Shares of Kate Spade & Co. (KATE, Financial) rose 22.92% on Dec. 28, 2016, after reports showing that the company was exploring a sale.
A month earlier, Kate Spade shareholder Caerus Investors indicated that the former would be an excellent acquisition candidate in the lifestyle accessories category. The investor observed that Kate Spade has suffered a lack of market appreciation in its share price and being undervalued compared to its historical valuations, current and potential growth of its business.
According to the Wall Street Journal, Caerus Investors called for the company to consider a sale in November. Caerus did not disclose the size of its stake in the apparel manufacturer but had about 0.85% as of Sept. 30, 2015.
Earnings performance
Kate Spade delivered its third quarter fiscal 2016 results on Nov. 2, 2016. The apparel manufacturer delivered 11.9% sales growth to $910.6 million for its recent 39 weeks of operations that ended on Oct. 1, 2016. Kate Spade also delivered a profit of $65 million compared to a loss of $44.4 million year on year.
"In the third quarter, several macroeconomic factors, including a challenging retail environment and continuing tourist headwinds, impacted our results. That said, we are making solid progress on several strategies that are continuing to drive growth in our business, which is reflected in the consumer's strong response to our collections at full price. We remain focused on the factors we can control as we continue to grow our business and execute our long-term strategy, maintaining our commitment to become a $4 billion business at retail." – Craig A. Leavitt, CEO of Kate Spade & Co.
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2015 review
In review, Kate Spade had a good amount of deductions to its sales during the same period last year. To start with, the company had $503 million in selling, general and administrative expenses compared to this year’s $459 million.
Kate Spade also had a $9.87 million loss in relation to notes receivable settlement. In its filings, the company redeemed senior secured loans with an aggregate principal amount of $400 million that were once due in 2019.
In addition, Kate Spade also experienced a good level of deduction, $4.6 million, in relation to discontinued operations from the sale of Lucky Brand in 2014 and wind-down operations of the Juicy Couture business in the same year.
(Morningstar data and press release)
Guidance for 2016
Kate Spade reaffirmed its fiscal 2016 guidance and sees a possible 11% growth with midpoint net sales guidance of $1.385 billion. The apparel maker also expects a possible 412% growth with a midpoint diluted earnings-per-share (EPS) guidance of 0.67 cents per share. These guidance figures indicate that Kate Spade has shown a good recovery in its sales and profits in recent years.
(Annual Report)
Kate Spade
The Kate Spade brand was launched in 1993. In 1999, Neiman Marcus Group purchased 56% of the company for $33.6 million and acquired the remaining shares in 2006 for another $59 million. Also in 2006, Liz Claiborne bought Kate Spade from Neiman Marcus Group for $124 million. The founders, Kate and Andy Spade, have been totally detached from the company since the Neiman Marcus buyout in 2006. Meanwhile, Kate Spade is valued at $2.3 billion.
Kate Spade has two lifestyle brands: kate spade new york and JACK SPADE (1). In fiscal 2015, Kate Spade derived 81.5%, or $1 billion, of its sales from the U.S. The company has three reportable segments: Kate Spade North America, Kate Spade International and Adelington Design Group segments.
(10-K and 10-Q filings)
Kate Spade North America
The segment consists of Kate Spade New York and Jack Spade brands in North America. The segment grew 15.6% in fiscal 2015 and had an adjusted earnings before interest, tax, depreciation and amortization (EBITDA) margin of 17.2% (2). Nine months into fiscal 2016, business in North America grew 13.6% and delivered an adjusted EBITDA margin of 15.9%.
Kate Spade International
The segment consists of Kate Spade New York and Jack Spade brands in international markets, principally in Japan, Asia (excluding Japan), Europe and Latin America.
In fiscal 2015, the international business had a negative 11.9% change and contributed 15%, or $188.2 million, in total Kate Spade sales. For the period, the international business delivered an adjusted EBITDA margin of 9.4%. Three quarters into fiscal 2016, international business grew 5.3% and delivered a 12.5% adjusted EBITDA margin.
Adelington Design Group segments
The segment consists of two parts –Â first, Kate Spade’s exclusive arrangements to supply jewelry for Liz Claiborne and Monet brands; second, licensed Lizwear and Liz Claiborne New York brands.
In fiscal 2015, Adelington Design Group had a negative 29.5% change in its sales to $23.4 million while contributing 2% of total Kate Spade Sales. The segment also had an adjusted EBITDA margin of 19.3%, highest among the three segments.
Nine months into fiscal 2016, Adelington Design Group experienced negative growth with -1.7% change from the year prior and delivered a 23.8% adjusted EBITDA margin.
Comparable store sales
(Figures excluded any additional weeks in the fiscal year, 10-K and 10-Q filings)
Kate Spade reports its comparable direct-to-consumer sales figures including and excluding e-commerce figures (3).
Valuations
According to GuruFocus data, Kate Spade had a trailing 12-month price-earnings (P/E) ratio of 17.8 times (industry median of 17.7), price-book (P/B) ratio of 6.67 times (industry median of 1.7) and price-sales (P/S) ratio of 1.7 times (industry median 0.96). The company does not provide dividends.
Market performance
Kate Spade had total five- and one-year returns of 16% and 10% while the broader Standard & Poor's 500 index had 14.3% and 20.7%, according to Morningstar data.
Cash, debt and book value
Kate Spade had $308 million in cash and $394.2 million in debt with a 1.14 times debt-equity ratio as of Oct. 1, 2016, compared to 5.83 times in October 2014 and 2.29 times in October 2015; 13.7% of Kate Spade’s $1 billion assets were in goodwill and intangibles while having a book value of $345 million compared to $173 million the prior year.
Cash flow
(10-Q)
Secondary to its strong profit growth, Kate Spade saw a good amount of cash coming in from its nine months fiscal 2016 operations. Kate Spade had lesser cash outflow related to its inventories and also saw a drop in cash flow received related to account payables.
Capital expenditures were $37 million, leaving Kate Spade with $23.4 million in free cash flow, compared to negative $32.3 million the year prior. Kate Spade allocated $3 million in Term Loan repayments and did not issue any debt for its recent nine months fiscal operations.
Conclusion
The ongoing turmoil in the retail industry did not skip Kate Spade's business. As shown by its recent comparable store sales figures, Kate Spade seemed to demonstrate a company that has began an effective turnaround. Selling businesses and getting rid of debt at an early stage shows the company’s confidence in its ongoing operations.
Kate Spade still carries a quite leveraged balance sheet but has improved its position compared to the year prior.
(GuruFocus.com)
In December, Mizuho reiterated its buy recommendation on the company and indicated a price target of $21 a share. Five-year historical multiple averages applied to Kate Spade’s fiscal 2016 EPS guidance and a 20% margin suggested a value of $20 per share. Given Kate Spade’s recent $18 share price, there seem to be a little, 11%, more room to run still.
Therefore, Kate Spade is a speculative buy with a $20 per share target price.
Notes
- 10-K:
kate spade new york
kate spade new york brand offers fashion products for women and children, as well as home products, under the kate spade new york trademark. The kate spade new york brand product line includes handbags, small leather goods, fashion accessories, jewelry, fragrances and apparel along with licensed products including footwear, swimwear, watches, children's wear, optics, tabletop products, legwear, electronics cases, furniture, bedding and stationery.
JACK SPADE
JACK SPADE brand offers fashion products for men, including briefcases, travel bags, small leather goods, fashion accessories and apparel under the JACK SPADE trademark. JACK SPADE products are sold primarily: (i) via the company’s JACK SPADE e-commerce website and (ii) through department stores.
- 10-K: Adjusted EBITDA: Segment Adjusted EBITDA excludes: (i) depreciation and amortization; (ii) charges due to streamlining initiatives, brand-exiting activities and acquisition related costs; (iii) losses on asset disposals and impairments; and (iv) the $26.0 million charge incurred in 2015 to terminate contracts with our former joint venture partner in China. The costs of all corporate departments that serve the respective segment are fully allocated.
- Comparable direct-to-consumer net sales defined in 10-K:
- New stores become comparable after 14 full fiscal months of operations (on the first day of the 15th full fiscal month);
- Except in unusual circumstances, closing stores become noncomparable one full fiscal month prior to the scheduled closing date;
- A remodeled store will be changed to noncomparable when there is a 20.0% or more increase/decrease in its selling square footage (effective at the start of the fiscal month when construction begins). The store becomes comparable again after 14 full fiscal months from the re-open date;
- A store that relocates becomes noncomparable when the new location is materially different from the original location (in respect to selling square footage and/or traffic patterns);
- Stores that are acquired are not comparable until they have been reflected in our results for a period of 12 months;
- E-commerce sales are comparable after 12 full fiscal months from the website launch date (on the first day of the 13th full month).
Disclosure: I do not have shares in Kate Spade.
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