We‘re adding Capri (CPRI) to our Best Ideas Long list. For those that follow our work closely, you know that we don’t take the ‘Best Idea’ designation lightly. We’ve had this one at the top of our Long Bench for the better part of six months, and the stock is up 50% over that time. But that’s chump change…there’s much more to come. This is a name that I think can triple over a TAIL duration, coming from earnings growth, multiple expansion, and one of the best cash flow and de-levering stories in retail. Here’s the call…
The Portfolio. The portfolio needs to be viewed as what it looks like today, vs what it will look like in 3-years, as both stories are dramatically different. Today the horse is Michael Kors, which is about 75% of revenue, and 100% of EBIT. It’s the cash cow. It’s also been tied to the dying department store channel, and peaked in 2015 at a 30% EBIT margin and has been in a decline since, which leaves little to get excited about (if you don’t bother to do the research as to what’s next). Then there’s Jimmy Choo (10% of sales), a perennial high-end brand that was lucky to make a dime in even its best year. Then there’s the recently-acquired Versace (15% of sales), which dominates the runway, but not the P&L – as profits have been nil. The composition of cash generation in this portfolio is hitting an inflection point today, which we think gets investors paid long side. One important point to keep in mind relative to peers is that CPRI has three power brands that are each founder-led, instead of being micro-managed and engineered under a corporate umbrella (the only real knock we have against TPR – though we’d own that one here as well). Here’s the TRADE, TREND and TAIL call on CPRI…
- MK: Covid and the downturn in consumer spending has presented Kors with the unique opportunity to ‘rip off the band aid’ of reliance on department stores (27% of sales) and focus on higher-margin owned-retail. This will never be a double digit comping business like it was five years ago, but we’re likely to see a low-single-digit growth rate and an EBIT margin going from 11% in the current fiscal year to 20% by year-5 of our model. That gives us an incremental $415mm in EBIT, or $2.25 per share after tax. Even using a ‘troughy’ 10x multiple, we’re talking an incremental $22 in stock price, or a double from current levels.
- Jimmy: The brand is growing aggressively into accessories during the downturn, much like we saw from Ralph Lauren 15-20 years ago when it grew from being a low-margin apparel brand into a multi-faceted luxury brand. The company did $590mm in FY2019 at a 3% margin, and we’re got total sales growing to $700mm at a 12.5% margin over the TAIL duration in our model. That’s another $0.50 per share after tax, or $5 per share at a trough multiple – though in using an appropriate multiple for a company with these growth, return, market dominance, and return characteristics, we can argue a 20x+ multiple easily – or about an incremental 50% to where the stock is trading today.
- Versace: One of the hottest brands out there…period. Though the P&L doesn’t know that. CPRI will change that. This Brand never earned a red cent – at least based on what I can tell from public docs… But what has been a trend-driving, value-sucking brand its whole life is on the road to putting up a luxury margin of 20%+ as CPRI build out its store network and refines its portfolio of product. We’re modeling a 15% margin over a TAIL duration, or an incremental $0.80 per share for one of the most in-demand fashion brands in the world. We’d give that a 30x+ multiple at least – there’s another $24 in stock price – which alone gives you a double from current levels.
TREND: Comps in the June quarter were brutal, coming in 65% below last year. It’s obvious that we’re seeing improvements off of the bottom as CPRI indicated when it hit the conference circuit in Sept (which drove the stock from $15 to $20), but recent datapoints out of both LVMH and Kering support the view that the high-end is recovering faster than the bearish view might otherwise be anticipating. We’re looking at a -20% comp in the upcoming quarter, with bias to the upside, and think that will improve to -msd in the coming quarter – which is ahead of consensus by about 1000bp. Overall, the consensus is at $0.55 for this FY (ending Mar), and we’re at $0.85. In other words, estimate revisions have finally bottomed.
TRADE. While hardly a part of the big call here, we have the company putting up profit of $0.04 vs the Street’s loss of ($0.02) this Q. Do I like the fact that I’m modeling a beat for the quarter? Yes. But let’s not let that get in the way of the big picture call, that there are multi-year margin and cash flow levels that will simply annihilate where earnings metrics are clocking in today. From a super near-term trading standpoint, the name is bullish on both TRADE (support = 20.26) and TREND durations (support 18.91). I think upcoming earnings will be a catalyst that will hold to the upside.
Cash Flow/Leverage. One of the biggest knocks on this name today is the leverage, which took a massive step-up when it bought Versace and Jimmy Choo in subsequent years for $3.3bn and levered up an otherwise stellar balance sheet. Net debt to EBITDA in the Sept quarter is clocking in at close to 12x – a simply unacceptable level for any retailer. That’s something you’d expect to see from JCP, ASNA, J Crew, KSS, GPS – or any of the marginal retailers on the fringe of Ch11. But that grossly underestimates the cash flow that should emerge from this model – which should take leverage down to 2.3x within just 2-years, or to sub 1x over the course of our five year model. That’s what happens when FCF margins go from 3% to 12% over a TAIL duration – that’s what get’s you paid. Bigly.
Valuation. The stock is trading at both 12x earnings and EBITDA – using depressed earnings and cash flow levels – at a time when other retail models are trading at 20-30x on depressed metrics. We think you get paid 2x with zero multiple expansion simply due to the top line growth and margin expansion in the model. But when you factor in the deleverage and increased focus on luxury assets accounting for a greater proportion of the company’s cash flow, then you get to a high-teens multiple on $4-$5 in EPS, which gets you to a 3-4-bagger from where we stand today at $22.50. If we’re early on this one and the company’s growth algorithm comes in below our model on the Nov 4th report, we think you’ve got at worst $5 downside. So there’s $60 upside, and $5 downside – find me that anywhere else in retail today.