EUR 850.00 For Business Accounts Only

Morningstar | Strong 3Q for Tapestry Accentuated by Profitable Growth at Kate Spade; Shares Still a Deal

While shares jumped high single digits on third-quarter results, we do not plan to alter our $45 fair value estimate for narrow-moat Tapestry and still see shares as an attractive investment. Sales grew 1% on a 10.6% adjusted operating margin for the quarter versus our 1% and 13.4% quarterly estimates, with increased brand spending at Kate Spade crimping operating margin. We see this spending as prudent as the firm revamps the brand image and shifts the merchandise to higher-price points.

Management affirmed 2019 guidance, calling for low- to mid-single-digit sales growth and adjusted EPS of $2.55-$2.60, in line with our low-single-digit and $2.56 estimates. It also provided a double-digit operating income and EPS growth target for fiscal 2020, in line with our 11% and 10% estimates, respectively. 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 expands Kate Spade distribution and takes full ownership of its international businesses.

The Kate Spade integration continues to progress on track (sales up 4% in the quarter). However, we are skeptical of management’s aspiration that Kate Spade can reach $2 billion in sales over the next three years at significantly higher operating margins. As a result, our long-term expectations for the segment call for mid-single-digit growth on a 17% operating margin on average over the next 10 years. We believe there is execution risk as the firm installs a new creative director (by the fourth quarter, new products will represent all the full price channel inventory, but only one third of the outlet channel) and tries to reposition the brand. While adjusted gross margin has been positive (up 90 basis points to 64.8%), overall profitability faltered (down 370 basis points to 4.7%) due to increased marketing. We continue to doubt the gross margin sustainability as inventory growth (up 13%) outpaces sales.

The story remained consistent from the previous quarter with Coach growing below market (1% growth while women's premium handbag and accessories market grew at a high-single-digit rate globally). However, we contend the brand remains healthy with adjusted gross margin improving 30 basis points to 71.7% but just remains under-indexed to high growth geographies leading to the top-line underperformance. We were encouraged by tangible results from the previous quarter’s fashion show investment with an improvement in Coach's unaided awareness from 32% to 41% and aided awareness from 69% to 72%, which we believe strengthens the brand’s image.