We got exactly what we wanted from this TPR print. The core Coach comp was intact (market was expecting a roll), KATE acceleration, and progress at Stuart Weitzman. Most of all, TPR authorized a $1bn repo, which is what I was lobbying for ahead of the quarter. My view is that we’re transitioning from an investment year to a growth #accelerating year via existing asset/business growth and harvesting recent investments in licenses – and if TPR did not recognize that with the stock trading at the lowest valuation since the Great Recession, then they’d be completely missing the boat – and I’d have to call my Bullish thesis into question. Ultimately the repo was a big validator for me, and I think the company will execute it.
Is today’s stock move a relief rally? Yeah… in part. But I think it actually marks a turning point in both the fundamentals as well as the sentiment (i.e. valuation) towards the stock. Momentum is building in areas that were problematic in FY19 (ending June), and TPR should emerge as 2020 unfolds as being one of the few names in retail where both sales and EBIT margins accelerate. Specifically, we have sales growth doubling to 6.5% at a 32% incremental EBIT margin with $500mm in stock buyback. That gets us to 14% EBIT growth, and 15% EPS growth – something TPR (and predecessor) has not done organically since 2012. We’re at $3.00 in FY20, vs. the Street at $2.85. Here are some key assumptions…
- We have the Coach brand comping 2% over the next three years. When you factor in growth in Asia, the footwear license takeback, and the growth in Signature a 2% comp does not seem aggressive.
- We have the Kate Spade brand comping up 5% next year – with a strong bias to the upside. We have Kate Spade operating margins expanding about 100bps as it combines SSS growth and synergies.
- We have Stuart Weitzman returning to profitability in ’20. Keep in mind that it has never had a demand problem – this was all in execution – and that should be behind the company by mid-2019. This is a brand that made $39mm in 2017. The profitability swing from ’19 into ’20 should be $40mm in EBIT, which alone is $0.11 per share.
- We no longer expect Tapestry to acquire another company next year – which was previously in our numbers. While another deal is possible, I’d only expect it to happen if the company is smoking expectations at Kate and Stuart Weitzman is both squarely profitable and in growth mode. In other words, we’ll only see a deal if our $3.00 proves conservative and the company earns the right to return to a multi-brand platform acquirer.
- We have the company utilizing half the repurchase authorization next year – funded entirely by internal cash flow.
OUR NOTE INTO THE QUARTER
TPR | TPR NEEDS TO BE BUYING STOCK HERE
Takeaway: 3Q looks safe, tho with plenty of hair. TPR better be buying stock right now ahead of NTM growth #acceleration while rest of retail rolls.
It’s very difficult to have any level of conviction into TPR’s print on Thursday. If expectations weren’t already for a 17% EBIT decline and people weren’t asking me if the company is going to guide down again, I’d probably be worried. Don’t get me wrong, TPR isn’t going to knock anyone’s socks off on the ‘quality of earnings’ meter on Thursday – but I think the quarter is safe. We’re modeling a moderate beat -- $0.45 vs the Street at $0.41 ($0.54 LY). If you’d have asked me two months ago I’d have said that a higher-quality mid-high $0.40s number was in play, but with the weak datapoints from nearly all of retail this spring – not the least of which is weaker luxury tourist spending in the US – I think we’re going to see a low-quality beat with the company holding FY guidance in tact (in effect, lowering 4Q setting up for a better quality beat).
TPR is trading like it’s broken, with the lowest valuation since the Great Recession (11x PE, 6.8x EBITDA – and at 4.2% the second highest dividend yield in company history.) It has close to zero buy-side support, but while this thing might have a whole lot of hair right now, it ain’t broken. Kate Spade is improving on the margin. The Street is looking for a -6-7% comp vs 11% last quarter. I think it comes in closer to -4%, then turns positive next quarter after the product (poorly timed/executed) redesign is fully cycled. Stuart Weitzman is about to go up against the easiest quarter, finally re-accelerating growth after its own gaffes last year. For what it’s worth, the core Coach brand was called out by Taubman as one of the better performers this past quarter, though that’s likely offset by weaker outlet traffic. But the promotional cadence does not suggest that the brand has taken a turn for the worse. So all in, we’re looking at lsd top line this quarter with EBIT down lsd. Better than the consensus, but hardly anything to write home about – and that’s why the stock does nothing but go down.
But that’s one of the reasons why I like it here. The market is looking through several factors that will accelerate top line and cash flow at a point when the rest of retail is slowing on the margin. No one seems to be looking at the optionality of the 25+ Coach, Kate, and Weitzman licenses that TPR can repo/take in house/renegotiate and/or bundle with licenses of its sister brands. Tapestry has announced five distribution takebacks, one license renewal, and one new license since closing on the Kate Spade acquisition. Two weeks ago Steve Madden announced Kate Spade was taking back its footwear license at year-end. It’s underlevered, generates close to $1bn in free cash annually, and has the ultimate war chest to support the stock. If I were TPR management, I’d take the ‘buy more brands’ mantra, take it out behind the barn, and shoot it. Given issues at Kate and Weitzman, it has lost the right – for now – to be doing deals. It has to fix what’s in front of them and capitalize on both the synergies and the growth potential that is embedded in the existing portfolio – which is greater than the consensus gives this story credit for. The only thing it should be buying right now is its own stock. Let’s see if management steps up and actually buys a share – after not having done so in size since 2014.
After a year of 2-3% top line growth (FY ends in June) we’re modeling 10% in the year that starts in two months. That’s 2% growth in Coach – driven in large part by increasing its logo percentage to 30-40% from the 10% level we see today. Not looking for anything heroic there. We’re modeling 15% at KATE – part of it is simply off of easy compares, but also driven by newly acquired licenses like China – which is one of the biggest growth engines at Kate right now. Then we’re looking for the continued recovery at Weitzman after its supply chain fail this past year.
If our model is right, then buying TPR at $31 is a no-brainer. And if management does not recognize that, and act accordingly with repo activity, then I’ll be very disappointed.