The 17.9% pop in KATE’s stock yesterday leaves little for us to add regarding the event itself. But we want to make one thing crystal clear, by the time KATE approaches year 3-4 of our model, yesterday’s stock action should look like chump change. We think there’s $3bn in revenue for this brand (at the consolidated P&L level -- $4.8bn in aggregate brand sales at retail), a high teens margin, and $3+ in EPS power. The 50-60% CAGR (depending on base year) makes us more than comfortable with a 30x+ multiple in the out years (much higher near-term), and a roadmap to a $90-$100 stock. We hosted a call on Wednesday where we outlined our thesis in a 40-page slide deck. Here’s the replay info and link to the presentation materials in case you missed it.
Materials Link: CLICK HERE
Replay Link: CLICK HERE
As for the quarter, the biggest positive for us (and probably for the stock) was the dramatic change in management’s tone. Again, this is a team that inadvertently evaporated $1.7bn in equity value during the 2Q call in the face of otherwise stellar results due to an odd mix of way too much information in the face of insufficient disclosure, and no real command of its future. But fast forward 13 weeks, and this time it was as if we literally heard a different management team.
1) First off, the call was tight – less than an hour. It is the shortest call on record for KATE, FNP, or LIZ back to at least 1998. The company has always drowned the Street with way too much information that ultimately does not matter. But this time the message was concise, and the company prevented a situation where the 20th analyst in the queue from a no-name shop could pester the CEO about why the store in Mercedes, TX was out of inventory of chambray totes.
2) The overall tone, cadence, and command of the business and message – especially from Craig Leavitt – was at least as good as one would expect from a company twice the size of KATE. In fact, when we juxtapose Leavitt with KORS CEO John Idol on their respective calls this quarter, KATE definitely gets the nod. (Now all Leavitt needs to do is execute like Idol has).
3) A definite tonal change on the part of management is that there appears to be zero tolerance for sustaining the existence of dilutive businesses – most notably Jack Spade and Kate Spade Saturday. Though KATE will move forward with its plan to invest in these businesses, it sounds like they are both on a short leash. At best, they only account for 5% of total sales for now. We’d rather see the real estate converted to KSNY, which would probably double the revenue contribution of those real estate assets. But 3 months ago, it seemed like the company would let these brands be dilutive forever. That’s clearly no longer the case (truth be told, it probably never was the case – but the public perception is that it was, which drained KATE’s multiple).
- Resetting the base: 2016 targets now call for Kate Spade & Co. EBITDA margins to be in the range of 18%-20% on a sales number that is tracking well ahead of plan. Two small changes in the language here: 1) Corporate expenses are now fully allocated in that target (which we knew was coming), and 2) it is now looking at the consolidated company which includes Adelingtion for the time being. If we pin Corporate at 5% and add that to the new targets that equates to about 23-25% on an apples-to-apples basis with the old reporting structure. To add context, it's important to note that corporate was 7%-8% of sales in FY 13 depending on which number you look at (Comparable Adjusted vs. plain old Adjusted).
- Comp: Guidance for the year (19%-21%) looks beatable to us. It assumes a window for 4Q between 8% and 14%. We're at 18%. Given the moving parts in 3Q, 4th of July and Semi-Annual sale moved into 2Q, we should see a sequential acceleration heading into Holiday. The elimination of 'Surprise Sales' is a bit of a headwind, but we are not overly concerned. Assuming that dot.com now accounts for 25% of sales (up from 18% in 3Q13), that implies a 21% growth rate in the quarter. At a 20% penetration number it’s 23%.
- EBITDA: KATE (and its predecessors) is not known for taking up guidance – it’s been the opposite historically more often than not. The company guided the range up $10mm for the year from $120m to $130m on an in line print. The lion share of that beat comes from upside in Gross Margin targets though we still see upside given the run rate over the past two quarters. -75bps in 2Q (ex. 240bps Kate Spade Saturday dilution) and +144bps in 3Q. To get to the high end of guidance which calls for 125bps of dilution we'd have to see a 300bps sequential declaration on the 1 year trend line and 150bps on the 2yr.