Summary
- PVH Corp. is a global apparel company that owns the brands Calvin Klein and Tommy Hilfiger.
- PVH has adjusted the strategic positioning of the brands yet has been unable to kick-start growth.
- Economic headwinds ahead are likely to hurt the business, with our view being that PVH is positioned to perform worse than average due to its accumulation of inventory.
- PVH has seen stagnated growth and difficulty in achieving consistent revenue. We think the next 12-24 months will be equally as tough, with no proof that growth is back on track.
- The business performs poorly compared to other apparel retailers, trading at a 50% discount for this reason. We see no upside and only negatives ahead.
Company description:
PVH Corp. ( PVH ) is a global apparel company, that produces clothing for men, women, and children.
PVH operates through six segments:
- Tommy Hilfiger North America
- Tommy Hilfiger International
- Calvin Klein North America
- Calvin Klein International
- Heritage Brands Wholesale
- Heritage Brands Retail.
Although PVH owns a host of brands outside of CK and TH, these two brands make up c. 90% of the company's revenue. The following is how Q3-22 revenue is split.
Q3-22 revenue split ((PVH))
PVH's share price has been on a downward trend in the last decade, with the business struggling to compete with the growing number of new entrants in the retail space, suggesting its brands may have stagnated. PVH's share price has recently picked up with demand remaining resilient despite weakening market conditions.
Investment thesis
With the current economic uncertainty and changes in retail trends, PVH is at a crossroads. We could see demand begin to trend downwards and sentiment around the business turn negative, or things could remain resilient and begin to kick start growth.
Our objective is to assess what the most likely outcome is, based on a bottom-up analysis of the company's fundamentals. This will involve a consideration of the key retail trends, economic considerations. and PVH's financials. Based on this, we will conclude with a valuation of the business.
China
The Chinese economy has been hit hard by Xi's initial persistence in maintaining a zero-COVID policy. This contributed to regular lockdowns, disrupting the economy and causing unrest. Growth in China slowed considerably and there was a real risk that segments of the economy would fail. In Q4-22, China finally gave up on this and began relaxing restrictions, which contributed to a large spike in cases.
The Chinese are one of the largest international consumers of apparel, with estimates placing China as the largest fashion industry in the world. Much of this demand is for western goods, with PVH's brands being no exception. For this reason, the business has experienced a delay in demand picking up from the region following 2020, whereas the west was very quick to bounce back. Further, PVH has a 163k sqft facility in Hong Kong, which has also caused supply-side constraints to their processes due to the lockdowns, contributing to an uptick in costs.
With cases finally declining in the country and things seemingly returning to normal, we believe there is scope for an uptick in sales to the region. Not only this, but travel to and from the country will also increase, again contributing to greater demand for apparel.
Social positioning
PVH has been changing the social messaging of its brands in recent years, particularly with Calvin Klein. Historically, the brand was synonymous with the "Clavin Klein model" look, which for women would be a slim hourglass figure. The business has been transitioning away from this imaging, as body positivity and sexual freedom is increasingly becoming an important aspect of media. Further, PVH has been accelerating its sustainability efforts, with this all being an important part of reinventing its image.
For many businesses, a pivot in the brand image can help revitalize what could be a stagnating brand. In the case of PVH's brands, we have not seen this effect. Calvin Klein's sales have remained stagnant which suggests the problem is bigger than just marketing. Further, goodonyou.eco believes many aspects of PVH's sustainability efforts have not been good enough, rating both CK and TH a 3/5.
Promoting inclusivity and diversity can only help the social good but we are not seeing the financial fruits of this labor. This is an area PVH has committed finances and time to and has seemingly failed to have the intended effect. It is difficult to see if management has a clear vision for how to kickstart growth in these brands but the current marketing push does not look to be working in our view.
E-commerce
PVH's apparel has been distributed primarily through retail locations globally, but in the last decade, we have seen a transition toward e-commerce retailers. These businesses have utilized lower operational costs to be price competitive, thus gaining market share quickly. For PVH, only 42% of their revenue is through retail (FY21), with 53% of sales through wholesale. This gives the business less direct exposure to the e-commerce shift as the wholesale stock is the responsibility of the retailer. Nevertheless, PVH has been focusing on growing its digital penetration to improve the brands' digital footprint, with 25% of revenue through this channel in 2021. When comparing this figure to many other brands/retailers in the industry, this is pretty poor. Many traditional in-store retailers are in the 30-40% ballpark, leaving PVH with work to do. This has likely contributed to the stagnation of the brands as online penetration is incredibly useful for keeping the brands relevant and in the public eye.
Further, PVH has made a strange decision in our view by partnering with Amazon for a CK store. This improves their digital presence and increases sales, but it dilutes their brand value. Amazon is not known for its high-quality apparel and selling through the site gives the impression that the brand is selling cheap goods. Our view is that this will only further diminish how consumers view the brand. This is once again unusual execution from management as part of an overarching expansion strategy.
Economic consideration
Current economic conditions can best be described as difficult for all.
Inflation rose quickly in 2022, driven by supply-side issues and relaxed government policy in recent years. In response to this, interest rates have been gradually increasing, with the hopes that they can cool demand and bring inflation down. This has been working, but was slow to take effect and is not causing a large monthly decline.
For PVH, this is a serious headwind. Consumers are suffering from a decline in discretionary income and are focusing on meeting their living costs, thus cutting unnecessary spending where possible. Clothing is one such example, as in most cases consumers are not in desperate need. PVH is feeling the impact of this, with Q3'22 revenue down 2% Y/Y.
Looking ahead, our view is that things will continue to trend downward in 2023. As the graph above shows, the most recent decline in inflation was far less than in prior months, which could mean further rate hikes are required. This means either 1 or 2 more rate hikes, or an even longer period of heightened inflation. Regardless of the option, consumers will focus. For this reason, we believe that sales will decline in the region of 0-5%.
What is compounding problems for PVH is the supply-side issues we mentioned previously. Many retailers are struggling with wage inflation and transportation costs rising, contributing to tighter margins. In Q3-22, PVH experienced a decline in GPM from 57.7% in the year before 55.9%. Although many retailers we see believe the supply-side issues are subsiding, we believe there is still a quarter or two to go before GPM normalizes.
Financial performance:
PVH financial performance (Tikr Terminal)
Presented above is PVH's financial performance for the last 10 years. The overall message from this is stagnation, with the business seemingly unable to kickstart sustainable growth.
Revenue has grown at a CAGR of 1%, reflecting what has been a lost decade for the business. Growth was revived between FY16 and FY19, with the business achieving 4 years of top-line growth, but this did not translate to the bottom line. This suggests that the quality of this growth was not very high.
The company's GPM is very good, both relative to the industry and compared to its historical level, with only a 1% decline in the most recent period but still well above FY19. With the majority of supply-side issues already priced in, we could see PVH normalize at this elevated level (>55%).
Although management has good control over its production costs, this is less so the case at an operational level, with S&A expenses fluctuating as a percentage of revenue across the historical period. This looks to be at an elevated level currently, driven in part by expenses incurred to achieve future cost savings. We expect this cost to marginally tick down going forward.
Within the P&L, we have seen consistent non-operating "noise" below operating profits, the large item in 2022 has been a c.$420M impairment of goodwill due to an increase in the discount rate.
Objectively, a profitability profile of 12% EBITDA margin and 5% NI margin is fine, the problem we see is growth.
PVH's inventory turnover has declined to a fairly unimpressive level across the historical period and in the most recent period. This suggests inventory is becoming more difficult to move, with FCF negative in the LTM period for this reason. Many retailers have made the mistake of over-purchasing inventory due to prior supply-side issues and our view is that it is going to bite them in the behind in 2023, with discounts required to move the inventory.
One decision by management we do concur with is their deleveraging efforts. With the business in stagnation, one of the best actions management can take is to deleverage. This gives management greater flexibility in the future. With an ND/EBITDA ratio of 1.94x, we consider there to be no credit risk.
Outlook:
Forecast PVH performance (Tikr Terminal)
Analysts seem far more bullish on this business than we are, forecasting 4% revenue growth and more surprisingly, 8% EBITDA growth. This suggests that Analysts buy into management restarting growth in the business, continuing on from FY19, but this time combining it with cost savings.
Our view is that growth is possible at this level but the margins are not. EBITDA / net income margin beyond 12% / 5% looks quite difficult in our view.
Peer group comparison:
Peer group comparison (TIkr Terminal)
Presented above is a cohort of brand-owning businesses.
PVH unfortunately underperforms the group across the board, reiterating that the business is not of the highest quality. Surprisingly, the business does well on a GPM basis, driven by its unwavering objective of using low-cost producers. This does not translate into EBITDA, however, with only Adidas performing at a level below PVH. Further, the company's decision to stockpile inventory looks to be far beyond that of its peers, who are returning a healthy 7%. Finally, growth cannot save the business in this comparison, with half that of the cohort forecast.
Valuation:
PVH valuation (Authors calculation)
Presented above are the respective valuations of the cohort. As they significantly outperformed PVH on average, we would expect them to be trading at a premium.
To assess PVH's fair value, we have considered 4 different calculations.
- Relative fair value - To assess PVH's relative fair value, we have taken a fairly sizable 50% haircut to the average comp's EBITDA multiple. The reason for this is the uncertainty around growth, coupled with inferior profitability. With investors seeing so little of the profits, we cannot justify an attractive multiple.
- Historic average - PVH has traded at an average of 10x its LTM EBITDA across the historical period, this valuation assumes a reversion to its mean. This is the valuation we see possible if growth is achieved, irrespective of if profitability is improved. Should quarterly results in 2023 show resiliency, investors should believe there to be value on the table.
- DCF valuation - To consider the valuation of PVH's cash flows, which it does normally generate, we have conducted a DCF valuation. This suggests an upside of 8% but ties investors into a long-term view of a business with short-term uncertainty. Our key assumptions are:
- A difficult 2023 with negative FCF and declining revenue.
- An uptick in revenue in the next 5 years, with FCF progressively improving toward its FY19 levels.
- A discount rate of 10%, exit EBITDA multiple of 8x, and perpetual growth rate of 2%.
- Analyst estimate - We have also considered how analysts view the business, interestingly also deriving an upside of 8%.
Overall, there is potentially some value here with PVH but we struggle to see this being achieved with actual price action. Markets are likely waiting for PVH to show proof it can achieve growth.
Final thoughts:
The CK and TH brands have value but we are not a big fan of how management is utilizing them. It does not seem like consumers are fully buying into where these brands are going. Further, we disagree with some of management's strategic decisions, such as the creation of the Amazon store to increase its online penetration.
The biggest risk we see for the business is that economic conditions will likely cause serious issues in their pursuit of growth, likely contributing to a decline in sales. Should this occur, market sentiment will move against the business, with our view being that PVH will be impacted at a greater level due to the amount of inventory it holds. We can easily see big discounts being required to shift the stock it has built up in recent months.
PVH's Financial performance has been uninspiring but has the potential to generate steady FCF for investors. The problem is that there are far better options in the market, namely CROX.
Although the business appears appropriately valued / marginally undervalued, we can only see catalysts ahead that will cause negative price action and greater negative sentiment. For these reasons, we consider the stock a sell.
For further details see:
PVH Corp.: A Big Underperformance Expected