Description

CPRI was last written up on VIC in October of last year by “surfer” when the stock was ~$52. After blowout earnings and nearly a 40% rip to ~$70, the stock proceeded to roundtrip, reported another great quarter, went back to the low $70s, and today reached a new 52-week low at $44.34 per share before closing this afternoon at $44.98. The underlying investment thesis for CPRI is simple and straightforward. It is trading as though sales are about to freefall at ~6x next year’s earnings. I am not suggesting if we head into a global recession that it will not have an impact on CPRI sales, but I think that there is a strong case to be made that CPRI is more insulated than the typical retail stock and is trading as though it is a subpar retailer and discounting a significant fall-off in high-end spending. And despite excellent management execution, the stock is underperforming the typical retail stock and trading at a large discount, when it is solidly in the luxury retailer category and I believe should garner a much higher multiple. Moreover, management has demonstrated its ability to manage through challenging times.

YTD Chart (CPRI = Blue, XRT = Orange, OHV2 (Hermes) = Turquoise, LVMH (Louis Vuitton-0HAU) = Yellow)

Even looking at the stock performance YTD, CPRI stock is significantly underperforming the XRT, Hermes, and LVMH. In fact, the stock was reaching new highs in February following another beat and raise quarter and proceeded to plunge from its February high of $72.37 following earnings to a then-52-week low of $45.05 within a few weeks because of Russia/Ukraine fears along with higher crude, when the stock was already substantially undervalued at $72. The main fears I have heard repeatedly are that Russians stop buying and that high oil prices will curtail consumer spending.

(1.) Russian customers are less than 2% of the market. Ferragamo recently reported and said that there was no impact from the war in the daily data they look at since war started from Russians or in general.

(2.) The luxury market is so undersupplied that even if they were to slow (which I do not expect), the remaining 98% of the market demand should easily absorb the extra product if any.

(3.) Sensitivity to crude is a legitimate impediment to discretionary spending for low-income consumers. For the luxury consumer, the impact of higher oil and gas prices is de minimis if at all.

(4.) A lot of the crushing shorting and selling in any consumer name happened when Brent crude went through $120 on the way up, largely through machines as the general rule of thumb historically is that the economy slows when oil goes above $120. Oil has now pulled back to ~$107. CPRI was fundamentally trading at 1/3 of its fair value at $72. At $45 per share, the stock is down ~38% since they last reported blow-out numbers, and the CPRI story continues to improve.

VALUATION

CPRI is unleveraged, generates a ton of cash, and continues buying back its shares. From these levels, I believe the stock can quadruple, to get to fair value of ~$202 per share (18.5x earnings which I estimate will be just shy of $11 per share two years out). 18.5x is the blended multiple of 25x on the 35% that is true luxury (Hermes trades at 40x, LVH trades at 25x, and these are the multiples AFTER the selloff), and 15x on the remaining 65% that is now “affordable luxury. Even using conservative assumptions into next year and a slowdown into 2023, CPRI should generate at least a double for investors from current levels.

(1.)  Net debt as of 12/31/2021 was $741 million, which is 0.5x net debt to EBITDA. The company will repay this debt and be completely debt-free by end of this year since they generate so much cash.  

(2.)  I estimate EPS  will be $6.40 in calendar 2022 and $7.50 in calendar 2023

(3.)  FCF per share is even higher than EPS because depreciation and amortization are higher than CAPEX, so FCF for 2022 is $6.75 and for 2023 is $7.80. This is a 17.5% FCF yield for an unleveraged company owning two of the most desirable luxury brands in the world. Given the enormous scarcity of true luxury brands and the desire of LVMH and Kering (owns Gucci) to buy more brands, the likely hood of a takeout is high in my view. I think this valuation disparity and the “left for dead” approach to this company by the street make CPRI an ideal company for value investors.

BACKGROUND

Michael Kors Holdings (MKH) IPO'ed in 2011. In July 2017, bought Jimmy Choo Ltd for £897 million. In September 2018 MKH announced a deal to acquire Versace. On January 2, 2019, after closing the deal, the company was renamed Capri Holdings. In 2H 2019, CPRI was trading mid-$70s and fell to single digits by March of 2020 as the pandemic fear reached a zenith and some sell-side analysts suggested CPRI might be a bankruptcy candidate due to its debt. Management executed during COVID and continued to deliver solid margins, cost savings, and increasingly saw higher growth and a larger percentage of revenue coming from its true high-end division, Versace, which was acquired in 2H 2018.

5-Year Chart - (CPRI = Blue, XRT = Orange, OHV2 (Hermes) = Turquoise, LVMH (Louis Vuitton-0HAU) = Yellow)

SPENDING TRENDS

Obviously, trends can change quickly as evidenced by COVID in 2020. However, looking at last month’s released MasterCard spending for March of 2022 vs. March of 2021 and vs. March 2019 (pre-pandemic), the increase in retail spending overall, was significant. E-Commerce spending increased by nearly 84% relative to March of 2019. In-store was up nearly double-digits vs 2019, and ~11% vs. last year. But luxury (ex-jewelry) and apparel were also up dramatically vs. 2019 and 2021. I believe Versace will be the biggest growth driver for CPRI, and it is also the highest margin and should receive the highest multiple. But Michael Koors and Jimmy Choo should also show significant growth over the next few years.  

AN INTERESTING PERSPECTIVE ON CPRI

CPRI has for the last 5 consecutive years (prior to the pandemic) bought back an average of $644 million worth of stock per year or 10% of the company per year. The run rate for the current year is similar now that the pandemic is behind us. Keep in mind that they did this before the company bought Jimmy Choo and Versace so now they have even more cash flow to repurchase shares. Given the growth in FCF as the company optimizes and monetizes the new brands, the company will generate enough cash to buy back the entire company in 7 years.  And this is without any debt on the balance sheet. The company could leverage up and take itself private in a few years – perhaps not a bad idea given how much stock the founders/management team owns. If this does not happen, and the stock stays at these levels, LVMH or Kering are likely to try to acquire CPRI.  Not only did these two companies want to buy Versace and Jimmy Choo when CPRI bought them, but LVMH has been trying to buy RL as they want an American “affordable luxury” brand. Ralph Lauren won’t sell, so Michael Kors fits the bill pretty well. With LVMH wanting to buy all three of CPRI’s assets I doubt they will pass this opportunity up.

THE BUSINESSES

CPRI has three divisions – Michael Kors, Versace and Jimmy Choo. With Q1 F2023 just starting this week, management has conservatively guided revenue to over $6.1B.

Versace

Capri is focused on extracting more value from its most recent acquisition, Versace, and to that end, recently hired Emmanuel Gintzburger as CEO of Versace effective this September. Gintzburger is regarded as a rising star in luxury fashion who at 42-years-old, is just hitting his stride. The wunderkind spent 4 years in APAC as a marketing manager for Louis Vuitton to start his career back in 1998 and moved on to stints with Sephora and Jeanne LANVIN before spending 7 years at Saint Laurent where he rose to Director of Worldwide Retail and Wholesale. He spent the last 6 years as CEO of Alexander McQueen and appears to be an excellent fit to grow Versace into a multi-billion-dollar powerhouse. The Versace acquisition was completed on 12/31/18 for $2.12bn. The brand was doing ~900m of revenues at MSD margins when acquired by CPRI. When CPRI acquired Versace, the brand was earning far less than similar competitors and neither had the marketing nor the proper exposure to optimize its success. CPRI focused on ramping Versace and attempting to unlock its potential by properly categorizing the various product categories, lines, and designs while simplifying and eliminating unnecessary parts of the division, reducing costs and improving efficiencies and designs. Versace also improved merchandising and provided a badly needed facelift to existing retail shops. Fiscal ’21 was set to be an inflection year but then Covid hit.   

CPRI will report FY2022 and fiscal Q4 2022 in a few weeks. Out of ~$5.56B in total revenue that management guided for F2022, Versace will surpass $1B and is targeting growth to exceed $2bn in sales within the next few years. I believe the numbers are conservative as management has been consistently underpromising and over-delivering for the past few years. The brand has been underexposed to the handbag category and plans to increase accessories and footwear exposure overall from 35% to 60% of revenues and these categories carry higher gross margins. Licensing revenues will shrink as the company brings accessories/footwear in-house which will help drive higher margins as well.

Michael Kors

Despite being the prior namesake of the company and the largest of the three segments, Michael Kors does not garner reasonable brand respect from investors as a luxury brand. Categorized as “affordable luxury,” many investors refuse to acknowledge the strides made within MK along with the growth and migration to more upscale products. While nobody (me included) is suggesting MK should carry the same multiple or to be regarded as highly as a Gucci or Versace, it is certainly a respectable and upwardly moving brand that certainly does not deserve to be regarded as a mass-market label as many skeptics have suggested. CPRI is very optimistic about the future growth of MK. The strategies put in place prior to the pandemic have been generating strong consumer demand as well as attracting new and younger consumers. Additionally, they are driving higher profitability as they continue to elevate the brand positioning.

In the early post-IPO years, customers were conditioned for sale items and the perception issues lingered for a few years as Michael Kors was not regarded as upscale. CPRI has made great strides by increasing the quality and managing the business much more efficiently. 

Jimmy Choo

Jimmy Choo (JC) had multiple suitors including LMVH and Kering, among others, before CPRI purchased the company in 2017. Management is diversifying JC away from its core women’s high-end high healed shoes and incorporating more accessories, handbags and moving the brand to a higher margin lifestyle brand. Management expects JC to generate ~$675M in F2023 and growing to $1B over the next couple of years. Last Q revenue grew 47% YOY with 9% OM which exceeded expectations significantly. 

CONCLUSION

The massive liquidation in this group over the last few weeks is primarily due to: 

1. Investors believe the Ukraine war will hurt business in Europe, and;

2. As economies re-open, the bears have been saying people will opt to spend money on experiences rather than goods, and within goods, on going back to work and going out clothes/accessories rather than sweatpants to say at home. For CPRI, (a.) the Company presented at the BAML conference in early March and reiterated its guidance even EXCLUDING Ukraine and Russia. (b.) As a luxury goods company, CPRI was hurt significantly from lack of travel so as people return to traveling this will help earnings. In fact, the company said they have lost $1.50 in EPS from LACK OF tourism so as tourism returns, earnings will get an incremental $1.50 boost (almost 20% upside to earnings). Moreover, CPRI did not benefit from staying-at-home clothes as they sell dressy items and bags. As economies reopen within goods, people will go back to buying CPRI's many lines of clothing and accessories.

Finally, it is noteworthy that Hugo Boss reported yesterday and said business accelerated everywhere despite lockdowns in China and the Ukraine war. 

NOTE - apologies for putting in the charts twice. I had technical difficulties and could not remove them from Google docs and replace them within this submission and have it show up readable. So, I re-pasted the charts here at the bottom so that if you cannot see them in the main submission, you can see them better below (I think.)

YTD Chart (CPRI = Blue, XRT = Orange, OHV2 (Hermes) = Turquoise, LVMH (Louis Vuitton-0HAU) = Yellow)

5-Year Chart - (CPRI = Blue, XRT = Orange, OHV2 (Hermes) = Turquoise, LVMH (Louis Vuitton-0HAU) = Yellow)

Catalyst

Earnings and continued execution. 

This is a "Show me" stock and I believe management will continue to execute.

Investors transitioning from growth to value as interest rates continue to move higher, and CPRI is remarkably cheap on an absolute basis and has excellent growth rates.