Tapestry already offers a distinctive portfolio in the luxury segment, and thanks to its high percentage of direct-to-consumer sales, Tapestry is able to achieve high profit margins. Tapestry is now attempting to emulate the model of some of the largest European fashion houses through the acquisition of Capri Holdings. Does this mean that now is the time to buy Tapestry shares? It is the subject of my investigation in this analysis.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of Tapestry. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I do not own any stocks in any of Tapestry's direct competitors either. Thus, I have no personal stake in Tapestry. If you want to purchase shares or fractional shares of Tapestry, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.
Tapestry was founded as Coach, Inc. in 1941 in New York, United States. Tapestry is a multinational luxury holding company that offers a diverse range of products, including handbags, ready-to-wear clothing, footwear, and jewelry. Tapestry currently owns three brands: Coach, Kate Spade, and Stuart Weitzman. Coach is their largest brand, representing 74,5% of total net sales in fiscal year 2023, followed by Kate Spade (21,3% of net sales in fiscal year 2023) and Stuart Weitzman (4,2% of net sales in fiscal year 2023). Tapestry will expand its portfolio from three to six brands through the acquisition of Capri Holdings, which owns the brands Michael Kors, Versace, and Jimmy Choo. Tapestry made the majority of its net sales in North America, which accounted for 65% of net sales in fiscal year 2023. Followed by Greater China at 15%, Other Asia at 14%, and the rest of the world at 6%. 88% of Tapestry's net sales are through direct-to-consumer channels, with 59% coming from their 1.429 company-owned stores and 29% from digital platforms. The last 12% of sales are through wholesale. Tapestry's brands are what gives it a brand moat, exemplified by the strong gross profit margins of 70,8%. Management has mentioned that they see tremendous long-term potential for their brands and will continue to drive stronger gross margins, demonstrating their confidence in the continued strength of the brands.
Their CEO is Joanne Crevoiserat. She joined Tapestry in 2019 as the Chief Financial Officer (CFO) and was appointed Chief Executive Officer (CEO) in October 2020. Prior to joining Tapestry, Joanne Crevoiserat served as the Executive Vice President and Chief Operating Officer at Abercrombie & Fitch Co. She also gained experience at companies such as Kohl's and Walmart. She holds a Bachelor of Science degree in Finance from the University of Connecticut and serves on the Board of Directors of General Motors. She has been recognized for her customer-centric, data-driven approach, her understanding of the unique needs and advantages of Tapestry's brands, and her focus on execution and growth. Additionally, she possesses deep financial and operational expertise. Joanne Crevoiserat has extensive experience in the industry and has often spoken about the importance of brands in a world where consumers can access almost anything they want, anywhere they want, and anytime they want. The emphasis she puts on brands may also be why she decided to acquire Capri Holdings for $8,5 billion. I appreciate Joanne Crevoiserat's emphasis on the importance of brands, as they are what give Tapestry its high margins and competitive advantage. Therefore, I am confident in Joanne Crevoiserat leading Tapestry in the future.
I believe that the Tapestry has a brand moat, and I have confidence in the management. Now, let's analyze the numbers to determine if Tapestry meets our criteria for having a strong competitive advantage. If you need an explanation of what the numbers represent, you can refer to "MY STRATEGY" on the website.
The first metric we will investigate is the return on invested capital (ROIC). I would like a 10-year history showing a minimum annual growth of 10%. Tapestry has mostly delivered high numbers, but there are some figures that stand out. One number is 2020, which was during the pandemic, and the other number is in 2018, the year when Tapestry acquired Kate Spade. The acquisition of Stuart Weitzman in 2015 is the reason for the third lowest numbers this year. Overall, the numbers are good, but it is slightly worrisome that Tapestry achieved its highest ROIC before acquiring Stuart Weitzman and Kate Spade. However, it is nice to see that Tapestry managed to achieve the highest numbers since the acquisitions in the past two years.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most significant of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. The numbers are a bit mixed due to significant declines in some years. 2020 was during the pandemic, so I understand that we experienced a decline. 2021 was marked by significant stimulus spending, leading to an increase in numbers. However, since 2022, there have been some macroeconomic challenges. Hence, although I'm not impressed with the numbers, I do believe there is an explanation for the pattern. This is why these numbers wouldn't deter me from investing in Tapestry.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins offer a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is unsurprising to note that Tapestry has consistently generated positive free cash flow every year for the past decade. Interestingly, free cash flow has only exceeded the 2014 level (the year before the acquisitions) twice. Once during the stimulus spending spree and then last year. It is encouraging that the free cash flow reached the second-highest level last year. Unfortunately, the levered free cash flow margin has not increased at the same rate, which is likely due to macroeconomic factors. The free cash flow yield isn't as high as it was before, but 6,5% is still considered high.
Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a three-year period. We calculate this by dividing the total long-term debt by earnings. After analyzing the financials of Tapestry, I found that the company has 1,75 years of earnings in debt. However, Tapestry will primarily finance its acquisition of Capri Holdings through debt. Thus, debt will be significantly higher in the next couple of years, and this is something that needs to be closely monitored. It is encouraging that the management has announced their intention to use their cash flow for accelerated debt repayment and has chosen to halt share repurchases in order to prioritize debt repayment.
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Based on my findings so far, I find Tapestry to be an intriguing company. However, no investment is without risk, and Tapestry also has its fair share of risks. One risk is macroeconomics. Many of Tapestry's products are considered non-essential items for consumers. The demand for their products and consumer spending in the premium handbag, footwear, and accessories categories may be significantly impacted by trends in consumer confidence, general economic and business conditions, high levels of unemployment, periods of inflation, interest rates, and the availability of consumer credit. Consumer purchases of discretionary luxury items, such as Tapestry's products, tend to decline during recessionary periods or sustained high unemployment when disposable income is lower. Another risk is competition. In its annual report, Tapestry mentions that the product categories in which it operates are highly competitive. Tapestry competes with other luxury brands based on style, price, customer service, quality, brand prestige, and recognition. Tapestry also mentions that the luxury segment is expected to continue growing, which encourages the entry of new competitors and increases competition from existing ones. Furthermore, during an earnings call, CEO Joanne Crevoiserat mentioned that Tapestry operates in an industry with low barriers to entry, making it easy for new competitors to enter the market. The acquisition of Capri Holdings. Once a company makes an acquisition that is equivalent to its market capitalization, it will always entail a risk. Especially considering Tapestry's track record with acquisitions, where the purchases of Kate Spade and Stuart Weitzman have not met expectations and have resulted in a decrease in return on invested capital (ROIC). Moreover, the acquisition of Capri Holdings will primarily be financed through debt in a high-interest rate environment. Finally, Capri Holdings currently has lower gross profit margins and operating margins than Tapestry.
There are also many reasons to invest in Tapestry. One reason is the large addressable market. Tapestry believes that its total addressable market is worth $320 billion, and with current revenue around $6,7 billion, Tapestry has plenty of potential for growth ahead. Tapestry may be on the right track as they continue to acquire new customers in the U.S., and these new customers transact at a higher average unit retail than existing customers. Tapestry is also expanding its presence in other markets, including greater China. Management believes there is more growth ahead in China, as their established platform in the region will drive long-term growth in the country. Direct-to-consumer sales. Tapestry makes 88% of its sales directly to consumers. Direct-to-consumer sales have higher profit margins compared to wholesale. Management has indicated that they have a highly profitable network of physical stores and a highly profitable digital sales channel. Direct-to-consumer sales also have another advantage. Tapestry will receive various data points from consumers, enabling the company to better understand consumer behavior and identify trends more quickly as they unfold. As a result, they can adapt to consumer trends much more quickly than if sales were conducted through wholesale. The acquisition of Capri Holdings. While the acquisition of Capri Holdings may pose a risk, it can also serve as a compelling reason to invest in Tapestry. Management believes that the acquisition will transform Tapestry into a powerful global conglomerate of luxury and fashion brands, expanding its portfolio across consumer segments, geographies, and product categories. Management believes that there will be cost synergies of over $200 million achieved within three years of the acquisition. They also anticipate that the acquisition will lead to significant value creation, with immediate accretion to adjusted earnings, improved cash flow, and strong financial returns. Furthermore, management believes it has an opportunity to develop the direct-to-consumer business with the Capri brands. If management executes the plan, the acquisition could be a success story.
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Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 3,88, which is from the fiscal year 2023. I have selected a projected future EPS growth rate of 7%. Finbox expects EPS to grow by an average of 6,9% in the next 5 years. Additionally, I have selected a projected future P/E ratio of 14, which is double the growth rate. This decision is based on Tapestry's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $26,41 We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Tapestry at a price of $13,21 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 975, and capital expenditures were 184. I attempted to analyze their annual report in order to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 129 in our calculations. The tax provision was 210. We have 229,186 outstanding shares. Hence, the calculation will be as follows: (975 – 129 + 210) / 229,186 x 10 = $46,07 in Ten Cap price.
The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Tapestry's free cash flow per share at $3,41 and a growth rate of 7%, if you want to recoup your investment in 8 years, the Payback Time price is $37,43.
I find Tapestry to be an intriguing company. I appreciate the management because they prioritize the importance of the brands, which is what gives Tapestry its competitive advantage. Tapestry is currently facing some short-term risks due to macroeconomic factors, but these are expected to improve over time. Competition will always pose a risk for Tapestry, but I believe they will thrive because management is emphasizing the importance of brands. Tapestry has a sizable addressable market and is consistently attracting new customers in the U.S. It is also experiencing growth in Asia. I really like that Tapestry mainly sells directly to consumers. This not only results in high profit margins but also provides Tapestry with a wealth of data points that they can leverage in future sales. The acquisition of Capri Holdings carries some risk, but if management successfully executes the acquisition, it has the potential to be highly profitable in the long run. Personally, I am somewhat cautious about the acquisition due to the high debt that Tapestry will need to take on. Additionally, their previous acquisitions have not unfolded as expected. It is possible that Tapestry would be in a better business position now if they had not acquired Kate Spade and Stuart Weitzman, both of which have lower margins than Coach. Therefore, I will not be investing in Tapestry at this time, even if I can acquire the shares at a 50% discount to their intrinsic value.
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