Description

Illustrative Investment Idea – Long – G-III Apparel Group (GIII)

G-III Apparel Group (GIII) is a global leader in sourcing, designing and manufacturing an extensive range of outerwear, women’s sportswear, dresses, and accessories under licensed and proprietary brands to a cross section of leading retailers.  As the largest North American wholesaler of women’s fashion apparel, G-III’s primary strategy is to sell well-known licensed brands including Calvin Klein, Tommy Hilfiger, DKNY and Karl Lagerfeld.  We believe G-III is a uniquely miss-understood asset, trading at a trough valuation, with material hidden earnings power that should be unlocked over the coming year through: 1) shutting down the Company’s struggling G.H. Bass & Co. and Wilsons Leather Retail operations; 2) improved China tariff headwind mitigation efforts; and 3) a continued strong core Wholesale business.     

G-III’s roots date back to 1956 when Aron Goldfarb immigrated to the U.S. from Europe and founded G&N Sportswear.  The current CEO and Chairman, Morris Goldfarb, joined the Company in 1972, and G&N was revamped as G-III Leather Fashion as the focus shifted to moderately priced women’s leather outerwear.  Over the next 15 years, the Company expanded into the men’s leather apparel market, and in 1989, GIII completed a successful initial public offering and was renamed the G-III Apparel Group.  Under Morris’s 46 years of proficient navigation through various fashion, economic and technological cycles, G-III has grown its market capitalization from under $100 million to $1.6 billion with over $3 billion of total sales.  Morris Goldfarb is currently the third largest shareholder of G-IIII with 4.2 million shares and recently made two open-market purchases totaling over $2 million, at an average price of $26.28 per share in June and July 2019.

In the next quarter, we believe G-III will initiate the first steps of shutting down its unprofitable Bass and Wilsons Retail operations by liquidating stores and will subsequently close all operations, thereby creating $0.61 per share of net earnings accretion for 2020.  We also believe the China tariff impact should only be a $0.04 headwind in 2020, compared to current expectations for $0.50.  We assume GIII receives continued vendor concession support and takes modest pricing, under the current 7.5% List 4A China tariff, recently reduced from 15%.  Thus, G-III should be able to largely offset all tariff headwinds resulting in just a $0.04 per share negative impact for 2020.  We believe the market has not accounted for the Retail shut-down accretion or the China tariff negligible headwind, which, in sum, adds $1.07 per share to current street estimates of $3.03 per share, or +34.3% of earnings upside potential based solely on these two events.  Importantly, this high degree of positive earnings revision visibility doesn’t assume any material sales or margin improvement for the core Wholesale business, or incremental share repurchases. 

Thus, we estimate 2020 earnings of $4.27 per share, implying shares trade at just 7.1x 2020 P/E, compared to its 14.3x 5-year average and Wholesale peer group average of 15.0x.  Further exemplifying the material valuation disconnect, G-III also trades significantly below the 11.4x average U.S. Department Store P/E multiple. 

We believe G-III’s material earnings upside potential, strong leadership and underlying Wholesale business trajectory, as well as its depressed valuation, offer tremendous alpha creation in 2020.  We believe fair value is 14.3x our $4.27 per share, implying $61.06 per share or +101.8% upside compared to the current stock price.  Moreover, if the market does not appreciate management’s execution over the next 12 months, we believe GIII could split the Company in two, separating its luxury business from the rest of the Company, or look to sell the whole Company to several potentially highly interested suitors.

Closing Unprofitable Retail Operations

We believe GIII’s retail losses are obfuscating the profitable growth of the Company’s core wholesale business and materially hampering the valuation.  We estimate GIII’s retail operation lost approximately $55 million in 2019 and $45 million in 2018.  However, in 2020, the Company should close down this money losing operation, resulting in $0.61 of EPS accretion, or 20.1% of upside to 2020 earnings estimates.

After years of store closures, G-III currently operates 92 G.H. Bass & Co. and 114 Wilsons Leather Retail stores.  In addition, G-III also operates 38 DKNY, 4 Calvin Klein Performance, and 12 Karl Lagerfeld Retail stores. G-III has acknowledged the detrimental operating drag from both Bass and Wilsons by closing stores at a 14% to 18% run-rate annually over the last 3 years.  Around the timing of their 3Q 2019 earnings call, we believe G-III had already halted all 2020 inventory orders for both brands.  Moreover, over the last 3 to 6-months, G-III has worked closely with an outside advisory firm to expedite the store shut-down endeavor and we expect a full liquidation process should occur in early 2020.

Since the Bass and Wilson shut-down process is currently being negotiated by G-III and their landlords, and liquidation sales have not yet begun, estimating the impact is a fluid process.  However, we believe G-III is in a great negotiating position, and can materially mitigate the one-time nonrecurring charges associated with a retail exit.  The 206 total Bass and Wilsons Retail locations have a maximum lease life of 3 years, and we forecast, looking out to 2022, the overall company Retail future minimum rental payments to be $209.7 million.  Importantly, we exclude $50 million annually, which includes Corporate and their Vilebrequin brand, but we add back $5 million for estimated one-time severance related charges, which gets us to an approximate $64.7 million one-time non-recurring shut-down cost.  G-III has also indicated they should end fiscal 2019 with at least $70 million of free cash flow and they also have a fully untapped $300 million ABL facility for the cash component of this one-time cost. 

Moreover, we estimate G-III’s total Retail segment will lose $55 million in 2019, with approximately 75% of that coming from the two aforementioned brands soon to be shut-down.  The DKNY, Karl Lagerfeld and Calvin Klein existing stores are not profitable.  However, G-III is closing 6 DKNY lower-tier locations this year, and will selectively convert some of the best Bass and Wilson locations to DKNY and Karl Lagerfeld as well as expanding DKNY outlet locations into some of the top-tier sites going forward.

When G-III acquired DKNY in July 2016, we estimate the Retail business was losing approximately $20 million annually.  Today, we believe the concept is losing less, approximately $10 million to $15 million in 2019.  We expect DKNY’s 2020 profitability to materially improve year-over-year via selectively increasing price, an improving size and scale, operational tailwinds and increases to store productivity via new outlet format conversions.  Factoring this in, as well as estimating flattish Karl Lagerfeld Retail EBIT, and including some degree of stranded costs post Bass and Wilsons shut-down, we estimate total Retail will lose approximately $4.1 million of EBIT in 2020.  We expect this segment to turn profitable thereafter with positive low-single digit margins in 2021.  We would also note qualitatively, G-III’s CEO, Morris Goldfarb, has remarked that they will “strive to make money in DKNY Retail in 2020,” so our estimates may prove conservative. 

We believe the retail division closing will result in $0.61 of earnings upside, or 20.1% accretion to 2020 earnings estimates.  Moreover, we also estimate the Retail shut-down will have a $0.91 per share positive impact to 2021 earnings, or 29.3% accretion.  Lastly, we believe G-III’s unique expertise in sourcing, designing and manufacturing top-tier fashion brands, strong leadership, and attractive balance sheet and valuation make it a much cleaner strategic acquisition target post the Retail shut-down.

Improved China Tariff Mitigation Efforts

In many ways, 2019 was a tumultuous year for the broader Retail industry, highlighted by the extreme volatility and lack of forward modeling visibility due to China tariff uncertainty.  G-III was the poster-child for perceived tariff P&L headwinds given their 50%-plus China sourcing exposure.  The two peak tariff related volatility months in 2019 were May and August, and G-III shares were down -40.4% in May and -28.4% in August.  Moreover, G-III shares were trading at $43.15 on April 30^th, 2019 and closed at $20.51 on August 30^th, 2019, or a decrease over this period of -52.5%. 

Total earnings headwind for 2019 is projected to be $18 million, or $0.25 per share, related to tariffs, which consists of both List 3 and List 4. After reviewing all sell-side models and consulting with management, it appears the sell-side is rather simply run-rating this $0.25 per share annualized headwind for a full-year in 2020, or approximately $0.50 per share.  In our 2020 model, we assume 5% vendor concessions and 1.5% price increases, all in-line with broader industry expectations, and the recently reduced 7.5% 4A tariff, down from 15%.  This results in an annualized $0.04 headwind for 2020.  Qualitatively, in our recent management conversations, G-III has articulated tariffs should have a “negligible” impact to earnings.  Since sell-side models are yet to update for the 7.5% 4A tariff change, written into law on January 15^th, and also under-estimate the mitigation efforts via vendor concessions and selective price increases across their portfolio, we believe the street is miss-modeling 2020 earnings, as it solely pertains to tariffs, by approximately $0.46 per share, or 14.2% to 2020 estimates. 

Outside of the earnings upside potential dues to the tariff headwind reversal and the retail closure, we also admire G-III’s long-term strategic decision to not make the hasteful decision in moving the vast majority of production outside of China like so many consumer companies.  We’ve heard consistent feedback across retailers that both the quality of product manufactured in other neighboring Southeastern Asia countries and speed to market are being sacrificed for near-term profit loss mitigation efforts.    

G-III’s Core Wholesale Business Strength

We are clearly excited about the potential for material earnings revisions in 2020 related to the Retail shut-down and tariff miss-modeling.  However, the core Wholesale business is extremely healthy.  Taking a step back, G-III’s Wholesale business constitutes 91% of total company sales and 110% of current EBIT.  Sales have consistently grown over the last 6 years at a +8.9% CAGR and between +3.7% and +21.4% annually.  Likewise, EBIT margins have expanded annually in all but 1 year, which was calendar 2015 when the East coast experienced 70 degree plus weather in late December.  We estimate 2019 Wholesale EBIT margins should be 10.6%, which is above their closest peer, PVH Corp’s (“PVH”) 9.5% margin.  Despite that, PVH trades at 10.5x 2020, or an approximate 3.4x turn premium even though PVH historically trades at a discount and has less near-term earnings visibility.

Moreover, G-III distributes across various channels with ~70% of total Wholesale sales coming from a diversified mix of U.S. Department Stores (43.6%), Off-price (19.0%), Big Box (5.6%) and Amazon (2.1%).  Macy’s (“M”) and TJX Companies, Inc (“TJX”) are the two largest Wholesale partners at 24.8% and 12.4% of total sales, respectively.  Moreover, as a percent of total Wholesale sales, we estimate Tommy Hilfiger and Calvin Klein currently constitute 52% of Wholesales sales and DNKY approximately 15%.  We also view Kohls Corp. (“KSS”) and Target Corp. (“TGT”) at just 0.9% and <0.5% of total Wholesale sales as significant long-term untapped opportunities.  We understand there is a negative stigma around G-III’s large Macy’s and Dillard’s (“DDS”) exposure, given the structural headwinds all U.S. Department Stores face long-term.  However, we estimate G-III’s Macy’s and Dillard’s specific business actually grew over 10% in 2019.  

We are also optimistic about the opportunity for the DKNY brand.  G-III acquired Donna Karan International (DKNY) on July 25^th, 2016 for $650 million from LVMH Moet Hennessy Louis Vuitton (“LVMH”).  This iconic brand, consisting of Donna Karan and DKNY, is highly complementary to G-III’s existing brand portfolio, and longer-term is projected to achieve $1 billion of sales for just the DKNY North America business alone.  DKNY should have material door growth potential and international expansion opportunities starting in 2020.  We estimate DKNY will grow over 20% in 2019 and conservatively model high-teens to 20% for each of the next 5 years culminating in $1.05 billion in sales by 2025 with a 15% to 20% EBIT margin, or $183 million EBIT potential.  Assuming the non-DKNY Wholesale business continues to deliver the 8.9% historical CAGR and low-double-digit EBIT margins over the same time period, total Wholesale EBIT should reach $567.5 million, resulting in 2025 Wholesale EBITDA of approximately $615.7 million versus total company street EBITDA estimates of $375 million in 2025.  Discounted back at 10% using the current 2020 peer group EV/EBITDA average multiple of 9.3x, the 5-year Wholesale EBITDA opportunity implies $3.4 billion underlying Wholesale segment value versus the current $2.5 billion enterprise value (“EV”) of the entire company.  This suggests GIII’s Wholesale segment alone is worth $52.25 per share, 72.7% higher than the current share price.

Share Repurchase and Insider Buying Show Strong Downside Support

As previously noted, Morris Goldfarb has led G-III for the last 46 years.  We believe Morris is not only highly aligned with his shareholder base, but his understanding of G-III’s underlying value in periods of market volatility are quite astute.  The Company has demonstrated its market savvy when G-III repurchased 723,00 shares for $20 million, $27.66 average per share, in December 2018 when the broader market declined -9.3% during the month.  This was the first open market share repurchase in the history of the Company.  Subsequently, G-III also repurchased 1.3 million shares for $35 million, $26.92 average price per share, during June and July 2019. 

Moreover, Morris has made two significant open-market purchases in the last few years, both after the stock suffered material losses.  In April 2017, Morris purchased 40,000 shares at an average price of $22.48 per share.  Subsequently, G-III appreciated +29% and +73% over the next 6-month and 12-month timeframe.  Importantly, Morris made another significant open-market purchase in June and July 2019, buying 80,500 shares at an average price of $26.28 per share.  Clearly, between the company’s opportunistic share repurchases and Morris’s open market purchases, both indicators show strong valuation support in the mid-$20 per share range and paint an optimistic picture going forward.

M&A Potential and S-O-T-P Analysis

Although not part of our core thesis, we would be remiss in not mentioning the long-term strategic value G-III offers to a potential acquirer, post Bass and Wilsons Retail shut-down.  Although there could be several realistic suitors, we think the most likely candidate to acquire G-III would be PVH, given PVH owns the Tommy Hilfiger and Calvin Klein brands (which represent approximately 52% of GIII’s sales). 

More specifically, PVH CEO, Manny Chirico, has publicly stated on several occasions, that due to depressed industry valuations, Retail industry M&A is “inevitable over the next 12 to 18 months.”  Moreover, we know PVH is willing to increase leverage to 4.0x from 2.1x currently, ex-operating leases, and is likely focused on the global apparel market.  PVH also has a track record of acquiring global brands they know well as seen by their Warnaco acquisition in 2012 at 11.3x TTM EV/EBITDA.  We note that prior to the acquisition, approximately 76% of Warnaco’s sales were Calvin Klein, licensed by Warnaco from PVH.  Similarly, G-III’s Tommy Hilfiger and Calvin Klein licensed sales constitute around 52% of G-III’s sales.  Based on TTM EBITDA, if we assume a G-III acquisition multiple of 10x to 12x, that implies $47.71 to $59.84, or 57.7% to 97.8% upside.  Thus, given the depressed valuation, and the material improvement to profitability after a potential closing of the Retail operations, we believe G-III is an attractive strategic acquisition target given its very consistent overall Wholesale portfolio of brands. 

Moreover, depressed valuations for many Retail and Consumer companies over the last few years have driven several companies to split-apart or divest various segments.  This has resulted in material revaluations upward as the market properly values the parts of the consolidated enterprise.  Recently, in 2019, we saw The Gap, Inc. (“GPS”), an apparel retailer, and American Outdoor Brands, Inc. (“AOBC”), a holding company, which includes Smith & Wesson and 19 other Outdoor related brands, announce their intention to split-apart business segments.  There also has been market speculation that L Brands (“LB”), parent company of both Victoria Secret and Bath & Body Works, could split-apart its two segments.

As it pertains to G-III, we believe a simplistic sum-of-the parts (“SOTP”) overview sheds light on how under-valued the Wholesale business is at current share prices.  Based on 2021, we conservatively estimate Wholesale grows at a positive mid-single-digit rate with 11.8% EBIT margins implying $412.4 million EBITDA.  Likewise, we estimate Retail improves to $85 million with 2.0% EBIT margins implying $5.2 million EBITDA.  Based on comparable company EV/EBITDA multiples, we utilize an 8.0x to 10.0x Wholesale range and 6.0x to 8.0x Retail range, which implies $3.71 billion and $36.3 million EV, respectively, resulting in an equity value of $58.62 per share, or +93.7% upside.  Lastly, with Wholesale comprising approximately 99% of the value, or $58.05 per share, and Morris’s keen understanding of his companies underlying value, we strongly believe he would explore alternatives to split-apart the Retail and Wholesale segments to extract maximum value for his shareholders. 

Similarly, and potentially a more likely alternative down the road, G-III could opt to sell its luxury portfolio consisting of Vilebrequin and Karl Lagerfeld to an acquisitive global branded apparel company like LVMH or PVH.  First, we suspect G-III would opt to buy-in the piece of Karl Lagerfeld it does not own, thereby making this option a more enticing scenario further in the future.  We believe these luxury brands could sell for 14.0x to 16.0x, implying $100.7 million and $45.8 million, respectively, creating 10.1% accretion to shareholders.

Conclusion

We believe several catalysts will unlock the material hidden earnings power in G-III during the first half of 2020. We believe the Company will shut down the combination of Bass and Wilsons Retail operations, China tariff miss-modeling will become properly adjusted, and the core Wholesale business should continue to grow profitably.  GIII’s valuation should materially expand as these earnings catalysts playout.  G-III’s two closest peers, PVH and Ralph Lauren Corp. (“RL”), have generated much slower Wholesales sales growth than that of GIII, but trade at premium P/E valuations to G-III of 10.5x and 14.2x, respectively.  Moreover, we have a high degree of visibility to our 2020 $4.27 per share estimate, and with an implied valuation at 7.1x, relative to GIII’s 14.3x 5-year average and 15.0x overall Wholesale peer group average, dislocations like this are a truly rare occurrence.  As previously mentioned, we believe Morris Goldfarb is a unique long-term value creator, and if the market doesn’t properly appreciate the upcoming initiatives, we believe either M&A or segment divestitures are plausible ways to create meaningful shareholder value. 

We derive our 12-month fair value using the 5-year average multiple of 14.3x 2020 EPS of $4.27, implying $61.06 or +101.8% upside. 

Catalyst

earnings;  retail closure;  m&a;