KATE: A 2-Yr Double, Again

Takeaway: We think numbers are still too low, and that 2015 will be a break-out year for KATE. There’s a clear roadmap to a $75 stock. 2-yr double.

Though most key metrics were already reported, this was a stellar quarter for KATE – marked by a) 28% comps (a 600bp sequential acceleration on the 2-yr), b) 31% growth in global store growth, c) 50%+ growth in e-commerce (2x+ acceleration from 3Q), d) a 21.2% EBITDA margin, closing (negative return), e) six new licensing agreements, and f) swift execution on the closure of Jack Spade and Kate Saturday. And all of this was in its seasonally most important quarter. This model is primed and loaded to have a fantastic 2015.

 

We’re Above Consensus. That said, we think that management was being overly cautious with its targets for 2015. There are so many levers in this model, and our sense is that the company downplayed them. KATE guided to $185mm-$200mm in EBITDA for the year – assuming the top end of revenue guidance, that’s 15.7%, or about flat on a year/year basis. But we’re modeling $237mm, or about 110bp higher than last year. That’s about 65% EBITDA growth for the year, a number we expect to moderate only slightly to 50% the year after.

 

Quite frankly, we like the company’s conservatism, as it will keep expectations grounded, and mitigate the liklihood of an earnings day sell-off, which happens too often for KATE to call it a coincidence.

 

What’s It Worth? So that begs the question as to what we should pay for KATE. By the end of this year, we’ll be eyeing about $345mm in EBITDA and $1.30 in EPS.  When looking at the 50% and 100% growth rates in EBITDA and EPS, respectively, we could definitely argue a big multiple. On the flip side, this is a fashion business, and there will almost certainly be a time (like KORS is experiencing now) where it will see multiple compression as it matures.   But keep in mind that KORS has a brand footprint of $6.4bn and EBIT margins of 30%. KATE has a $1.4bn footprint (smaller that Tory Burch at $1.9bn) and margins of only 11%. It will be a long time before we have to ask the ‘is it over’ question. Until then, we think the multiple will continue to defy gravity in the eyes of anyone that’s not a growth investor.

 

For argument’s sake, let’s keep the forward multiples in place that KATE has today – 50x earnings and 19x EBITDA. We think that there’s upside this year as the company beats. But on 2016 numbers we’re looking at 50x $1.32 = $66, or 19x EBITDA in the mid 50s. Roll ‘em to ’17 and you get to over $2+ in earnings power, or around a $75 stock.

 

KATE: A 2-Yr Double, Again - kate1

 

Here’s A Few Things That Were New To Us on The Call Today

License Agreements

-          KATE announced 4 new home license agreements to the portfolio today. That gives them 6 on the year in mostly focused in the home/tableware department, but the one we think presents the biggest opportunity is on the watch front with FOSL.

-          The way the math works, it’s good for $0.02-$0.03 in year 1, a nickel in year 2, and $0.10 in year 3.

 

Store openings

-          The company guided to 50-55 new KSNY stores for the year. Net out the Saturday and Jack Spade closures for the year and it equates to 24 new openings for the year.

-          It’s important to remember that these stores are not create equally. We think it’s generous to assume that KSS and Jack operate at 50% of the unit productivity of the flagship banner. Sales per average unit for the year were $4.5mm, meaning the combination of Saturday and Jack were in the $3mm ballpark while KSNY was producing at $4.7mm per box.

-          Not only that, but if we assume that the average Jack/Saturday box was plugging along at $3mm per unit, that means it was a $91mm retail operation with an operating loss of 21mm for the year. That’s a -23% EBIT margin.

 

Gross Margins

-          There was a lot of convoluted talk on the call around gross margins that we have to admit we had to read 3 times just to understand what the heck George was talking about. Here is our summary in plain English.

-          Inventory liquidations in the Saturday/Jack brands equated to a $14.4mm hit in gross margin. That’s 126bps of the 210bps erosion during the year. Then you have to factor in the fact that the two sister brands were operating at a gross margin about 1000bps+ below KSNY. That tells us Kate Spade proper was humming along at a 62% gross margin clip – we don’t think that Fx (which is 80% hedged) or a few new outlet doors will offset that.

 

EBIT/EBITDA Margins

-          Consolidated EBITDA margins ended the year at 12.6%. Up 200bps YY. The combination of Jack Spade and Kate Spade Saturday ate away 310bps in EBITDA margin. $6.4 from the 2Q14 inventory liquidation and another $29mm in 4Q.

 

Brian McGough

Alec Richards


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