Tapestry Inc. on Tuesday got caught in the squeeze between developing a long-term strategy and satisfying Wall Street’s short-term demands.
The fashion group managed to beat Wall Street’s third-quarter consensus estimates for earnings per share by 4 cents, boosted in part by a change in its tax rate. But the company’s discussion about the integration of the Kate Spade brand as well as some hiccups connected with the product line at Stuart Weitzman gave investors pause over what the fourth quarter might be like — and maybe even the quarter after that.
Wall Street punished the firm for that, sending Tapestry shares down 11.7 percent to close at $47.46 in Big Board trading.
But the reaction on the short-term prospects seemed to ignore what is likely to be an improved longer-term positioning of a company that now includes three brands: The core Coach label; Stuart Weitzman, which Coach acquired for $574 million in 2015, and its newest baby, Kate Spade, acquired in July 2017 for $2.4 billion.
The company said in its earnings report that Coach — still the main driver for Tapestry’s earnings — showed strength, particularly in its North American business.
Victor Luis, chief executive officer of Tapestry, said in telephone interview that synergies from the Kate Spade integration onto Tapestry’s platform is at $45 million, up from initial projections of between $30 million and $35 million. That savings on an annualized basis would meet next year’s run rate estimate of between $100 million and $115 million in savings. Revenues at Kate Spade slipped slightly — Susquehanna International Group analyst Bill Dreher said 0.7 percent to $269 million — but that was due to strategic planning as a result of a pullback on promotional sales in the wholesale channel and fewer online flash-sale events. Offsetting the sales decline was the consolidation of the ventures for Mainland China, Hong Kong, Macau and Taiwan.
At Weitzman, sales were up 5 percent to $85 million, but sales and margins were impacted by production delays and lower sell-through of carryover product. Luis said the company “expects the Stuart Weitzman brand to get back to growth in the second half of fiscal-year 2019.” He explained that the line from creative director Giovanni Morelli “has a level of complexity” that required changes “in the supply chain in Spain that [it] was not prepared for,” as well as in the execution of the product, which impacted its timely delivery. According to Luis, the company is adding infrastructure and capacity to meet and support the creative vision for the brand. The product will begin to flow “heavily [into stores] in August, September and holiday,” the ceo said.
As for Coach, sales in the quarter rose 6 percent to $969 million, with global comparable-store sales up 3 percent. In particular, Greater China comps rose, with the Mainland, Hong Kong and Macau all comping positively. The quarter also represented the first comps gain in Hong Kong and Macau since fall 2014 when the retail market was negatively impacted by geopolitical events.
Coach brand president Joshua Schulman, who was also on the call with Luis, said the strength in the quarter was due to the overall health of the Coach brand.
“A lot of it was driven by product. The customer liked the product, fueled [in part] by the relaunch of [our] Signature line. We saw positive comps growth for the Coach brand, with outperformance in North America across our retail brick-and-mortar stores, and at wholesale and e-commerce channels,” Schulman said. He added that some of that growth was attributed to the brand’s footwear collection, which the company took back in-house last year.
With the take-back of control of its Kate Spade ventures, the Stuart Weitzman business in Northern China and the buyback of the Coach business in Australia and New Zealand, much of Tapestry’s future growth will be international.
Luis explained that when the company took back the Coach operations in China a few years ago, it was the same size as Kate Spade today, which the company grew to a business north of $600 million from $500 million. Also growing were the number of stores over the years to 180 locations from just 30. “That gives a wonderful indication of the huge opportunity for Kate Spade in that market,” Luis said, adding that there is an opportunity to also build out the Stuart Weitzman business. He also noted that opportunities in Mainland China for the footwear brand was were key drivers in the company’s decision to invest in the Weitzman brand.
With much of the handbag and accessories supply chain operation for Kate Spade fully integrated on Tapestry’s platform, even though there’s a little more work to do that’s back-office-systems-related, might another acquisition be on the horizon?
According to Luis, “We’re very focused on Coach, Kate Spade and, of course, Stuart Weitzman. We’ve said that in terms of capital allocation, our first priority is growing our businesses organically, and second is acquisition. Third is returning cash to shareholders.”
Jefferies analyst Randal Konik has a “Hold” on shares of Tapestry, noting: “We think valuation is high for a company that is not operating on all cylinders.” He also noted that while synergies are good at Kate Spade and Coach, there could be a question regarding the long-term sustainability of positive comps at Coach, and that restoring positive comps at Kate Spade may take time.
In contrast, analyst Dana Telsey at Telsey Advisory Group has an “outperform” rating on shares of Tapestry. She said, “[W]e remain encouraged by the ongoing solid global comp growth at the Coach brand. We see the brand’s results as speaking to the continued success of its repositioning, which is the ultimate driver of the Tapestry investment thesis.” She also noted that the Kate Spade contribution to operating income has been elevated as the company continues to pull back on promotions, which would help long-term brand health.