An Iconic Platform Launch. We recently visited the NYC Kate Spade flagship with TPR management, including EVP, President of Kate Spade North America and Head of Global Merchandising Emilia Fabricant; Interim CFO Andrea Resnick; VP Investor Relations Christina Colone; as well as members of the Kate Spade field and store organization. We came away with renewed conviction in the new Kate Spade platform launch (rather than simply a new product launch). Platform launches reposition a brand for the long-term. In this note, we showcase photos of the new product, which was made available in stores in early February. The story is about the forward merchandise under new creative director Nicola Glass. We estimate that by the end of March ~50% of the product will be new (accounting for ~25% of FY3Q19 sales) and will build to 100% new product by the end of June (accounting for ~75% of FY4Q19 sales).
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The January reading plummeted, falling two rankings from December’s reading of 3/10, suggesting investors started re-shorting stocks during the January rally after being sidelined at year end. In January 45.7% of retailers posted a short position >15% (up from 39.1% in December). Since we last published this report on 12/17/18, the XRT is up 1% vs. the S&P 500 +4%. We rank Sector Sentiment on a scale of “1” being the most negative sentiment to “10” being the most positive sentiment. The basis for the ranking is based on the number of retailers in the sector with >15% short positions.
Although many companies posted sales upside for the holiday season, we think the upside is the result of deeper promotions (despite clean inventory) in order to coax consumers to shop. CPRI and TPR reported quarterly earnings last week that echoed this sentiment. Both companies cited a promotional environment, among other issues, that resulted in misses on the top-line and on gross margin vs consensus. We expect general misses to gross margin and sales given the trend of deeper promotions over the last four quarters from a peak score of 43 or “Flat” in 1Q18 to 33 or “Deeper” in 4Q18.
Betting on Kate. During the quarter Kate Spade was responsible for the ~$55M sales miss. Expectations anticipated negative comps and promotional pressure to purge legacy product. However, the outsized negative surprise caught investors, who are betting on a spring 2019 turn for Kate Spade, off guard. We have seen the product, and our stance on a successful relaunch is unwavering. We are placing our bet on a 2019 turn, albeit pushed out a quarter given the poor demand for the final outgoing collection from the prior design team. Our Outperform call remains founded in inflections forthcoming in the next few quarters: 1) a Kate Spade product-led turn in spring 2019, 2) abatement of competitor CPRI - OP promos noted during holiday, 3) anniversary of SG&A investments and distributor buybacks mid-2019, and 4) continued growth in Coach and Kate Spade stores in Greater China offsetting weakening tourist traffic. No doubt, Coach Outlet remains a source of margin pressure and is marginally weaker than expected, but we believe a successful turn at Kate can offset this weakness at Coach.
FY2Q18 reported EPS was $1.07 vs. Cons of $1.11. TPR missed on total sales (Kate Spade missed by $55M), comp, gross margin, offset by in-line SGA and lower than expected tax rate. FY4Q18 Adjusted EPS was $1.07 vs. Cons of $1.11. Total sales missed at $1.80B vs Cons of $1.86B, which was driven entirely from Kate Spade’s miss of $55M. Coach brand comps were +1% vs. Cons +1.6%. Kate Spade comps declined -11% vs Cons -3.7% due to underperformance of legacy product. Gross margin was flat YoY but missed at 67.0% vs. Cons of 67.8%, with promos eating into the significant cost benefits we saw last quarter. SGA increased 70 bps YoY but came in 10 bps lower than Cons of 44.8%. We note a lower than expected tax rate contributed ~$0.03 to the beat. Our Outperform call is predicated on the following inflections potentially forthcoming in the next few quarters: 1) a Kate Spade product-led turn in spring 2019, 2) abatement of competitor CPRI promos noted during holiday to move inventory, 3) anniversa
We recently upgraded shares of TPR (click here for 1/24/19 note) to Outperform based on 1) what we thought to be stabilizing holiday quarter promos, but with a notable deterioration at Outlet in January, 2) our bet on a Kate Spade product-driven turn in CY19, and 3) valuation discounting China, European, and wholesale channel risk factors. We expected pushback on China and Europe slowing growth but were surprised the most pressing negative theme was a worsening promotional competitive backdrop in North America. We acknowledge Michael Kors was aggressively promotional throughout the holiday quarter (similar to the prior quarter) and January promo checks were deeper at Coach Outlet. Nonetheless, feedback has been almost unilaterally to the downside. For FY2Q19, we expect potential gross margin upside at Coach and Kate Spade from supply chain initiatives (offset by Stuart Weitzman), Greater China comp strength offset by negative tourist impact, continued weakness in Europe and slight comp recovery in Japan. We believe SGA will deleverage given the impact of investments, but operating income will leverage. We expect clean inventory at all brands. TPR will hold their FY2Q19 earnings call at 8:30am on 2/7 (Dial-in: 1-877-510-8087; PW: 1578006).
We are upgrading shares of TPR to Outperform from Peer Perform based on 1) holiday channel checks that suggest business stabilization at the core Coach and Outlet brands with flattish promos YoY, 2) prospects from the spring 2019 launch of a new look for Kate Spade that we believe will resonate with their core Millennial target, 3) valuation that is trading near multi-year historical lows, 4) minimal exposure to the struggling department store channel, and 5) outsized fear of China risk. We believe mainland China strength can offset reduced Chinese tourist traffic. We expect operating margin expansion driven by organic growth, synergies, distributor consolidations, and systems investments.
Heightened supply risk for 2019. During 3Q18, retailers took a turn for the worse, as inventory increased modestly at a faster rate than sales. With no ability to raise prices to drive comp, retailers must rely on increased unit volume to drive sales growth. Note that this is a snapshot entering 4Q18. Most results, save for a few exceptions (e.g., TGT – PP, COST – PP, covered by Scott Mushkin, and LULU-OP), have missed holiday sales. We expect inventory exiting 4Q18 to show even higher inventory-related business risk.
The December reading rose for the second consecutive month, suggesting with valuations pulling in short sellers may be derisking. The November reading was 2 out of 10. In December 39.1% of retailers posted a short position >15% (was 42.2% in November). Since we last published this report on 12/17/18, the XRT is up 6% vs. the S&P 500 +2%. We rank Sector Sentiment on a scale of “1” being the most negative sentiment to “10” being the most positive sentiment. The basis for the ranking is based on the number of retailers in the sector with >15% short positions.
We believe 2018 may have been “peak season” for retailers. We continue to believe in the Retail Death Curve phenomenon. The 2018 lift in mall traffic was against easy compares and pent-up demand. Despite clean inventory in 2018, there was no evidence of broad-based pricing power. Retailers were as, if not more, promotional than prior year and “bought the comp.” Tax reform savings were reinvested in store-related wages and deferred capital spending – both contributing to a higher fixed cost infrastructure than before tax reform – adding to greater deleverage risk.
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