CPRI has emerged from the pandemic as a higher margin, leaner, more diversified business with luxury brands constituting a higher and growing percent of its portfolio. LT structural improvements, margin expansion, and portfolio evolution are being significantly underappreciated by the market. The company has multiple years of strong earnings growth ahead and can eventually hit $7.00-$8.00 in EPS on a multi-year timeframe with multiple expansion justified as Kors shows stability and luxury becomes a greater mix of earnings. In the next few years luxury will account for 40% of revenues and one-third of earnings. Changing a brand perception/distribution (Kors) and revitalizing underearning brands (JC, Versace) requires time and capital investment and it’s important to note that this has occurred. Operating improvements are rapidly showing through in results as of late because the company happens to be at an inflection point after a multi-year investment process so operating leverage and ROIC are now accelerating for the business. The past few quarters saw significant improvement on the margin front (both GM% and EBIT%) for all brands.

Michael Kors

Management’s target is for Kors to return to revenue growth and at least $4.4bn of annual sales on a normalized basis. On a medium-term basis the company is targeting 25% EBIT margins vs. 20-21% in Fiscal ‘19/’20 and 30-32% at its peak.  

In prior years, the core customer had been trained to buy Kors items on sale as the brand had become overly promotional with too much low-quality channel exposure (too many off-price/dept store locations). The company has made efforts to address this over-distribution problem the past 2 years, significantly reducing its lower quality wholesale doors and exiting certain channels entirely. Wholesale distribution points have declined 14% over the past 7 quarters (439 decrease in doors vs. March 2019 end) and the company has also exited select unprofitable retail doors. Meanwhile, e-commerce/DTC has increased in penetration helping to drive full-price sell-through.

Revenue/margin growth will be further driven by product mix evolution (lowering accessories mix coupled with growth in menswear, footwear, and ready-to-wear categories), SKU count reduction (30-40%), and rising AURs driven by product innovation. Penetration of the Kors Signature product line is margin accretive given higher price points and in F3Q’21 this increased across all categories, with accessories (40% vs. 30% prior year) and menswear (45% vs. <30% prior year) seeing particularly strong improvement. These efforts have translated to 450bp+ of operating margin improvement in each of the past several quarters. Importantly, management commentary indicates the company is still early on with respect to implementation of margin driving initiatives. The company is still not through the entirety of its SKU reduction plans and expects further pricing initiatives to flow through in coming quarters.

The biggest pushback on the CPRI thesis is based on bearishness on the Kors brand as even by FY’25 when luxury targets are hit, Kors will still represent 60% of revenues and 70% of operating profit, with some believing Kors is simply benefiting from current tailwinds in the category. I’d argue that what Kors is doing right now is structural and early stage - organic price increases due to elevated product offering, SKU reductions, and taking the customer up the pricing curve are all points of evidence that Kors can be a viable full-price brand. And the model is baking in a smaller revenue footprint and margin profile versus its peak pre-crisis highs. Some are bearish on Kors because they prefer Coach as a brand (part of TPR) though I don’t view the situation as zero-sum where the brands are stealing share from one another. US wholesale is still a risk for the company as Macy’s is still likely 10-15% of Kors’s US wholesale exposure but I think risk has been mitigated and other earnings drivers are more dominant at this point.

Finally, I’d point out that at the current share price, even if Kors were to stabilize at a much lower revenue run-rate with lower than targeted margins - the implied value of JC/Versace is in line with luxury brands. Alternatively, assuming Kors does hit management targets and were to get a fair valuation multiple, you are essentially getting the luxury brands for free at this valuation. Ultimately, I think an investment in CPRI does require a constructive view around Kors but a SOTP analysis does underscore the fact that the market isn’t pricing in a massive recovery for the brand or for the luxury contribution becoming a more significant contributor.

Versace

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. The brand was underearning and underpenetrated when acquired by CPRI and the company spent the subsequent year following the acquisition re-aligning the product assortment, paring back extraneous parts of the business, cutting costs, revamping its design and merchandising efforts, and renovating its existing retail network. Fiscal ’21 was set to be an inflection year but then Covid hit.   

Management is targeting growth to $2bn in sales (on longer-term basis) with low-20% EBIT margins. The company plans to increase its global retail footprint to 300 stores which represents ~8.5% unit growth going forward, assuming 4-yr trajectory to target. 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. Management is targeting store square foot productivity of $2500 (vs. $1500 in F’19) for reformatted stores, bringing it more in-line with higher-end luxury houses. As of F’3Q’21 roughly 40% of the store base has been remodeled to the new concepts. Getting to 15% operating margins in 2 years and 18-20% over time remains an undemanding target for a true high-end luxury brand such as Versace given comps are earning 25%+ margins (Gucci EBIT margins are ~40%, for example).  

Jimmy Choo

The JC acquisition was completed 11/1/17 for $1.35bn. Management is targeting $1bn in sales and ~15% operating margins versus $590m sales in Fiscal 2019. The company is making a big push toward accessories (handbags, leather goods, belts) to turn JC into a higher margin lifestyle brand. The brand has predominantly been focused on women’s high-end footwear (72% of sales) which tends to be a more competitive lower operating margin business. Footwear should reach 59% of the mix by FY’22 end while accessories should grow to 30% in that time. This would represent a substantial improvement but still leave the brand under-indexed to competitors in terms of accessories mix and on a longer-term basis, accessories should be able to hit 50% of the mix. Margins should further improve based on a lower cost structure (less R&D/marketing as mix shifts, elimination of product lines, back of the house labor cuts) and operating leverage will also contribute off of a larger store base. The JC store base should increase to 300 stores globally which represents ~7% unit growth on a 4-year basis.

Balance Sheet

Significant FCF generation and deleveraging is part of the equity story as well. And I expect the company to be in a net cash position by FY’23 (March ’23). EBITDA to FCF conversion has averaged 65% historically.

Valuation

At a price of ~$50 per share CPRI is trading at 8.8x FY’23 EPS estimate and 6.25-7.0x P/E against LT EPS estimates that should reach $7.00-8.00. 14-16x $5.50-5.70 of FY’23 EPS results in a target value per share of $77 to $91 (+54-82% upside). Prior to levering up due to the JC and Versace acquisitions the Kors business traded at 15-17x P/E.  Longer term, shares could trade much higher still as the earnings profile could justify a higher multiple on higher EPS estimates and the overall business earning 23%+ EBITDA margins. 18x P/E multiple on $7 EPS equates to $126/share value or 150%+ upside (18x represents a 70/30 blended average based on 15x Kors and 25x luxury).