200bp at Kate this year, which is pretty much what management guided. We don’t think that they’re sandbagging, as the costs to integrate the Japanese business are real. Where we could be overly conservative is if comps come in meaningfully ahead of our 20% model, in which case they’d leverage occupancy to a greater extent that we think.
4) Other Notables
a) We have ‘Other Income’ ticking up by about $1-2mm per quarter, in part because of foreign currency gains, but also because this is the area where minority interest shows up. Believe it or not, we expect some of those business to contribute (albeit on a small scale).
b) Conversely. We have interest expense down by about $1mm per quarter as net debt levels tick down slightly from year-ago levels starting in 2H.