2023-05-18 09:19:54 ET
Summary
- Capri Holdings is set to announce its earnings on May 31, 2023.
- The company's stock has declined by 40% since its Q3 earnings release due to weak Q4 guidance.
- Persistent inflation and macroeconomic headwinds can potentially affect the company's consumer base.
- We reviewed the synergy of the acquisition of Jimmy Choo and Versace.
- We believe "affordable fashion" is more likely to be a trend than a novelty.
Introduction
Capri Holdings Limited (NYSE: CPRI) is scheduled to announce its earnings on May 31, 2023. The company's stock has experienced a significant decline of 40% since its Q3 earnings release, primarily attributed to unexpectedly weak Q4 guidance. The company projected a decline of 14% in revenues and a decrease of 7% in EPS, while the stock is currently trading at a forward PE ratio of 6.95x. We believe this is the result of a fear of persistent inflation and macroeconomic headwinds having a negative impact on the company's consumer base.
According to market consensus, Capri is projected to narrow the decline in Q1 2024 and regain EPS growth by Q3 2024. Therefore, it is expected that Q4 2023 will be the most challenging quarter for the company in the next four quarters.
Consensus (Seeking Alpha)
Examining its brand repositioning strategy
Since 2017, Capri has embarked on a brand repositioning strategy. The company began by acquiring Jimmy Choo on November 1, 2017, followed by the acquisition of the renowned Italian luxury fashion brand Versace on September 25, 2018. This move aimed to elevate the overall image of the Capri. Additionally, the company took steps to reduce its presence in the wholesale channel, particularly in department stores, to address concerns regarding brand image and pricing control.
Store count by brands (CPRI)
Open more outlet amid criticism of brand dilution
Contrary to the criticism surrounding brand dilution through outlet store discounts, Capri has been expanding its outlet store presence. Over the past three years, the company has steadily increased the ratio of outlets to regular stores across its three brands.
Outlet/store ratio (CPRI, LEL Investment)
Outlet/Store ratio (CPRI, LEL Investment)
While there is a prevailing belief that consumers opt for discounted prices at outlets rather than paying full price at regular stores, we hold a different perspective on the evolving role of physical stores. In today's landscape, the function of outlet stores as inventory liquidators is less crucial, as e-commerce platforms can effectively implement limited-time discount sales. Such time-limited discounts serve to safeguard the brand's image better than a year-round outlet discount.
Moreover, with the advent of e-commerce, consumers in urban areas can access discounts without the need to travel to physical outlets in suburban areas, effectively creating a segregation of consumers based on income levels. Consequently, outlet stores now primarily offer exclusive outlet-only products and serve as a means for the company to target customers in lower-income areas.
To assess the performance of Capri, we conducted a comparison between FY2023 and the pre-pandemic period of FY2020, focusing on the individual brands. The analysis revealed noteworthy revenue growth and improved margins across all three brands. These positive metrics strongly indicate that the company's strategic initiatives have been highly effective.
Financials by brands (CPRI)
Financials by brands ((CPRI))
Michael Kors seem to be young again
According to Comparably , while Michael Kors may have a lower NPS score compared to renowned luxury brands like LVMH and Burberry, it is performing comparatively better when compared to peers in the same tier, such as Tory Burch.
NPS comparison (Comparably)
NPS comparison (Comparably)
Although Michael Kors has faced criticism from millennials and older generations, the brand has gained favorability among Generation Z and younger demographics. This positive reception among the younger audience is a promising sign for the brand, as it showcases the sustainability and enduring appeal of the concept of affordable fashion.
NPS by age (Comparably)
NPS by age (Comparably)
Jimmy Choo was saved from falling
Established in 1996 in the United Kingdom, Jimmy Choo initially concentrated its efforts on the European market. However, due to its relatively short operating history and limited backing from a strong parent company, the brand has encountered difficulties competing with its European peers. Moreover, the shift in consumer behaviors brought about by the prevalent work-from-home culture has presented additional challenges. As a result, Jimmy Choo has observed a notably lower NPS score compared to its industry peers.
NPS comparison (Comparably)
NPS comparison (Comparably)
NPS comparison (Comparably)
While Jimmy Choo's NPS score may lag behind its competitors, the brand is making notable strides in increasing its visibility within the United States. Jimmy Choo saw a spectacular 77% increase in revenue in the U.S. from the nine months ending in December 2022 to the same period in 2019 after being acquired by Capri. This growth in the U.S. market, however, was offset by a decline in the EMEA region.
Google search (Google trend)
Recently, it has come to our attention that Jimmy Choo has been actively targeting American brides . This strategic move appears to be a response to the decline in office occasions resulting from remote work and the growing athleisure trend. By focusing on the bridal market, Jimmy Choo can tap into more stable and consistent demand.
Capri leveraged Versace to improve its status in fashion
On the other hand, Versace, founded in 1978, possesses core strengths in visual appeal and apparel. However, in our opinion, the highly competitive nature of the apparel market poses a long-term vulnerability for the brand. Thus, we are not surprised that Versace decided to sell it to Capri at its prime.
We believe that the strategic acquisition of Versace and Jimmy Choo offers Capri a stronger footing for its expansion into the luxury fashion market. Notably, this move has allowed the company to secure a reliable supply chain of high-quality craftsmen in Europe.
Additionally, Capri has effectively leveraged the strength of the Versace brand to establish partnerships with prominent celebrities such as Bella Hadid, who has become the face of the Michael Kors brand. Through this strategic collaboration, Capri has successfully enhanced Michael Kor's brand image and increased awareness of Versace in the United States.
Capri is anticipated to record revenue declines of 14% for the fourth quarter of 2023, mostly as a result of subpar performance in the wholesale industry. However, the firm anticipated increasing retail sales and operating margins, which are crucial signs of a strong company, in our opinion.
Although Capri did not pay any dividends, it has recently intensified its share buyback activities during FY 2023. Having already repurchased shares worth $950 million, the company still retains the capacity to buy back an additional $800 million worth of shares.
This amount is substantial compared to its market capitalization of $5.1 billion. As of December 2022, the company's leverage ratio stands at 3x, providing room to expand its balance sheet to support the ongoing buyback program.
Affordable fashion: more a trend than a mere novelty
Michael Kors experienced a significant rise and subsequent fall in the realm of affordable fashion. The brand gained prominence and popularity by offering stylish and accessible luxury items at relatively affordable prices, attracting a broad consumer base. However, with the easing of the money supply cycle and the subsequent increase in consumers' purchasing power, there has been a noticeable shift towards the purchase of high-end luxury products. This trend has prompted the fashion industry to question the long-term sustainability of the affordable fashion segment.
However, we found some evidence that affordable fashion may not just be a novelty but a trend. According to the World Bank, from 1980 on, there has been a declining trend in global income inequality between countries, indicating that emerging economies have narrowed the wealth gap with developed nations through economic growth. However, within individual countries, wealth distribution has become increasingly imbalanced, highlighting growing inequality domestically.
Income inequality between vs within country trend (World Bank)
Income inequality between vs within country trend (World bank)
The increasing Gini index in the United States, as reported by the U.S. Census Bureau, serves as evidence for the observed rise in domestic wealth inequality.
U.S. Gini index (U.S. Census Bureau)
According to data from the World Bank, the global poverty rate has been on a declining trend in recent years, excluding the COVID period. This indicates a potential rise in the overall middle-class population.
Global poverty rate (World Bank)
By analyzing the above dataset, we can infer that the global middle class is expanding while wealth distribution within countries is becoming more imbalanced. This implies that the market for "affordable fashion", has grown significantly over the past decades. We believe this trend can be attributed to the emergence of capitalism and the increasing globalization of trade. Therefore, Capri seems to be well-positioned to benefit from these trends. Although there is a risk of de-globalization due to rising geopolitical concerns, we anticipate that the trend of income inequality within countries will likely persist.
Risks
Capri acquired Jimmy Choo in a $1.44 billion deal, which resulted in $684 million of goodwill. However, the company has accumulated a total of $514 million in goodwill impairments for Jimmy Choo. Such impairments can signify a reduced forecast for future operating cash flows. Despite an increase in revenues, Jimmy Choo has continued to operate at breakeven or a loss following the acquisition. This could be attributed to unfavorable contract terms with suppliers or poor management. Regardless of the underlying reasons, it appears that Jimmy Choo is expected to face further challenges in the future.
Valuation
The forward P/E ratio of the company's stock currently stands at 6.95x, which is considerably lower than its average over the past 10 years. This low P/E ratio can be attributed to market expectations of persistent inflation and macroeconomic headwinds that could potentially impact the company's consumer base.
Historical P/E ratio (Macrotrend)
Historical P/E ratio (Macrotrend)
When evaluating Capri's margin, it is deemed weaker in comparison to its peers in the luxury industry. However, it remains relatively strong when compared to other companies in the consumer discretionary sector or on an absolute basis.
Valuation Multiple (Seeking Alpha) Margin comparison (Seeking Alpha)
Summary
While Capri experienced weakness in its wholesale sector, its retail segment is displaying growth and expanding margins. We anticipate that its addressable market will continue to expand amidst geopolitical conflicts. Surprisingly, the market seems to have overlooked the positive impact of the Jimmy Choo and Versace acquisitions since 2017, as well as the brand's growing popularity among Generation Z.
With a 10-year stock return of -32%, we believe the current entry point presents an attractive opportunity for long-term investors. Therefore, we rate the stock as a "Buy".
Stock Chart (Seeking Alpha)
For further details see:
Capri: Potential Growth From Gen Z And Affordable Fashion