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Morningstar | Samsonite's 3Q 2018 on Track but We Factor in Trade War Sales Slowdown; FVE to HKD 38.50. See Updated Analyst Note from 14 Nov 2018

Samsonite's third-quarter performance is within our expectations for slowing second half growth, but we factor in risks of weaker U.S. sales into our 2019 assumptions leading to a reduction in our fair value estimate to HKD 38.50 from HKD 40. The shares are still priced relatively attractive and although the market is punishing the stock for a likely slower growth trajectory, our fair value estimate is supported by improving free cash flow. We expect free cash flow to grow at a compounded annual rate of 34.9% over the next five years, slightly faster than the 31.3% pace over the 2012-17 period despite capital expenditures that will average a higher proportion of revenue at 3.3% versus 2.7%. In contrast, EPS growth should slow to 8% from 21%.

Our narrow-moat rating is intact as we see the risk of slowing U.S. sales growth in 2019 as being a function of higher import duties that is impacting the luggage industry at large in the U.S. The majority of luggage sold in the U.S. has some China made content, in which import duties have increased by 10%. Samsonite is raising prices by 7% in the U.S. to pass on the heightened duty. This price increase is likely to filter through in 2019, but third-quarter performance already shows weaker growth as tourist arrivals and sales have softened from U.S. dollar strength. We are a bit more concerned about the risk of declining market share in China with cheap substitutes available, but the recent personal income tax cuts should boost consumer sentiment.

So far, the multi-brand strategy is working for Samsonite with ex-U.S. sales of Tumi getting a lift from its expanded presence and with American Tourister's rebrand. Sales growth for Tumi should still come in around 11% in 2018 despite the shift away from selling to trans-shippers. American Tourister sales is on track to achieve 20% growth. The retail store push is eating into EBITDA margins in 2018, but management expects improving operating leverage to filter through in 2019.

EBITDA margin so far in 2018 has fallen short of original company targets and guidance and we think it is likely to slip to 15.6% from 16% a year ago. Samsonite's management attributes this to the aggressive pace of new store openings, particularly for Tumi in Europe, that has raised distribution costs. So distribution cost, as a portion of revenue, is likely to be around 32%, which is above our original assumption of 31%. The pace of this store expansion should stabilize in 2019, and this is the reason Samsonite expects the trajectory for EBITDA margin improvement to resume.

However, because of our concerns over the risk of additional import tariffs in the U.S. that could dampen Samsonite sales, we factor in flat EBITDA margins in 2019 with distribution costs to remain at 32% of revenue. As such, we don't see margins improving until 2020. Our fair value estimate remains underpinned by our projection for distribution and marketing costs to normalize in our midcycle estimates. While we have also factored in sales growth to slow to 6%, operating income growth will pick up from the reduction in costs.