Here's an update on our key longs in 2013, most notable WWW, FNP, RH, and NKE. While style factors in the market will ebb and flow as it relates to liking small-cap, high-beta names with high short-interest (i.e. everything except Nike), the crux of our long-term calls on the names revolve on earnings, and how much the market does or does not respect the upside (or downside) relative to consensus.
This is an overview of our key calls, and a financial representation of where we're different from consensus. Next, keep an eye out for more detailed reviews in the 'what could go wrong' department, which we think is critical at this point (so we avoid the dreaded 'round-trip'). Finally, look out for some new names that are currently sitting our idea bench. Enjoy the 4th.
Brian McGough
1) WWW: The Street is grossly underestimating the revenue growth opportunity as the legacy WWW scales its recently-acquired brands over its global infrastructure. Under its former owner, Sperry, Keds, Saucony and Stride-Rite only generated 5% of its sales outside of the US, and most of that was in Mexico and Canada. Legacy WWW, on the other hand, is the most global footwear company in the world (yes, even moreso than NKE and AdiBok), with 65% of units sold outside the US through an elaborate network of seamlessly-integrated third-party distributors. Given that the infrastructure is already in place, the incremental sales should be brought on close to a 20% incremental margin, versus 8% margin today. Similarly, minimal capital is needed on the balance sheet to grow these brands, making the growth trajectory over the next 3-5 years very ROIC accretive. The stock might look expensive at 19x earnings and 12x cash flow, but the street’s numbers are low by an incremental 10% per year. We're at $5.65 to the Street's $4.25 four years out. We’d buy aggressively on a pullback, but are not so sure that will happen. We think WWW is a double over 2-3 years. It’s rare to find names like this.
2) FNP: One of the best growth stories in retail. The brand has an $800mm footprint today, but we can build up to at least a $2bn-$3bn footprint over 5-years. What's unique about Kate Spade is that it has a considerable growth runway in its’ existing US handbag business, but also in a) new categories like ready-to-wear, fragrances, eyewear and other accessories, b) new concepts like Kate Space Saturday and Jack Spade, and c) new geographies like Japan and China (already proven), and d) new channel growth opportunities with Outlet growth and e-commerce development. One thing we like in particular about FNP is that Kate is sitting at an operating margin near 10%. Note that Coach and Kors are closer to 30%. We won't argue that Kate is Coach or Kors -- as its sales per square foot are 40% below those concepts (for now). FNP has been investing in Kate's infrastructure which it will leverage as the top line continues to grow. In other words, we're not very concerned about margins slipping at Kate. Quite the opposite, actually, as we think that margins will approach 20% within 5-years. In the end, we’ve got Kate Spade EBITDA going from $127mm this year to over $440 by year-5 of our model. In the interim, FNP should jettison Lucky and Juicy -- and have $350mm in cash left over after completely mitigating its debt burden. That should leave the company with about $2.25 in EPS power in year 5 based on our math. Spot-checking that math even more simply, let's use a $3bn revenue footprint and a 15% operating margin (maybe the rev is aggressive, but the margin is conservative). we get $450mm in EBIT. After 38% tax rate (which is likely to come down as Int'l % goes up) and 119mm shares, we get $2.35 in EPS. This puts the $22.50 stock price in a different light. We liked it at $5, we liked it at $10, and while we will be vigilant about overstaying our welcome, we still like it at $22.50.
3) RH: At risk of sounding sensationalistic after talking about the upside in WWW and FNP, we'll say that RH has a growth algorithm that is unparalleled in retail. Having historically been a retailer that is held hostage to ebbs and flows in the economy and the home furnishings business through its undersized retail stores as well as its catalogue business, the company is dramatically expanding into new categories in the Home Furnishings space in which its current market share is zero. This includes RH Kitchens, RH Tableware, RH Antiques, RH Fine Art, and RH Objects of Curiosity, to name a few. We're seeing square footage growth bottom out today while the company puts up comps in the +40% range. Then over the next three years, we're going to see square footage growth accelerate to close to 20% by our math at the same time comps will very gradually slow -- but still remain healthy as the new 25k-40k square foot Design Galleries (with sales/square foot between $1,000-$1,500) take the place of the existing 10k square foot stores (ss/ft $600-$800) and make up a greater proportion of RH's overall store base. In other words, the revenue outlook is becoming more stable, not less. Another angle… with the ability to show only 20% of its product to the end consumer, it’s been logistically impossible to showcase all its product offering. We like to say it's like having a dozen Ferrari's but only a two-car garage. With the recent preannouncements and earnings release, the consensus has come a bit closer to our estimates, but we're still 50% ahead of the Street in 2015. We think that the longer-term earnings power of RH is better than $5 per share ($3+ bn in sales, and a 12% operating margin). Like WWW and FNP, we'd love it on a pullback. But for now we can't point to one.
4) NKE: Not the huge upside that we see in any other names above. But our estimates are 10-15% ahead of consensus for the next 3-years. The chief concern most people tend to share with Nike is that the US business, which has been fueling Nike's bottom line, mathematically needs to continue to slow on the margin. But keep in mind that we have proof that Europe -- both Central and Western -- has stabilized in this business, and we’re anniversarying a slowdown last year in China, and Emerging Markets. In fact, the company already reported high single digit futures growth, which is in part due to better product pricing (nice tailwind). By the time we begin to lose visibility in the business, the event calendar heats up with World Cup in Brazil. In the interim, inventories are growing at a lesser rate than both sales and futures, which adds to the bullish gross margin setup. In all reality, Nike probably set a low bar with its earnings guidance. Our $3.17 for the year is about $0.15 above the Street. The only thing that could stop Nike at this point is Nike. With its current management transition of no fewer than half a dozen senior roles, there will definitely be uncertainty in the organization. But aside from the now infamous Bill Perez CEO year (2005/06) we've never seen a Nike management transition that did not work. It's one area where the company is flawless.
