There’s no company we cover that worries us as much headed into a print than KATE. Tomorrow is no different. The quarter looks to be in good shape, but we’re not as concerned about the numbers the company will print tomorrow as we are about a) the high bar that guidance assumes from here with a low-teens comp baked into Consensus models for 2H, and b) the overwhelming lack of interest in the name from most of the investors we talk to.
To be perfectly clear, we still think there is a lot to like as the company goes from having lost money every year since 2007, to one with strong sales momentum, some earnings/cash flow and valuation support, and plenty of catalysts to continue to drive earnings growth from here. The problem is, right now, the market does not seem to care. We strongly believed that once 2016 rolled around investors would be looking at 60% earnings growth rate and $0.80 in earnings power and would slap a growth multiple on KATE again. That hasn’t been the case. And we don’t think the macro overlay is helping at any rate. Last year it was all about the handbag space imploding, led by KORS and COH. Today, sentiment on the space has improved, but we just saw May real luxury spend (Jewelry/Watches & Pleasure Vehicles) go negative in the US for the first time in 4 and a half years. Those are not confidence inspiring data points – even if we think that KATE, who has less than 5% share of the market, is an outperformer.
For the year, we are more or less in line with the street – Hedgeye $0.81 vs. Consensus $0.78, meaning for the stock to work from here it’d need to be driven by multiple expansion rather than earnings out performance. We’re not banking on the latter, especially in the light of the continued pressure on the tourist dependent outlet channel, which pressured margins in 1Q. At some point, we think the $1.20+ in earnings power we have modeled for 2017 will matter to investors, but that’s for not another 3-6 months at the earliest.
Additional Thoughts Into The Print:
Tourism: This was the company’s Achilles heel in an otherwise solid 1Q16 print. There was a slight drag to comps due to the pressure in the outlet doors, which makes the 19% comp even more impressive because the Juicy outlet door conversion was a tailwind that never materialized – but the biggest hit was to the gross margin line which contracted by 20bps. Management noted that continued pressure in both international tourism and the outlet channel were contemplated in guidance for the year, which calls for mid-to-low-teen comps and $0.70-$0.80 in earnings, but any additional pressure would lead to potential downside. We know what the likes of RL reported in April with -25% international tourism comps, and what CRI (not the best comp, but most recent data point) reported last week that foreign tourism comps softened sequentially from -17% to -18% in 2Q16. At the very least, we think this limits the upside to margins, which we think the company would need to recognize in order to generate earnings beats from here.
Promotional Cadence ✓: On the positive side, the promotional cadence in 2Q was spot on with what we saw in 2015. All in the google interest trends were slightly ahead of last year with a bit of weakness at the end of the quarter when the company didn’t repeat a 60% off sale (30% off this year). That’s important context when we look back at 2Q15, when the decision to promote quality of sale cost the company $6mm in online sales. That’s the easiest comp of the year, and goes to a $2.5mm tailwind in 3Q16 and a $13mm headwind in 4Q16. That’s clearly evident in the comp compares in the back half, which go to mid-teens vs. 9-10% in 1H – another reason we don’t see considerable upside to current numbers.