The TAIL call on COH looks as good today as it did yesterday – now % EPS upside is greater. Our estimate was 30% above the Street before the print, and will likely be even higher (35%+) when consensus estimates shake out – if people believe guidance (the 15.2% draw down in the stock suggests people fell for it hook, line and stinker).
The ‘sandbag game’ is irrelevant when an algorithm is decelerating – like we see with UnderArmour. But when EPS beats are coming at a greater magnitude on an accelerating EPS/Cash Flow algo with ROIC accelerating by 1,000 bps…I get pretty pumped. That’s when sandbags matter. When nearly every line on the P&L and balance sheet are so bullish and likely to come in so much above consensus, that’s when the name goes from being expensive today to cheaper in 6 months $10-$15 higher. Our cash flow bridge implies a $70+ stock in 12-18 months.
The big issue here is the TREND – and whether KATE really eroded like management guided. The answer is ABSOLUTELY NOT. If KATE really rolled (which does NOT happen overnight), why wouldn’t COH -- the only bidder -- have waited another 3 months to buy cheaper. If KATE guide was bullish, then lawsuits would have more teeth. KATE EBIT estimates were clocking in at $215mm before the print. Now guidance is for $140mm-ish. The math doesn’t work for me. Here’s why…
- First off…KATE had EBIT of $184M in 2016. And yet it’s going to have $135mm in EBIT in 2018, implying an incremental margin of 27% on ‘dilutive’ Flash Sales?
- Coach guided Kate Spade’s SSS to decline HSD% vs the -2% Kate reported in Q1 and –LSD% in Q2. The implied roll in the guide is due to a pullback in flash sales and not a deterioration in the Kate brand. That’s what matters to us – especially in a #retail5.0 world.
- Also Coach is likely to learn (it already knows, but isn’t telling) that there’s a Kate Spade flash sale customer just as there is a Coach Factory customer. We don’t want that too pervasive – we know what happened to the Coach brand over the TAIL duration. But there’s runway here – ie a different kind of clearance promotion that is not brand dilutive,. I trust Coach management to nail that – not KATE management, which was among the worst in the business.
- We need to assume that the pullback in Flash Sales is margin dilutive. It’s not – it’s accretive.
- Also keep in mind that the 250bps of EBIT margin expansion in 2016 and more than 100bps we’re projecting in 2017 isn’t from promotional wholesale doors or flash sales. It’s store maturation, investments in the build out of international expansion, licensing growth, and leveraging corporate expenses. No mention of these factors on the call.
- Flash Sale mitigation is brand-enhancing. You can’t find many brands that trade near-term sales to prop the brand – and have it end badly. The only brand I can think of there is Abercrombie – but there was a clear price/value problem there – price did not change as competition did. Ditto for RL. That is NOT what we’re seeing at KATE.
- This flash pullback comes back in FY19 in the form of accelerating organic sales growth at better ASP/full price sell-through. COH seemed to leave that part out of the call.
COH TAIL CALL
No one line item drives this story – it’s got ‘big balance’. This is acquired growth for a year at a ‘day 1 accretive’ price, and then real organic growth in day 366. In other words, unlike stories like Hanesbrands, Ascena, Wolverine, or Tailored Brands that blow up when the acquisition cycles, Coach has gas in the tank to keep beating expectations.
Sorry, but ‘the space’ does not stink. Units per capita bottomed in 2009, and are holding stable in a modest uptrend of 1.3x-1.4x per capita. Population + ASP = mid single digit category growth with Coach share loss ebbing, KORS imploding, and COH controlling one of the best-growing assets in ‘faux luxury’.
There’s a big difference between ‘synergies’ and simply operating Kate better. This is where COH management has kept expectations so low. Lux deals are not about cost cutting – ever. If you see that, then run for the hills. Biolsi’s model gets us to $700mm in incremental EBIT by 2020, and over $1bn in CFFO.
KATE/Coach overlap = the most complimentary EVER? Remember when Adidas bought Reebok? I do. I worked at Nike back then. That was one of those 'high fives' while having your fourth beer in the Friday ‘booze garden’ while watching Kiss play live on the Ronaldo field. Adidas and Reebok had 90% overlap by category. Paul Fireman orchestrated one of the best deals Retail had seen in a decade. Then the merged entity hemorrhaged 80% of its combined share. I think Coach/KATE will be the opposite.
Why does KATE have well above-average store productivity, and ‘worst in class margins?’ = Bad Management. KATE management was great at brand building – weak at best operationally, and being public. That’s an easy fix for Coach. In fact, Craig Leavitt (KATE CEO) already got booted (willingly) as that was the only way he could get his $25mm check (the same misaligned incentive that resulted in such a low deal price).
Big licensing optionality. This was under almost every radar – and was even under ours until a few weeks ago. Coach has four meaningful licenses. KATE has 19. Not all can be taken back – nor does COH want them back. But remember when Roger Farrah either pulled licenses back in house or jacked up royalties? There you go…
KORS = Defensive, expensive, no natural synergies and big customer overlap. Basically, it’s everything COH/KATE is not.
