2023-06-05 09:00:00 ET
Summary
- Capri Holdings (CPRI) stock is undervalued, trading at a 75% discount to the index average and 50% discount to companies such as Ralph Lauren.
- CPRI's guidance is back-end loaded due to the repositioning of the wholesale channel, cost benefits, and Asia business growth but easily achievable. Importantly, the guidance assumes no buybacks.
- Acquisition by a major luxury player would be highly accretive, and CPRI's current valuation makes it an attractive target.
- This stock is likely to return to all-time highs within 12 months. The CEO recently bought $10 million worth of stock at $41.57. He is a highly respected and accomplished professional.
- You can buy the stock today at a 15% discount to where the CEO, John Idol recently purchased shares. The "short consumer discretionary" trade is long in the tooth.
I cannot emphasize this point enough. CPRI's guidance is back-end loaded due to the repositioning of the wholesale channel, cost benefits, and Asia business growth but easily achievable. Importantly, the guidance does not assume any buybacks (CPRI guidance never assumes buybacks as can be seen historically but they consistently back a ton of stock every year (8 million shares this last quarter alone). EPS likely has another 10% upside from buybacks alone.
The commentary from pundits and analysts following Capri’s earnings reports largely appeared to be short-seller talking points that were both one-dimensional and misleading. The stock is absurdly cheap, and analysts are trying to rationalize the pricing with arguments ranging from “the upscale consumer is about to roll over” (not indicated by any of the dozens of companies that recently reported) to “management should have guided down” (why should they guide down if historically they have delivered the results and have good reason to believe that they are giving accurate results based on the best information they have available to them?). I even heard one ludicrous commentary that centered on the conjecture that Michael Kors might be “losing relevancy.” When stocks react in an unexpected way following an earnings report, the explanations can range from baffling to absurd. I offer my perspective and why this is an amazing opportunity for investors to scoop up a company with such iconic/marquee brands at a valuation that is simply unheard of within the luxury space.
- I think the market has crushed CPRI post-earnings because they wanted the company to guide down instead of maintaining guidance that is back-end loaded. I think this is a big mistake, not only because this extraordinarily low valuation already prices in massive earnings cuts (to trade in line with comps the current price for CPRI assumes a 75% earnings cut) but because the guidance is back-end loaded because:
- The repositioning of the wholesale channel is all taking place in H1 (big operating deleverage from wholesale shipments falling 2x to 3x the level of sell-through sales at wholesale).
- The cost benefits from reducing the wholesale exposure really come in during H2.
- The marketing budget this year is very front-end loaded (mainly Q1)
- Asia business will grow profits significantly in H2 this year vs last because (a.) China was in lockdown in H2 this year and (b.) Versace reports with a month lag so it did not get any benefit this Q4 from the acceleration post-re-opening
- The guidance assumes a flat share count when in reality they will still buy back a lot of stock this year even though they may also pay down some more debt. People are saying the flat share count in the guidance means they won’t buy back stock. This is incorrect. If you look at last year, they also guided to a flat share count at 144 million shares, and 12 months later there are 117 million shares outstanding (number on the front of the 10k published yesterday)
- On valuation, the company is guiding to $6.40 in EPS for this year, but this number is depressed due to the negative impact on earnings from reducing wholesale exposure (i.e. the fact that they are shipping into the wholesale channel at a much lower run rate than the wholesalers are selling through). Adjusting for this I get to $7.00 in earnings even on depressed margins vs their targets. At the current price, this is 5x cash EPS multiple.
- It is true that they bought back more stock than they had free cash flow for this year as (1.) The company is underleveraged so even after doing this the leverage is barely 1.4x EBITDA. And (2.) They believe the stock to be so offensively undervalued even in the $60s.
- Free cash flow this coming year should be ~700 million so even if they want to pay back a little debt to bring the leverage down to say 1.2x, they still have $475 million to buy back stock which at this price means buying back over 13 million shares (i.e. over 11% of the current share count). Obviously, this would lift earnings way above guidance.
- Analyst concerns about the Michael Kors decline in earnings from a small revenue decline are misplaced. When looking at Michael Kors this year the earnings grew low single digits in H1 YoY but then fell in H2 purely because of the wholesale restructuring. If you look at wholesale realignment. If you look at the retail business, it grew also in H2 by low single digits.
- As a brand, Michael Kors has been steadily strengthening as CPRI has pulled back on distribution while elevating the brand (precisely what Ralph Lauren has been doing). Case in point – even with the wholesale realignment this year, Michael Kors earnings are higher today than five years ago even though the revenues are 15% lower. If the brand was losing relevance as some bearish commentary has suggested, it would not be doing this and it would not be growing the client base by 20% per year.
- Lastly, if you look at the sales growth for Coach vs Michael Kors, it is similar if you adjust for channel mix since Coach has almost no wholesale.
So CPRI, which continues to generate massive FCF trading at a 20%+ FCF Yield with both management and the company buying stock, where is the disconnect? Take a look at Yardeni's Recent Report on Stock Valuations and PE ratios. CPRI is trading with a ~75% discount to the index average and more than a 50% discount to companies such as Ralph Lauren ( RL ).
Forward P/E Ratios for Russell 2000 (Yardeni Research)
This is similar to the ratios for the S&P 500 for the past 30 years. (Macrotrends)
S&P 500 P/E Ratios for Past 30 Years (Macrotrends)
CPRI stock has been decimated and cut in half from its February highs. Management continues to execute yet the sell-side remains skeptical. The pervasive "sell consumer discretionary and retail" has been a thematic short call for several quarters as fears remain that the Fed's aggressive rate hikes will throw the economy into recession and flatten the consumer. At 5x P/E, it would seem that this is more than factored into the stock price of CPRI.
One Year Stock Chart of CPRI (TradeStation)
LVMH has traded typically more than 1.5x the 12-month forward P/E ratio of the CAC 40 and is currently closer to 2x. This puts LVMH at ~30 P/E or more than 6-fold higher than CPRI. Is CPRI takeout bait at this valuation? French luxury company Kering (Balenciaga, Bottega Veneta, Gucci, Alexander McQueen and Yves Saint Laurent) tried to purchase Ralph Lauren ((RL)). (Ralph Lauren Shares Are Jumping - What's Going on?) but the founder of RL did not want to sell, but there is clearly an appetite for luxury brands and there are multiple potential suitors. (RL Reversing Some Gains Following Takeover Speculation)
Luxury Is Expensive But Not CPRI (Bloomberg)
An acquisition of CPRI by any of the major luxury players would be highly accretive. Hugo Boss, which is a reasonable comparable for Michael Kors trades at 19x P/E. Tiffany's traded consistently in the low to mid-20s P/E as can be seen below prior to being purchased by LVMH for nearly $16 billion. Tiffany's was the only true "luxury" brand company trading in the USA when it was bought. Tiffany's has 22% operating margins compared with CPRI's ~19.5% OM today, but when the restructuring is complete, CPRI will have EBITDA margins that are HIGHER than Tiffany's . If CPRI were taken out for the same multiple as Tiffany's, CPRI would be closer to $180 per share. Whatever luxury comparable companies someone wants to equate with CPRI, whether Hugo Boss, RL, Tapestry, etc., CPRI is trading at far too steep of a discount. Versace and Jimmy Choo are truly luxury brands. Michael Kors is moving upwards but is certainly a reasonable comp to RL or Tapestry. Companies like Tapestry and PVH are arguably way cheaper than they deserve to be at present, but the disconnect for CPRI is on an entirely different level. At this valuation with their management team and luxury brands, I am "all-in."
Tiffany Historic P/E Ratio (YCharts)
For further details see:
Capri Holdings: 5x P/E Makes No Sense