EUR 850.00 For Business Accounts Only

Morningstar | Gloomy Near-Term Guidance Obscures the Long-Term Potential for Tapestry’s Brands; Shares Cheap

Despite the double-digit share price decline on second-quarter results, we do not plan to alter our $45 fair value estimate for narrow-moat Tapestry. Sales grew 1% on a 22% adjusted operating margin for the quarter versus our 1% and 20% estimates, but management warned of an uncertain global environment (primarily China) by lowering guidance. The firm now expects low- to mid-single-digit sales growth in line with our low-single-digit forecast, and full-year adjusted EPS of $2.55-$2.60, down from $2.75-$2.80, versus our $2.77 estimate. However, the near-term profit constraint, due to expense deleveraging and growth of lower-margin fare, should mostly be offset by accounting for the time value of money. We maintain our long-term forecast calling for 3% revenue growth and operating margins expanding to 19% (up from 16% in fiscal 2018) on average over the next decade as the firm continues to integrate the Kate Spade segment and takes full ownership of its China business. We currently see shares as an attractive investment opportunity.

In the near term we expect the firm will struggle to execute on all five of its strategic initiatives for Kate Spade (specifically, the introduction of higher-price aspirational products) as it attempts to reset the brand in consumers’ minds. Balancing international expansion, a changing product line, and participating in a highly competitive retail environment will prove difficult. We contend that the quarter’s performance of a 1% sales decline and decreasing adjusted operating margin to 22% from 23% foreshadows more challenges as inventory continues to build (up 10% year over year) putting pressure on margins and sales going forward. As a result, our long-term expectations call for mid-single-digit growth on an 18% operating margin for the segment on average over the next 10 years, slightly below the high-single-digit sales rate management projects for the premium handbag, footwear, and outerwear industry.

The Coach segment, which accounts for more than two thirds of sales, remains steady in the brand portfolio, as sales grew 2% on a 69% adjusted gross margin (up 90 basis points) and 30% adjusted operating margin (matching our 2%, 69%, and 30% estimates, respectively). While Coach lost market share in the quarter (men's and women's premium handbag and accessories market grew at a high-single-digit rate globally), management cited that most of the growth was in Europe where they are under-indexed, and we do not believe it represents any direct weakness in the Coach brand relative to other luxury players. Additionally, we were encouraged by the firm’s brand investment with the first ever Shanghai runway show (which received over 1 billion impressions) as we argue these activities will continue to drive the aspirational and premiumization of the brand (underpinning our intangible asset moat source).