Calvin Klein Recovery Playing Out in First Quarter at PVH

We expect little change to our $128 fair value estimate, as these results align with our previous expectations for mid-single-digit full-year growth at Calvin Klein and our above-guidance 2015 EPS estimate of $6.93. We continue to think that PVH possesses a narrow economic moat given its scale and retail relationships, and that management will use this advantage to reposition Calvin Klein in full-price channels, providing both acceleration in top-line growth and margin upside. We think Calvin Klein will benefit from full-price sales in Europe (jeans margins are flat now), jeanswear product improvements, selling square footage increases, and growth in Asia and Latin America. For Tommy Hilfiger, underpenetrated markets offer geographic expansion opportunities, and moving licenses in-house has potential.

Although the stock received a boost on these first-quarter results, we still believe that the full upside of square-footage and pricing increases at Calvin Klein is underappreciated by the market and that the stock trades at an attractive margin of safety for investment.

PVH Strategically Manages Its Leading Brand Portfolio We think PVH will continue to capitalize on its leading brand portfolio--the basis for our narrow moat thesis--and manage it strategically, culling brands with declining market demand and developing or acquiring those with true market potential. Following the $2.9 billion acquisition of Warnaco and sale of Bass, we think management's attention will now turn to integration and internal growth, focusing on the Calvin Klein segment.

We think the Warnaco acquisition was strategically sound, giving PVH full control of the Calvin Klein brand, product quality, marketing, and distribution. However, we acknowledge that management seemed to underestimate the amount of investment it would take to integrate Warnaco technology systems, invest in jeans product quality, and reposition Europe jeans out of clearance and discount channels. We think 2015 will be a turning point and that we will see progress. Although we expect significant currency headwinds to mask progress, we think that average unit retail increases (roughly 10% currently in jeans in North America) and an additional 150 newly installed shops will drive constant currency average annual mid-single-digit top-line growth for Calvin Klein in 2015 and beyond. We expect CK jeans margins to improve from flat in the United States and Europe to low-double digits and to boost overall PVH operating margin to 13% from 11% currently over the next five years on further pricing increases of roughly 30%-35%.

We think the main focus within Tommy Hilfiger will be to broaden distribution globally with a particular focus on emerging markets. A joint venture in Brazil began in early 2013, and we think the country remains an underpenetrated opportunity. Furthermore, we expect the brand to benefit from Warnaco's Asia and Latin America platform over the longer term.

We have a favorable longer-term revenue and earnings outlook for PVH, but we note risks including broad exposure to the euro, weakness in the turnaround of the Calvin Klein jeans business and Heritage Brands retail business, the ongoing promotional environment, and possible macroeconomic headwinds in Europe.

Brand Strength Keeps Company's Narrow Moat Intact Following the acquisition of Warnaco in 2013, we think PVH has successfully acquired and developed its brands into a distinctive array of lifestyle products for which customers are willing to pay a premium and has thus developed a narrow moat. We believe PVH can sustain a return on invested capital above its cost of capital, and we project a 14% compound annual rate of return on invested capital over the next five years versus our 8% cost of capital assumption.

Heritage Brands has strong U.S. market positioning, with neckwear topping a 50% share on a unit basis, dress shirts approximating a 45% share, woven shirts with a 19% share, and knit shirts with an 11% share (from a company presentation using 2012 unit volume in U.S. department and chain stores combined). However, it is the Tommy Hilfiger and Calvin Klein businesses that really stand out as leaders in their respective lifestyle brand categories. Tommy Hilfiger was acquired by PVH in 2010 and did more than $3.5 billion in global sales in 2014 with its classic preppy-with-a-twist brand generating strong global brand awareness. The Calvin Klein brand was acquired in 2003 and was supplemented by the acquisition of Warnaco in 2013, which gave PVH the Calvin Klein jeanswear and underwear licenses, thereby reuniting the disparate parts of the brand and giving PVH full control of its image. Time Magazine has cited Calvin Klein as one of the top 100 icons in fashion, style, and design, and Calvin Klein is the only brand that ranked in the top 10 of each category in the WWD 100, a brand awareness survey spanning more than 1,000 brands in nine categories. We think this image and recognition will only be enhanced now that PVH has full control of product quality and marketing.

Brand strength has given the company pricing power. Through the acquisition of Warnaco, management has been able to decrease the Calvin Klein jeanswear presence in discount and off-price retailers and is expanding the full-price business. We think this repositioning has increased the strength of the brand. Despite the current strength of the brands, we believe a narrow moat rating is more appropriate than a wide moat rating. Fashion is by its nature a constantly changing force. It is redefined and adapted by each generation to reflect its unique lifestyle, values, and style. Few brands truly transcend the generations and remain valued by multiple generations, and most of those fall in the luxury category. In our opinion, Tommy Hilfiger and Calvin Klein are still too young to have proved their multigenerational staying power.

Sound Acquisition Decisions Have Enhanced Shareholder Value We assign PVH a Standard stewardship rating. Emanuel Chirico has been chairman and chief executive officer since 2007. Previously he held various positions in the company including chief operating officer, president, and chief financial officer. Before joining PVH, Chirico worked for Ernst & Young as head of its retail and apparel practice group. The remainder of the board is composed of 12 other directors, 11 of whom are independent, with backgrounds in advertising, communications, finance, operations, and consumer products. We think the board is diverse enough and has an adequate mix of internal and external knowledge and skills to guide PVH through its strategic and operational requirements. We believe the company has successfully capitalized on and increased the strength of its current brand portfolio in existing markets and through international expansion. We also believe that acquisitions, including that of Calvin Klein in 2003, Tommy Hilfiger in 2010, and Warnaco in 2013, have strategically fit with existing capabilities, thereby adding new high-growth vehicles with synergies and benefits to existing brands. The acquisitions were at a fair value, in our opinion. We estimate that Tommy Hilfiger was purchased for $3 billion or 8 times trailing earnings before interest, taxes, depreciation, and amortization, and Warnaco was also purchased for roughly $3 billion but at a 9 times pro forma EBITDA multiple. We think these purchases have served to enhance shareholder value.