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Morningstar | Narrow-Moat PVH's 1Q Overshadowed by Weak Trends, Macro Issues; Shares Undervalued

Narrow-moat PVH’s adjusted earnings per share of $2.46 in 2019’s first quarter exceeded our forecast of $2.39. Sales of $2.36 billion nearly matched our forecast of $2.37 billion, while adjusted operating margin of 11.3% beat our 11.1% estimate. The adjusted operating margin outperformance was mainly due to good results for Calvin Klein in Europe and the North American wholesale channel. The 13.3% adjusted operating margin for Calvin Klein exceeded our 12.5% estimate and was a 110-basis-point improvement from the first quarter of 2018. However, first-quarter results were overshadowed by disappointing guidance for the remainder of 2019, which caused shares to fall by a low-double-digit percentage on May 30.

Although Calvin Klein and Tommy Hilfiger are doing well in Europe, PVH reported weakness in May, especially in North America and China. Some of this weakness is due to the strong U.S. dollar (the U.S. Dollar Index is at its highest point in two years) and the trade dispute with China. The strong dollar affects currency translation and reduces international tourism to the United States. We believe international tourism accounts for nearly 40% of PVH’s U.S. outlet store business, which reported negative 4% same-store sales in the first quarter. PVH suggested about $0.05 direct impact on EPS from tariffs so far but seems more concerned about the effect of a slowing economy on consumers in China and the U.S. For example, factory workers in China may be affected by a slowdown in manufacturing as production shifts to other Asian nations.

PVH’s new full-year adjusted EPS guidance of $10.20-$10.30 is below our forecast of $10.37 despite the $0.07 first-quarter beat. As a result, we expect to reduce our 2019 adjusted EPS forecast by a few cents and lower our $143 fair value estimate by a low-single-digit percentage. We view PVH shares, which have dropped about 50% over the past year and now trade at an adjusted price/earnings below 10, as significantly undervalued.

We believe PVH has considerable strengths despite current issues. The international popularity of Calvin Klein and Tommy Hilfiger allowed the brands to overcome first-quarter weakness at U.S. retailers like narrow-moat Nordstrom. Tommy Hilfiger’s international segment reported 12% constant-currency growth in the first quarter, including 9% same-store sales growth. Calvin Klein’s international business experienced 5% constant-currency growth in the first quarter despite softness in China’s economy. We believe that many of PVH’s problems, including tariffs and currency, are macro in nature and may be short term. We are encouraged that PVH did not lower 2019 guidance by a larger amount, given the headwinds it outlined. We think business trends may improve in June. PVH faces a difficult comparison with 2018 in the second quarter, but second-half comparisons will be easier. We estimate PVH will generate about 35% of its 2019 adjusted net income in the third quarter. Thus, although the second quarter will be challenged, we think the full-year outlook is not as bad as it could be.

PVH is expected to close two acquisitions of licensing partners in 2019. It will acquire 100% of its joint venture in Australia and the Tommy Hilfiger retail business in Hong Kong and parts of Asia. While the near-term impact of these deals is modest (about $150 million in incremental 2019 revenue), we view them as important over time. We believe full ownership of these licenses will allow PVH to expand its brands through improved marketing, distribution, and e-commerce. We think PVH has had success with taking ownership of its licenses in the past. Moreover, we think there are opportunities for more deals of this type, as we estimate more than 50% of Calvin Klein’s global sales remain outside PVH’s direct control.