Tapestry Earnings: North America Market Challenged With Capri Deal Looming; Shares Undervalued

Narrow-moat Tapestry’s results fell slightly short of our expectations in its June-ended fiscal 2023 fourth quarter, as its North America sales dropped 8%. In addition, the firm’s fiscal 2024 guidance for sales of nearly $6.9 billion and EPS of $4.10-$4.15 is shy of our preearnings-call respective estimates of $7.04 billion and $4.36. Tapestry’s report came one week after it announced that it will buy no-moat Capri CPRI, which reported a 10% decline in its quarterly sales, for $57 per share (see our previous notes). Despite an expected reduction in our fiscal 2024 estimates to incorporate Tapestry’s new guidance, we expect to lift our fair value estimate to about $60 from $57 as it is buying Capri at a discount to our valuation. We believe investors are underestimating the benefits of the deal and view Tapestry’s shares as attractive.

Tapestry missed our 2% estimate with flat quarterly sales growth. Coach’s sales (77% of total) edged up 3% versus our 2% forecast, but sales of Kate Spade (19% of total) and Stuart Weitzman (4% of total) suffered declines of 10% and 13%, respectively. In the long run, we forecast annual sales growth of about 2.5% for Coach and 5%-6% for Tapestry’s two smaller brands. However, long-term plans could change after the Capri acquisition, especially as we believe Versace and Jimmy Choo may have brighter growth and profitability prospects than Kate Spade and Stuart Weitzman.

Tapestry’s 72.4% quarterly gross margin eclipsed our forecast by 90 basis points on lower freight expenses, price increases, and higher-margin Coach’s outperformance. However, its 16.9% operating margin fell short of our 17.8% forecast due to the sales shortfall and the timing of expenses. Although we believe Tapestry can lift its operating margins from fiscal 2023′s 17.6% to above 19% within about two years, we forecast operating margins of only about 15% for Capri. Thus, the integration is likely to be margin dilutive despite an expected $200 million in synergies.