Capri Holdings: Designer Fashion Brands Still Facing Headwinds (NYSE:CPRI)

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Capri Holdings Limited (CPRI) is an apparel marketer and retailer focusing on premium and luxury fashion through a brand portfolio that includes “Versace,” “Jimmy Choo” and “Michael Kors.” This year’s pandemic has represented a significant disruption to the company’s operations as lockdown measures forced the temporary closure of the company’s nearly 1,300 worldwide store locations pressuring sales which fell by 67% year over year in the last quarter. While the stock has rallied off the lows this year, shares are still down over 45% in 2020, amid the financial impact and ongoing uncertainties related to recovery. Notably, we highlight the recent resurgence of coronavirus cases along with limited international travel to tourist shopping destinations as ongoing headwinds. Ahead of the upcoming fiscal 2021 Q2 earnings release, we are taking a cautious view on shares of CPRI and see risks tilted to the downside.


CPRI Financials Recap

The company last reported its results for the period through June 27 in early August. The takeaway from the report is that April likely represented a low point for the operating environment as management highlighted sequentially improving trends in recent months as most stores reopened.

As mentioned, sales in Q1 fiscal 2021 fell by 66.5% y/y, although the product mix and pricing led to the gross margin reaching 67%, up from 62% in the period last year. Still, considering the reduced sales volumes, the EPS loss of $1.21 reversed a profit of $0.30 in the period last year.

By segment, Michael Kors – representing over two-thirds of the business – saw sales fall by 68.7% year over year. On the other hand, the smaller Versace group which contributes about 21% of total sales fared slightly better, with sales declining by 55.1%. All three brands, including Jimmy Choo, generated negative operating margins. Some of the positives the company is focusing on are the trends in e-commerce with gains for all brands and omnichannel growth, which includes sales on mobile and alternative platforms.

(Source: Company IR)

It’s worth noting that despite the challenges, the balance sheet position remains supported by a strong liquidity profile. Capri ended the last quarter with $207 million in cash and $1.1 billion in total liquidity, including credit lines. Net debt reported at $1.6 billion has declined over the past year.

(Source: Company IR)

Company Guidance and Consensus Estimates

While Capri is not offering full-year earnings guidance, management is estimating fiscal 2021 revenues at $3.6 billion, down 35% year over year, which would include the recent Q1 results and gradual recovery over the next few quarters.

In the longer term, the company maintains a positive outlook pointing to underlying momentum in Asia where regional sales have been stronger. Capri intends to continue its expansion plans targeting more stores for Versace and Jimmy Choo, while consolidating the Michael Kors brand.

(Source: Company IR)

In terms of consensus expectations, the market estimates for fiscal 2021 revenues at $3.7 billion is slightly ahead of the company guidance. The market also expects CPRI to reach positive EPS of $0.58 this fiscal year while earnings should accelerate through 2022 with a forecast of $2.94 per share. While the direction of the outlook is improving, keep in mind that CPRI generated adjusted EPS of $3.89 last year, implying the current forecasts do not expect the company to reclaim its previous level of profitability through at least fiscal 2023.

(Source: Seeking Alpha)

Analysis and Forward-Looking Commentary

The strength of Capri Holdings is its high margins generated from the luxury apparel segment which supports strong cash flows. In a normalized operating environment, the business is very profitable and commands a market premium. Versace is one of the most well-recognized fashion brands in the world that has a loyal following and remains on the cutting edge of industry trends. By this measure, we expect the company to survive the current challenges and be well-positioned to eventually recover.

On the other hand, as was discussed in a recent article by Seeking Alpha contributor Ishwarya Prasanna, Michael Kors continues to represent a drag on the broader business, with weaker trends and a sense that the brand has lost its target audience attempting to be too many things at once. Disappointing growth from Michael Kors even before the pandemic showed the need for a brand refresh. Capri is addressing these dynamics by closing non-performing stores and focusing more on Versace and Jimmy Choo, which we believe is a good strategy.

In terms of valuation, looking beyond this year and into fiscal 2022, the consensus estimate for EPS to reach $2.94 implies a 1-year forward P/E of 7.4x. While this is objectively a cheap multiple for what could be a strong turnaround story, consider that there are significant uncertainties regarding the near-term outlook and the earnings recovery may simply not materialize. Risks are tilted to the downside as it relates to the high-cost structure of the retail business that depends on consistent traffic for both company-owned locations and wholesale partners.

Ongoing Headwinds

While the company guidance for the year ahead is encouraging, current developments warrant some caution. Cases of coronavirus infections are again spiking worldwide in what has been described as a “third wave” with particular concerns in Europe and parts of the U.S. As it relates to Capri Holdings, any setback in the pace of normalizing operations and regular store traffic limits the recovery in sales. Heading into the holiday shopping season, the potential that local governments in various jurisdictions re-close retail establishments or enforce stricter social distancing rules can directly impact Capri Holdings and force a revision lower to earnings estimates.

There is also a dynamic that the ongoing pandemic continues to limit global travel and tourism to traditional shopping destinations. Currently, major countries have restrictions on foreign air travel, which have particularly disrupted the entertainment and hospitality industry. Capri Holdings as an apparel retailer often places stores in areas that are likely to see high-spending visitors and vacationers. While the products are still available in most markets and through e-commerce, poor performing brick-and-mortar store trends can pressure earnings. The potential that the pandemic lasts longer through 2021 is a bearish trend for the stock.

The other risk to watch here are broader macro concerns. While consumer spending in markets like the U.S. has been relatively resilient, a weaker labor market and reduced incomes may linger for the foreseeable future. Beyond a deterioration to the global growth outlook, the next couple of quarterly earnings will be important to confirm a sales recovery and the resiliency of cash flows.

Upcoming Fiscal 2021 Q2 Earnings Report

While a date for Capri’s fiscal 2021 Q2 earnings release has not been confirmed, the report is expected in early November. The current consensus is for revenue of $898m, down 38% y/y while EPS may be flat at $0.00. We think there could be some upside to the sales figure but see earnings pressured on the cost side. The comments by management and any update to guidance will be more important.

(Source: Seeking Alpha)

With the stock currently trading at $22.00 per share and up over 300% since the low in March, we take a neutral view on CPRI with a hold rating. We want to see some confirmation that sales and earnings can return to pre-pandemic levels. Our take is that CPRI is likely to trade based more on market sentiment and headlines over the near-term financial results. To the upside, the stock could gain momentum if there are indications the global business and the apparel retail industry are normalizing, possibly with the pandemic getting under control.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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