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Members Area Signal from Noise Capri Holdings Recovery, Makeover Could Send Stock H

Signal from Noise

Capri Holdings Recovery, Makeover Could Send Stock Higher

December 4, 2019

Vito J. Racanelli SENIOR EDITOR & MARKET INTELLIGENCE ANALYST

– Wall Street, Investors Have Lost Patience With Slowing Michael Kors Sales, EPS

– But 66% Stock Drop Overdone; Shares Are an Option on Versace, Jimmy Choo Growth

– CPRI Makeover, Diversifcation Should Raise EPS, Growth and Boost Stock Price

In a year that has seen the broad market soar by about 25%, shares of luxury products maker Capri Holdings (CPRI) have gone decidedly the other way. CPRI is in recovery mode this year and doesn’t get much love from either investors or Wall Street. For example, only about 40% of the analysts who follow it have a Buy rating on it. Given the Street’s typical optimistic bent, that counts as half-hearted regard at best. I see this as a positive contrarian indicator.

Meanwhile, the stock action refects market disdain. As recently as the summer of 2018, CPRI shares traded at $75, very near its all-time high. But they have since fallen by a about two-thirds to $36 lately. Why the cold shoulder?

Granted, the Michael Kors business, at 75% of total sales the most important of Capri’s three main brands, has been sluggish of late, after years of powerful growth. As recently as the fscal year ended March, 2016, Kors sales rose a solid 8% to $4.7 billion, but in fscal 2019 Kors brand sales were $4.5 billion. So with total revenues and earnings per share growing more slowly than in the go-go years, investors are disappointed. There’s a sense—undeserved, I think—that the brand has lost its mojo.

More short term, the violence and unrest in Hong Kong has undermined sales of nearly all luxury brands, as Asia is the generally the fastest growing region for expensive cars, handbags, clothes, shoes and baubles. The region is expected to represent half the market in 2025, up from 37% now. That hurt CPRI in the second quarter ended September. In August, after heavy criticism on Chinese social media, Versace apologized for an image on one of its T-shirts that China took as implying Hong Kong and Macau were independent. That furor is likely to die down, but it wasn’t helpful to quarterly sales.

In spite of these problems, the stock’s demise looks overdone. That could represent an opportunity for investors who wait out CPRI’s metamorphosis.

As the company has noted, fscal 2020, which ends next Source: CPRFI March, is an investment year. In late 2017, CPRI bought the Jimmy Choo brand for $1.35 billion. Results are being hurt by dilution from the $2.1 billion acquisition of Versace one year ago; the costs of the integration of the now three brands, as well as needed investment to upgrade and expand those businesses and Kors. While all this is happening, it’s also paying down its $2.6 billion debt by $500 million per year.

This is depressing EPS short term, but should pay of with better growth long term. CPRI is implementing a multi-brand model. Think Louis Vuitton Moet Hennessy LVMH. This renovation will take a bit of time, but by 2021, if not before, the inchoate indications of recovery should be clear and the stock could rise sharply, perhaps close to 100%.

What’s CPRI up to? Diversifcation. First, through those acquisitions, it is diversifying away from the Kors signature handbags and accessories products, into the apparel, shoes, jewelry, watches and perfumes, among others. Second, CPRI is making Asia a more important part of its future, with sales as a percentage of the total now 18%, double that of fscal 2017. Sales to the US (Americas) has dropped to 55% from 70% two years ago. Additionally, expect production and logistic synergies. In terms of products, CPRI is moving up the luxury scale, as Kors is a mid-tier aspirational brand compared to the high end occupied by Versace and Jimmy Choo. That should help valuation. CPRI could expand each brand’s line with selling from the others. The social media presence—important for luxury brands—of the three brands is among the highest of all such brands.

The premise to CPRI’s makeover is that it can apply the same playbook to Versace and Jimmy Choo that LVMH is using with its various brands, says Rossana Ivanova, senior equity analyst at Atlantic Investment, which owns a signifcant CPRI stake. Not only will CPRI become more diversifed, the company plans important store expansions and increasing store level productivity to Versace and Jimmy Choo, she notes. For both brands, the retail footprint should rise to about 300 from 200 currently.

The market currently isn’t giving CPRI credit for the changeover. “There’s a tremendous runway for these brands,” she says. Sales are expected to rise to $8 billion in the not too distant future from $5.8 billion in fscal 2019, with Versace and Jimmy Choo growing around double digit percentage rates.

Source: Bloomberg, FactSet

By almost any valuation metric, whether its own history or peer stocks, CPRI’s shares look inexpensive. (See nearby table.) If management is able to efect these changes, I believe the stock likely won’t stay that way.

Atlantic values Versace and Jimmy Choo at about $5 billion (or three times sales compared to the four times LVMH paid for Tifany), which leaves the remainder of CPRI trading at about three times enterprise value to earnings before interest and taxes (EV/Ebit), excluding leases. Eight times, or about $65 per share, would be a fairer sum of the parts valuation for CPRI, says Ivanova.

Currently, the stock trades at a price/earnings ratio less than seven times consensus forward EPS of $5.28 in fscal 2021 (adjusted for various impairment, restructuring and other one-time charges). CPRI’s median P/E is over 10. And remember, Ivanova adds, debt repayment of $500 million per year is worth over $3 per share. Once debt is paid down, $8-$9 per share seems achievable; with a bit of P/E expansion a price higher than $70 is possible. By the way, CPRI insider action is leaning bullish, according to www.insiderinsights.com, a website that analyzes insider activity.

Where I could be wrong: The transformation could take longer than expected. While we don’t foresee a recession soon, a contraction would hurt CPRI in the intermediate term.

Bottom Line: The market is missing the CPRI forest for the trees. Yes, Kors needs to perk up. But if management cannot transform the company, the LVMH acquisition of Tifany’s (TIF) suggests someone else might.

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Vito J. Racanelli SENIOR EDITOR & MARKET INTELLIGENCE ANALYST

Disclosures (show)