Earlier this month, I wrote a broad overview of the struggling retail industry, where I discussed the various problems affecting certain retail companies. One of them was Tapestry (ticker: TPR), the holding company for the Coach, Kate Spade, and Stuart Weitzman brands.
Tapestry reported earnings today for the fourth quarter and 2019 fiscal year and its stock dropped about 20% within the day. Specifically, the company reported slow-but-positive sales growth across all three brands, and flat-to-slightly-down net profits year over year. The company expects some pressure in the next quarter, but sees single-digit revenue growth and relatively flat earnings for fiscal year 2020. Due to weakness particularly from the Kate Spade brand, the company does not intend to make any acquisitions within the next fiscal year, and instead intends to focus on organic growth.
The stock is now down 64% from 2018 highs and down 75% from all-time highs. This disastrous stock result has been huge compared to the relatively mild underperformance of the company’s fundamentals, because clearly the market is worried about continued weakness from the company.
After the big 20% sell-off, the company now pays a nearly 7% dividend yield with a payout ratio from earnings and free cash flow of less than 60%. Additionally, the company intends to buy back about 5% of its stock next year. Therefore, the company doesn’t need a lot of growth to provide low double-digit returns; it just needs to not deteriorate further or start shrinking, and that’s not guaranteed. If the company can show stabilization and improvement, a 30-50% rapid increase in valuation would not be surprising.
I don’t own any Tapestry stock, so today’s sell-off was intriguing and warranted a closer look.
(blue line = fundamentals; black line = stock price)
Brand History and Overview
Until the last few years, Tapestry was known as Coach. Their handbags are their iconic product line, but they make a variety of accessories for men and women.
In 2015, Coach acquired the Stuart Weitzman brand, which makes women’s designer footwear. They are primarily known for their boots and sandals, but they also make sneakers and flats. Think $300 sneakers, $500 heels, and $700 boots. The products are made in Spain, and this was a fairly minor acquisition worth less than 1/10th of Coach. A good tuck-in purchase that can have good in-store synergy with Coach products, in my opinion.
In 2017, Coach acquired the Kate Spade brand. This was a bigger acquisition, worth about 1/3rd of Coach. Kate Spade targets a Millennial demographic and has a broad variety of clothes, bags, and footwear like Coach. From my analysis, I fail to see a good justification for this acquisition considering how much they spent and how little synergy there is. After this acquisition, the parent company changed its name to Tapestry, and it manages those three brands.
Since Coach became publicly-traded in the early 2000’s, it has massively outperformed the S&P 500:
However, all of that outperformance happened early on, and the stock became overvalued. Since then, the stock has moved sideways with high volatility, sales have continued to increase, but profits have flatlined. After today’s big sell-off, the stock is trading for the lowest price-to-earnings ratio in company history.
Coach’s brand was very strong, and the company had huge 40%+ annual returns on invested capital years ago, which helped drive that early outperformance. Over the past decade, however, with retail increasingly under threat from online competition, Coach/Tapestry has seen its operating margins deteriorate from 30% to under 15%. The company's returns on investment capital are now about 14%, which is good but not stellar. This has been the main source of the company’s stagnation.
Opportunities and Risks
Tapestry has over 1,500 physical locations, and more than half of them are outside of the United States. They have websites for each of their brands that they sell products through, and their physical stores also let customers order online after perusing the store in person, which can increase selection beyond what is currently in the store. They also partner with retailers to sell their products at thousands more locations both online and offline.
What I like about Tapestry is that they are not a middleman like many retailers are- they are a producer of luxury and semi-luxury branded products that they sell directly to consumers and through other retailers. So, as more retail sales worldwide shift from physical to digital, Tapestry can continue to partner with various companies to sell their products. As long as customers want luxury and semi-luxury bags, wallets, clothes, and shoes, Tapestry has a potential future across various mediums.
The key risk, instead, is that there is so much competition that it’s hard to stand out, requiring more marketing and lower prices, which cuts into margins. Additionally, recession risks are building around the world, and luxury goods tend to be very cyclical. Coach of course had a big slowdown during the financial crisis, and had a second dip in its fundamentals during the 2015/2016 global slowdown. The world is currently in another slowdown, which might or might not become a recession.
I wouldn’t touch this company with a ten foot pole if it had a bad balance sheet. It’s risky enough as it is. A key reason why Tapestry interests me is that its balance sheet is quite strong. They have $1.2 billion in cash, cash-equivalents, and short-term investments compared to $1.6 billion in total debt, resulting in a net debt of about $400 million, which is well under one year’s worth of net income.
Waiting and Watching
If Tapestry manages its brands well, it could come out the other side of this slowdown with a lot of potential upside. It pays a 7% dividend yield to hold it, is buying back shares, and has a 30-50% potential valuation upside potential if it can demonstrate stabilization and at least mild improvement.
Tapestry is not suitable for a core stock holding in my opinion. Although it is profitable and has a strong balance sheet, growth is lacking and the retail sector is under pressure. If I do make a purchase, it would be for a small position. It’s more of a high-risk and high-reward type of investment.
I don’t see a catalyst in the near term that would bump the price up, other than some potential buy-the-dip upwards pressure. While I think Tapestry makes an interesting purchase at the current time, I plan to gather more information about the current global slowdown and further company developments before making a decision whether to buy in. This one is on my watch list for future opportunities.