CPRI - Tapestry: Decent Price Decent Prospects

2023-07-11 20:52:36 ET

Summary

• Tapestry is seeing growth in China and among Gen Z customers but faces challenges in the US, its biggest market, due to potential interest rate hikes and recession.
• Strategic efforts to woo Gen Z shoppers could bear fruit, and initial signs are encouraging.
• Stands out with a number of positives relative to peers, and could be positioned to benefit when conditions improve.

Signs of growth for Tapestry ( TPR ) helped by China's post-pandemic re-opening as well greater spending by Gen Z shoppers. It remains to be seen if the momentum could continue; weakening macro conditions in their biggest market - the U.S., - suggest soft near term prospects. Tapestry has a number of positives however and could be well positioned to benefit when conditions improve.

U.S. sales may weaken and China's revival may not be enough to offset any U.S. sales decline

After a noticeable post-pandemic slowdown American fashion house Tapestry (owner of accessible luxury brands Coach and Kate Spade and footwear label Stuart Weitzman) is seeing signs of a pickup in growth helped by China and Gen-Z customers. The company’s 9% YoY organic top-line growth in Q3 2023 i.e., quarter ended April 2023, outpaced rivals like Capri Holdings ( CPRI ) (revenue down 3% YoY on a constant currency basis during the April quarter).

It remains to be seen if Tapestry could maintain this momentum. Macro challenges in the U.S., the company’s biggest market, look set to worsen with the Fed’s anticipated interest rate hikes later this month . Unlike ultra-luxury rivals who enjoy a relatively resilient customer base, affordable luxury brands generally have more sensitive shoppers, making companies like Tapestry particularly vulnerable to economic downturns. Tapestry’s target customer base (households earning an average $100,000 annually) is already undergoing considerable pressure; as of the end of December 2022, 51% of Americans with $100,000 or more in annual income said they lived paycheck to paycheck, according to the survey conducted by LendingClub and Pymnts.com, a 9% increase compared to one year earlier. The slowdown in consumer spending is already reflected in Tapestry’s financials with Tapestry’s Q3 2023 revenue growth of 9% (on a constant currency basis), being considerably slower than the 16% YoY constant-currency growth reported the same quarter in 2021 before the Fed began raising interest rates. A post-pandemic shift of consumer spending away from goods and towards services is also a contributing factor, and this too shows little signs of abating so far.

Moreover, handbags (which account for more than half of Tapestry’s sales) are arguably a more “discretionary” purchase compared to apparel. Tapestry management has guided revenue growth of 3% YoY on a constant currency basis for FY 2023 (year ended July), slowing from the 17% YoY constant-currency revenue growth reported last year. For perspective, Capri Holdings reported a 5.3% YoY revenue growth on a constant currency basis for the fiscal year ended April 2023, and Ralph Lauren reported a 10% YoY revenue growth on a constant currency basis for the fiscal year ended April 2023. Ralph Lauren is clearly an outlier but that could be attributable to the fact that apparel is a bigger business for Ralph Lauren ( RL ) (the company doesn’t break down sales by product management discussions suggest apparel is a key growth driver for the company) unlike Tapestry who generates more than 50% of revenues from bags, and Capri who generates more than 50% of revenues from accessories which includes bags.

Revenue from the U.S., Tapestry's biggest market accounting for 66% of revenues, has barely changed over the past three quarters (partly due to reasons outlined above) and any revenue decline from the U.S. driven by worsening macro fundamentals may not be sufficiently offset by revival in China (barring an unforeseen better-than-expected recovery in China).

Looking further ahead, Tapestry’s prospects are uncertain given the inherently “here today gone tomorrow” nature of the fashion industry. However there are reasons to be optimistic.

Strategic efforts to woo younger fans could deliver results

Tapestry is making deliberate efforts to court Gen Z shoppers - a coveted customer base that, along with millennials (Gen Y), have emerged as the biggest drivers of luxury spending. Gen Y, and Gen Z together with the younger Generation Alpha are expected to account for 80% of global luxury purchases by 2030 according to Bain & Co. Tapestry launched Coachtopia, a sub brand that focuses on circular, and sustainable bags and apparel (for instance every bag is made from upcycled leather scraps which would have otherwise ended up in landfills), born with input from a community of Gen Z Coach fans, and positioned as an “ expressive luxury ” brand. The brand’s product attributes, brand values and marketing positioning of sustainability and inclusivity directly caters to ethics-and- authenticity conscious Gen Z and Gen Y shoppers; according to a survey 84% of Gen Z and 73% of millennials will spend more on sustainably produced and ethically sourced products according to Tata Consultancy Services. Coach appears to be one of the few affordable luxury bag brands with an aggressive Gen Z-focused strategy. Michael Kors for instance doesn’t appear to have a comparable strategy at the moment. Execution is key, however the fact that Coachtopia’s first and second drops sold out within days suggests their efforts are resonating well with customers, and could help Coach maintain its lead as Gen Z’s preferred handbag brand.

Positives relative to rivals

Tapestry has better margins than affordable luxury rivals like Michael Kors and Ralph Lauren. Tapestry’s debt to equity is slightly better than Capri's.

In addition, qualitatively, there is much to like about Tapestry relative to peers like Michael Kors. The company has a largely D2C model with about 90% channel control (which ensures better customer experience and keeps the company closer to customers), and strong brand positioning (Coach is positioned as a classic American brand while Kate Spade is positioned as a whimsical, feminine brand). Michael Kors by contrast relies heavily on wholesalers , and there appears to be some image issues and customer confusion over the brand’s two collections - Michael Michael Kors and Michael Kors (the former being the more trendy, lower-priced line aimed at younger consumers and the latter being the sophisticated, pricier line aimed at older, wealthier shoppers), not a strong point from a brand value perspective.

Risks

A better than anticipated recovery in China and a more resilient than anticipated market in the U.S. could be materially positive for Tapestry and its stock.

On the business side, fashion is a fast-changing industry and Tapestry’s performance may take a hit if the company fails to keep pace with changing consumer preferences or worse makes a wrong turn through strategic missteps, and thus execution risks are significant.

Conclusion

Analysts are generally bullish on the stock.

With a forward P/E of just 11 lower than its historical average of 12 and lower than the sector median of 14.7, Tapestry is looking a little cheap. However, a looming recession and increasing macro challenges in the company’s biggest market may result in weakening earnings and doesn’t make the stock a convincing buy at this point but given a decent valuation and fundamentals which make the company among the fitter players to potentially benefit when economic conditions improve, TPR stock could be viewed as a hold.

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