Description

Tapestry, Inc. (Ticker: TPR) offers luxury accessories and lifestyle brands through a network of retail stores, and concession shop-in-shops, as well as via the Internet, in North America, greater China and Asia, including Japan and Australia, and Europe. The firm’s products are manufactured by third-party suppliers, and include handbags, leather goods, footwear, outerwear, watches, travel accessories, scarves, eyewear, fragrance, jewelry and other lifestyle products. TPR trades today at a very cheap EBIT/EV yield of 10.4%, which is cheaper than more than 90% of stocks that we consider tradeable (> $1.8 bn market cap). We think that it has become too cheap, as we believe the market does not appreciate the new growth prospects created by the company’s activities in Asia.

VIC members will recall Coach Inc., which has been written up on VIC previously, but “Tapestry” is the new(ish) name for a corporate identity created when Coach acquired complementary luxury fashion brands, Stuart Weitzman in 2015, and Kate Spade in 2017. This combination created an international multi-brand company in the premium fashion market, featuring three powerhouse brands that offer diversification across industries where fickle tastes can change quickly.

Bears argue that these acquisitions were dilutive, and that the original Coach brand, whose revenues in North America account for ~40% of total firm revenue, is stagnating, having shrunk in North America this fiscal year.

Yet sometimes with value stocks, you find a low-growth legacy business that is reinventing itself in small, higher-growth areas, and this growth can get overlooked or misunderstood by the markets. Such is the case with TPR, which boasts growing exposure to a new generation of Chinese and Asian consumers, who are hungry for the company’s well-known brand names, and luxury products. The company’s iconic brands are status symbols in China and Asia, whose young and growing consumer class is rapidly becoming a dominant force in global luxury and fashion markets.

LUXURY / FASHION

The state of luxury fashion generally is excellent. According to the consultancy Interbrand, last year luxury fashion and accessories brands, headlined by Gucci and Louis Vuitton, grew faster than those in all other sectors, including technology. Brands or products associated with luxury of any kind have benefited from increasing affluence around the world. And where are some of the biggest, fastest growing markets for luxury brands? In short, Asia. Or more specifically, China.

CHINA / ASIA

A recent McKinsey & Company report stated that in 2019 China will overtake the US as the world’s largest fashion market. According to the report, China has 17 million luxury consumers who are in their 20s and 30s, making up two thirds of the country's total luxury consumers. These young Chinese consumers are acquiring a global taste for fashion, and are reshaping the global fashion industry.

China will continue to play an outsized role in these markets in the years ahead. According to a report released earlier this year by Bain & Company, the Chinese accounted for 33 percent of the global personal luxury goods market in 2018, with the proportion expected to increase to 46 percent by 2025. It’s inevitable that China, with its 1.4 billion people, and an economy growing at 6% per year, will start to generate increased demand for a wide variety of products, many of which have had success in western economies.

TPR’s growth, particularly with respect to its two newly acquired brands, reflects the fashion and luxury trends seen in China and Asia, as compared with its markets in the US, which is a more mature market where the company has greater penetration. In many respects, the brand acquisitions were an attempt to position the company for growth in Asia.

GROWTH GEOGRAPHIES

The company breaks out its revenues into 4 geographic areas:

North America - 61% of revenues

Greater China (mainland China, Hong Kong, Macau and Taiwan) – 15% of revenues

Other Asia (Japan, Australia, New Zealand South Korea, Thailand, etc.) – 17% of revenues

Other (Europe and the Middle East) – 7% of revenues

Of these four areas, it is Greater China and Other Asia, growing at 12% and 10%, respectively, that account for the lion’s share of TPR’s growth. Some of the growth figures are explosive. Last year in Greater China, Stuart Weitzman doubled its business and Kate Spade tripled its business.

TPR sees the trends in place, and is firmly focused on consolidating and growing its China and Asia business. In January, TPR opened 7 Stuart Weitzman locations in mainland China, and in February, the company held its first-ever fashion show in Shanghai to celebrate 15 years in the market. TPR brands have been leaders on various social media platforms popular in China, including WeChat, Sina Weibo, and Redbook.

TPR also completed buybacks of parts of its Stuart Weitzman and Kate Spade businesses in Asia, taking back operational control of sales and distribution in parts of China, Singapore, Malaysia and Australia. TPR is betting big on Asia. It’s a sensible strategy that opens up a long runway of growth.

TARIFFS

What about Tariffs? As recently as 2011, approximately 85% of Coach’s accessory products were manufactured in China. Over time, however, the company has diversified its sourcing away from China, moving it to Southeast Asia and India. Today, just 3%-4% of TPR’s bags are manufactured in China, which insulates the company from the effects of tariffs.

FRANCHISE VALUE

We believe that in order to be a franchise, a company must have some sustainable competitive advantage that affords it pricing power, and allows it to generate excess returns on capital over time. Brand can be a powerful competitive advantage. Two metrics we think reflect a firm’s competitive brand advantage are Return on Assets and Return on Capital. We like to use long-term, 8-year geometric average returns for insight into whether a firm has a defensible economic moat and is able to maintain excess returns over time.

TPR generates a phenomenal 8-year Return on Assets of 18.8%, which places it in the 98^th percentile for that metric within our tradeable universe (smid-caps+). Similarly, TPR’s impressive 8-year 26.3% Return on Capital place it in the 96^th percentile of our tradeable universe.

Another metric we like to use to assess a firm’s franchise qualities is long-term free cash flow versus assets, defined as the sum of 8-years of free cash flow divided by total assets. This metric seeks to capture a stock’s ability to generate cash on its investments over time. TPR’s trailing 8-years of free cash flow sums to slightly over 100% of total assets, placing it in the 78^th percentile of our tradeable universe. 

TPR also has remarkably high and stable gross margins, which over the past 5-years have printed in a narrow range of 67% to 69%.

These are all strong indicators that the company’s brand is strong, that it retains significant pricing power, and that it efficiently creates a lot of free cash flow based on a comparatively modest asset base.

FINANCIAL STRENGTH / OPERATING MOMENTUM

In addition, the company appears to be in a financially strong condition, and over the past year, the business has shown various signs of operational momentum. TPR is generating positive net income and strong operating cash flow, with an ROA and free cash flow/assets that increased versus the prior year. The company has traditionally been a cash cow, and that certainly continues to be the case.

Gross margins increased over the past year, during which time the company also saw an improvement in asset turnover (sales scaled by beginning total assets). The company’s debt/asset ratio declined over the past 12 months, indicating a reduction in leverage. Recently, the company announced a $1 billion share repurchase authorization, which is a shareholder-friendly return of capital, which complements recent solid dividends of $350-$400 million (currently $1.35/sh., for a 4.4% yield).

In short, the company is showing a variety of signs of maintaining a strong economic moat, and of solid, and increasing, financial and operating strength. Management seems to be doing all the right things.

SUMMARY

We believe the markets have become overly bearish on TPR, and have not given the company credit for the significant growth trends emerging in Asia, and particularly in China. The company’s recognizable brands have enabled it to earn high long-term returns on capital and assets, and to generate huge free cash flows over a long period of time. We think this will persist. The company is well-positioned financially, with many metrics trending in the right direction, including increasing ROA, and gross margins, and continued cash flow strength. We think given the growth prospects in Asia, and the company’s solid financial strength, that at an EBIT/EV yield of 10.4%, and a trailing P/E of under 13x the company represents a good value.

Catalyst

- Continued growth in China and Asia

- Continue brand strength, returns on capital

- Continued return of shareholder capital: share repurchases, dividends