Conclusion: KATE remains one of our top ideas. We continue to believe that earnings power will rise from just $(0.15) in this (investment) year, to better than $3 per share over 3-5 years as the Kate Spade brand fills out its footprint, grows productivity, and takes up margins. We think that this story is unique in that it’s not just about a company that’s adding a bunch of stores, or a brand that found a niche and is growing it accordingly. This is brand that built a strategy around selling product across multiple categories (handbags, accessories and apparel, etc…), to multiple affluent consumers (Kate Spade, KS Saturday, and Jack Spade) in several channels of distribution (wholesale, retail, dot.com, and concessions) in several regions of the world. These characteristics might be expected from a multi-billion dollar company. But keep in mind that KATE is less than $800mm in sales. Never in 20 years have we seen a consumer brand be so broad in its reach and yet so concentrated in its focus. We’ve been fans of KATE/FNP/LIZ since it was at $4. We’re often asked when we’re going to get off the story. The simple answer is…not yet. Not until the financial model ceases to work for us. Based on everything we see, this will be a name to stick with for some time to come. Revenue streams that go from $800mm to $3bn are tough to find.
A FITTING CURTAIN CALL
This was a solid quarter – though the market is already making that point clear. We think it was a fitting curtain call for outgoing CEO Bill McComb. Let’s face it, the guy was arguably one of the least popular CEOs in retail 2-3 years ago. The Street couldn’t stand the guy. But the reality is that behind the scenes, he was doing all the heavy lifting that ultimately created so much value for some of the very people who criticized him. He sold Mexx – easily the worst Paul Charron (former CEO) acquisition we’ve seen – and there were many. He punted the stodgy department store Brands, got rid of Juicy, and finished off with a sale of Lucky. Maybe not the best economic terms for all of the deals, but he got it done. Period. And all while growing the crown jewel. Congrats Bill. We wish there were more like you.
TRANSITION IS BIGGEST RISK, BUT NOT REALLY
All that said, we put back on our analyst hat and wonder what could go wrong now that McComb is gone. Regardless of our high opinion of the ‘new’ management team, we need to respect the reality that whenever there’s change in a complex organization, things can go wrong. We can’t point to any obvious stress points right now, however. The reality is that Craig Leavitt was being groomed to be the next CEO for the past 18 months. They kept it quiet, but it’s the truth. Any major business planning meetings (even for non Kate brands) – Craig was there. CEO-level customer calls – Bill and Craig. Organizational decisions – you guessed it…he was part of them. On top of that, the fact that George Carerra – who has always been a very operational-focused CFO – was elevated to COO makes perfect sense. George will prove to be a big crutch for Craig in key areas where Craig quite frankly should not be focusing his time. The punchline is that this whole management transition started long before anyone thought it did, and we think that the company covered most of its bases.
SOME THINGS THAT STOOD OUT FOR US ON THE CALL
The reality is that there’s really no change to our thesis. This quarter gave us further ammo supporting our bull thesis. But there were a few things that stood out…
- We’re seeing an acceleration in store openings, and the quality is high. Out of Juicy’s 120 stores, about 30 will make their way into KATE’s fleet. They’re only converting the highest quality properties. The company has about 215 stores today, and will add about 90 in 2014 – that’s about 42% growth in units.
- In addition to the unit growth, we’re starting to see a far greater proportion of units come into the comp base. Only 60% of the current fleet is in the comp base today, or about 130 stores. We should see another 100 added by the end of 2015 – something that we think will be weighted toward 1H15.
- Let’s address the comp guidance of 10-13% for the year. The reality is that in his new role, Leavitt does not want to miss a comp – ever. We think that 10-13% is a slam dunk for a few reasons. First off, as noted in the point above, as we see more stores added to the comp base, it is a natural lift to y/y sales comps. More specifically, as the stores start to approach the ‘sweet spot’ of the comp curve of roughly 3-4 years, it provides an added lift – which bolsters our model in 2015 and 2016. Lastly, productivity at Kate was only $1265 this quarter, and while impressive, it’s still a far cry from the high teens and $2000+ rate being realized by US luxury competitors.
- Kate’s EBITDA margins were up for the first time this year, despite investment in Kate Spade Saturday. The company did its best to keep margin expectations grounded for 2014, and they probably succeeded in keeping them up no more than 100bp. Our numbers assume twice that rate.
- Adelington: The division isn’t really worthy of real estate in a research note, but there were a few notables that relate to other retailers. A) the QVC license is underperforming, which hurt revenue, B) The conclusion of the Dana Buchman/KSS partnership dinged the top line, but on the flip side C) Since the change in JCP’s promotional strategy, KATE has seen more positive trends in its Jewelry business.