Capri Holdings stock is a buy on European strength (NYSE: CPRI)
Luxury sales in Europe hold up
We were one bit surprised last week when we saw LVMH Moet Hennessy Louis Vuitton (OTCPK: LVMHF) (OTCPK:LVMUY) announce solid first quarter sales, despite a difficult environment in Asia. As we pored over the numbers to try and glean data that would be applicable to the names on our watchlists, we were a little surprised to see which geographies contributed to the impressive results. For those who weren’t watching, the French luxury house posted revenue of $19.5 billion, up 23% organically against the 17% consensus expected by analysts. Organic revenue in the US grew by 26% and in Europe by 45%, with Asia (excluding Japan) being the disappointment as it only grew by 8%. This all sounds pretty boring, until you start watching the management commentary and the trickle of news that came out after competitors were published discussing their bullish views for the industry.
Although we follow LVMH, as anyone who follows names in this particular industry should, we weren’t so much interested in what LVMH had to say as the company itself, but in the information it could provide for names with decent European exposure. So while we’ve written before about how Tapestry, Inc. (TPR) is a name we really like (article available here), we have to admit that we’re gearing up for Capri Holdings Limited (NYSE: CPRI), as their geographic sales footprint could provide some diversification outside of Asia, while providing additional exposure to all markets that are currently seeing outsized growth. These other markets are specifically the Americas and Europe, and although we were initially concerned about sales in Europe due to the Russian invasion of Ukraine, it appears that consumers have not been deterred from purchasing luxury goods so far. Closures in China are affecting current demand, so while names like Tapestry should do well in the long term with this growing market, others, like Capri, could outperform in the short term due to less revenue exposure to the region.
Also, Tapestry doesn’t really compete at the higher end of the luxury spectrum, but Capri (through its Versace brand) might find itself in a position to benefit from some of the moves European luxury houses are making; more specifically, their ability to raise prices to compensate for inflationary pressures and the good performance of currencies against the euro. According to Bloomberg (see article here), Cartier is likely to raise prices by 3% to 5% while Chanel has been much more aggressive and has raised the prices of some handbags, “by more than 50%”.
Versace is on its way to becoming a $2 billion+ brand, and it’s a true European fashion brand with the ability to join its peers in driving up prices. That, coupled with Capri’s European revenue in the first nine months of this year (just over 26% of total revenue), could help the stock not only outperform in the coming quarters, but also when paired. to other names, like Tapestry for example. , could help balance a portfolio and diversify some of the geographic risks that investors currently face.
The purchase of Versace was a once-in-a-lifetime acquisition, and over the past few years it has proven that this management team can work with the “big boys” of European luxury brands. As Versace will become a $1 billion+ brand this year and is on track to become a $2+ billion brand in the near future, management has already explained how it has the opportunity to significantly increase its revenues simply by matching the activity of its physical stores to that of their European competitors. Their current footprint could do up to 4x more business just by matching this business, and with the store refreshes that are underway, it looks like management is working to address this issue to continue reaping the rewards within reach. tomorrow.
No one will dispute Versace’s place among high-end luxury brands, but Capri’s other brands are much more accessible to consumers. Management is currently working on the premiumization of these brands, that is, making them more luxurious and desirable for consumers. It’s not something that happens overnight, or with a new product line, but it is a process that takes time. Management believes that they are succeeding in their plans as they see an increase in AUR (average retail unit), need to reduce discounts and see high demand for items with logos. While this is true for all of their brands, it’s good to see, especially for the Michael Kors brand.
Operating margins remain strong at Michael Kors and likely have a bit more room to grow over the next few years, but we think investors should watch Versace’s margins as they have ample headroom to grow from current levels. As Versace becomes a bigger part of the business, this margin expansion could become a more important driver of EPS growth than revenue growth (depending on timing and actual revenue growth). business, of course).
Capri’s capital allocation strategy
We really appreciate companies that reward shareholders by returning excess cash to them rather than wasting it on acquisitions that don’t make much sense or flooding executives with obscene compensation packages. Capri currently does not pay a dividend, however, the company has repurchased shares under the new $1 billion share buyback program it announced last quarter (and has a history of buybacks). Since the announcement, Capri has repurchased about 3.2 million shares for about $200 million. The Company’s share buyback program has $800 million remaining as of February 2, 2022.
Management reiterated on the last conference call that they are really only interested in European luxury brands for M&A activity and there are currently none of interest to them; so expect Capri to continue to pay down debt and repurchase stock as they are very optimistic about their ability to grow the current business and believe the stock does not reflect its full value.
How would we trade that
We already own Tapestry stock and want to use Capri Holdings to gain more exposure to Europe and the ultra-luxury market, so we are stock buyers here. We believe consumers will eventually switch from buying to experiencing, but continue to see value in some of these American fashion names that have been fixing or expanding their brands over the past few years.
Although we are directly long on the name at current levels, we will also try to sell the April 29, 2022 CPRI put options at a strike price of $50/share. The current bid/ask is $1.40/$1.75, so at the midpoint of $1.53, the 8-day option generates an option premium of 3.06% (based on the 5 $000 of capital it locks up) for us, or $123 per contract. We will sell one put contract for every 100 shares we buy, because we have a number of call options in Tapestry that we can associate with those put options. If Capri shares go down and the shares are offered to us, then we can exercise some of our calls in the price we have on Tapestry to move that trade forward.