Takeaway: It’s not broken. It’s not COH (it’s more like RL). The cash flow offers tremendous support. Downside risk here is low relative to upside.
We’re adding KORS to our Core Ideas list as a Long. The truth is that we think both KORS and KATE should be bought on the massive selloff we saw following KORS’ print and guide. Let’s be clear – these are two dramatically different companies that are in different stages of their maturation curve. But horrible market sentiment towards what is perceived to be the ‘luxury handbag space’ is unabashedly shellacking anything touching the category (except, interestingly enough, wholesale distributors like Macy’s). We think that has left both names flat-out cheap, with catalysts to the upside as the year progresses. While KATE remains one of our Top Ideas, we’re officially adding KORS to our Long Idea list. (Note: Longs, in order, RH, KATE, NKE, WWW, KORS. Shorts, KSS, HIBB, FL, TGT).
Here’s a couple of quick bullets on what we’re thinking on KORS…
- We recently issued an Idea Vetting Book on KORS [Materials: CLICK HERE, Replay: CLICK HERE], where we came away concerned about the return trajectory, but more positive about what was priced in over the near-term. With today’s correction, we think the catalyst for the shorts has been outed, downside support is material, and there’s upside to the name if KORS even comes close to hitting numbers.
- KORS is not ‘going the way of COH’. Coach is a one-trick pony that built a business for one consumer, in a singular category, in one primary channel, in one geography. That’s not scalable. KORS built a high-end brand serving multiple consumers, in numerous categories, in several different channels of distribution, in most regions of the globe. Unfortunately, the business size and margin structure is similar, but that’s happenstance. These are different models. Are we enamored by the ‘jet-set’ KORS consumer? It’s not as appealing to us as KATE’s. But we’ll take it over COH any day.
- There’s still a lot of growth here – just not in the US. If the US business stays flattish over 3-years, then we still get to a consolidated top line growth rate of about 9%. Is that KATE-like, no such luck. But the punchline is that this brand trajectory looks a lot more like Ralph Lauren (global growth) than it does Coach (stagnant in US).
- There’s no question that margins are coming down. But when we model HSD top line and 22%% EBIT margin by 2018 compared to 29% last year, we get to $4.40, $4.80, $5.13, and $5.50 through 2018.
- Not impressed with high-single digit EPS growth – even at 10x current year earnings? Then you should probably look at the cash flow.
- KORS should generate $2.85 per share in free cash flow this year – assuming the midpoint of company guidance – which we think this very reasonable. It’s got a 5% free cash flow yield today, and 10.4% on 2018. This company could repo 5% of its stock this year, a number that goes up to 10% within 3-years assuming muted modeling assumptions.
- Sentiment has come close to bottoming out for KORS. We’ve seen several Sell-Side analysts capitulate – adding to elevated short interest levels (that seemingly picked up today).
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Takeaway: Last night Hormel Foods announced it will acquire Applegate Farms for $775mm.
There is no shortage of “old line” food manufacturers looking to acquire growth brands.
Last night Hormel Foods announced it will acquire Applegate for $775mm. The strategic fit make sense given Applegate's strong brand position in the natural and organic prepared meats category, a segment in which Hormel has limited exposure.
Hormel expects the acquisition to be neutral to FY15 EPS and accretive by $0.07-0.08 per share in FY16. The accretion will likely come from revenue synergies and not cost savings. Hormel will likely improve the top-line growth profile, as Applegate will benefit from expanded sourcing and increased distribution.
Not surprisingly on the back of this news we are seeing a positive reaction to some of the other names that could also be in play: LNCE, WWAV, JJSF and PF. We would also note that HAIN is not responding as favorably to recent M&A news.
We continue to believe that HAIN is not a target, due to the structure of the company and collection of brands that do not participate in the “organic category.”
Below is a one page summary of the Hormel/Applegate deal:
Hedgeye CEO Keith McCullough weighs in with his latest market and economic take during his appearance on Fox Business with Maria Bartiromo this morning. He also offers his thoughts on the government recalculating GDP and inflation numbers.
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