EUR 850.00 For Business Accounts Only

Morningstar | Narrow-Moat Tapestry's First-Quarter Results on Track; Kate Spade Sustainability Is Still a Concern

Narrow-moat Tapestry’s first-quarter results showed continued progress on its Kate Spade integration. More specifically, sales grew 7% (outpacing our 2% full-year estimate) while gross margin expanded 170 basis points to 67.8% (in line with our 67.9% full-year forecast). This differential resulted entirely from the outperformance in Kate Spade (about 20% of sales) that grew 21% versus our assumption of flat. However, we posit most of these gains were a result of the firm’s efforts to consolidate control of its international distribution (seen in the established control of the brand’s joint venture in Asia) and lapping the stub period from last year that excluded 11 days due to the timing of the acquisition. Supporting this stance was a comparable sales decline of 5% for Kate Spade. As a result, we remain skeptical about the sustainability of management’s double-digit sales growth aspirations. We see the double-digit revenue growth for Kate Spade expected in fiscal 2019 as overly optimistic as there still could be several executional headwinds as the brand repositions for growth in China while balancing increased pull back in wholesale disposition and integrating a new creative director. Our long-term expectations call for mid-single-digit growth for the Kate Spade segment on average over the next 10 years, slightly below the high-single-digit rate management projects for the premium handbag, footwear, and outerwear industry.

Management reiterated guidance calling for mid-single-digit sales growth (versus our low-single-digit forecast) but increased the bottom end of its full-year adjusted earnings per share to a range of $2.75-$2.80 (up from $2.70-$2.80) primarily due to a lower projected tax rate. While shares trade at a modest discount relative to our unchanged $45 fair value estimate (based on our expectations for 3% average sales growth and operating margins expanding to 19% over the next decade), we think investors should await a larger margin of safety.

The Coach Brand (more than two thirds of sales) grew 4% for the quarter (generally in line with our assumption of 3%) through brand accretive outlets such as e-commerce seen in expanding gross margin by 260 basis points (to 71%). While our long-term outlook incorporates gross margins 70% for the segment, we continue to believe this metric highlights the firm’s pricing power (evidence of its intangible assets) and should drive its ability to earn an economic profit over the next 10 years.

Finally, Stuart Weitzman (mid-single-digit percent of sales) continued to struggle with execution issues as seen in development and delivery delays. However, it appears the worst is now behind the firm, and we affirm our belief that the segment will return to profitable growth as it has added manufacturing capacity while also rolling out on the Tapestry online and distribution platform. We estimate 2% growth for the year versus flat reported sales for the quarter.