Tapestry Stock: Growth Slowdown Imminent (NYSE:TPR)

Coach shop after departure gate for international flight of Ngurah Rai International Airport

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Luxury fashion company Tapestry (NYSE:TPR) has a particularly attractive price-to-earnings (P/E) at just shy of 10x. This is in stark contrast with the likes of Hermes (OTCPK:HESAY) at 44.3x or LVMH (OTCPK:LVMUY) at 22x. But does that mean Tapestry is due for an upturn in share price? This analysis looks at the company’s positioning and fundamentals in comparison to peers to understand what’s next. It concludes that there’s weakness in some of its recent numbers, and it doesn’t always compare well with peers either.

A Coach isn’t a Birkin

There are luxury goods, and then there are luxury goods. The likes of Hermes produce Birkin bags, which are the ultimate in coveted luxury to the extent that there’s a long waitlist for them. On the other hand, are bags by Coach, Tapestry’s highlight brand and its biggest source of revenue. They are luxury bags too, to be sure, but along with TPR’s other big brand, Kate Spade, they fall under the category of affordable luxury. In essence, this means that the company’s catering to a very different consumer category from Hermes. Presumably, it doesn’t just target the wealthy, it can also be afforded by aspirational consumers or those with rising incomes. It follows that it’s more susceptible to fluctuations in the economy. And that the market dynamics it’s faced with are fundamentally different too.

The macro assessment shows a weakening

In this context, I took a look at how it’s faring in the current macroeconomic climate of slower growth, elevated inflation and rising interest rates. A summary table is below, which shows weakening because of slower demand and high inflation even as its ability to pay for its current liabilities is strong, with a current ratio of 1.8x.

Macro assessment

Seeking Alpha, Tapestry financial results

China impacts growth

Getting into the details shows that for its latest financial year ending July 2, 2022 (FY22), its revenue grew by 16.3%. But numbers for the final quarter of the year (Q4 2022) reveal that revenue growth had dwindled down to just 0.6% YoY. TPR doesn’t provide a split-up of geography-wise growth, but it does say it “Drove double-digit sales increases… across North America, Japan, Other Asia and Europe, which offset a low-30% revenue decline in Greater China due to Covid-related disruption, as anticipated”.

Now, Asia has a relatively smaller revenue share for the company of 27% than some of the other luxury goods companies, with Greater China accounting for 15% of this share. A sharp drop-off in sales to China can still have a disproportionately high impact. At the same time, it’s hard to ignore that a lion’s share of its revenue, at 67% comes from the US. The economy is in a technical recession, having reported two straight quarters of shrinking GDP. This suggests that there might have been some impact from it on growth in Q4 2022. Speculative as this sounds, I’d keep it at the back of my mind.

Keeping track of revenue growth is critical also because Tapestry has not just slowed down to a crawl in Q4, it’s lagging behind peers in terms of full-year numbers too. Its revenue growth for the last financial year is higher only than Burberry’s (OTCPK:BURBY), which is at 14.6% (see chart). The average growth, including the biggest luxury companies, is 28.4%. Even for its closest peers, represented by companies like Capri Holdings (CPRI), Burberry and Prada (OTCPK:PRDSY) the number is at 24.9%. Some variations can be due to differences in a financial year ends, but on the whole, the number is still indicative.

Revenue growth

Tapestry financial results, Seeking Alpha

The operating margin’s healthy, but some decline seen

Next, to assess the impact of high inflation on Tapestry, its operating margin was considered. It too dropped to 15.3% in Q4 2022 from 17.6% in FY2022. This is down to its higher cost of sales, which rose by 22.2% for the full year. This number grew by a slower 12.5% YoY in Q4, but that’s only because of a base effect as the company first saw a huge 128.3% rise in this in Q4 last year. Its operating expenses fell in Q4, which is notable, since the hit to its operating profit, which showed a nominal fall, trickles down from the decline in gross profits. Whichever way we look at it, however, it’s clear that inflation has impacted TPR’s margins. I’d look out for future trends in the cost of revenues to assess how the company’s impacted when the base is more normal.

That said, it’s worth noting that the company’s operating margin for FY22 isn’t bad. In fact, it’s comparable to a number of other luxury goods companies’ margins save Hermes, Kering (OTCPK:PPRUY) and LVMH. Its margins are actually higher than those for Prada and are comparable to those for Capri Holdings and even Richemont (OTCPK:CFRUY).

Operating margins

Tapestry financial results, Seeking Alpha

Persisting risks

Nevertheless, the upshot from the macro assessment is that weakness is visible in the latest sales growth as well as margins, to a lesser extent. With the US economy’s growth expected to slow down significantly in 2023, its sales could be impacted further, given its dependence on the market. In any case, its guidance for FY23 is muted, with an expectation of a 3-4% revenue increase.

While inflation is expected to come off significantly by this time next year, for now, it stays high and despite all indications of being temporary in the past, it has persisted. TPR could feel the squeeze if demand slows down further while inflation stays high. Interestingly, though, the company anticipates an almost 20% rise in diluted EPS next year. Positive as this is, in the current environment I’m not sure if this is achievable.

Poor price performance

Additionally, its price performance isn’t encouraging either. An investor who bought the stock 10 years ago would now be seeing a 44% decline in capital. This is the biggest drop seen among the luxury stocks in consideration here, and one of only three stocks that have managed to erode capital. Much like other luxury stocks, it has seen a fall over the past year too. It’s not the worst fall, but in the overall scheme of things, it’s far from encouraging (see table below).

Price performance

Seeking Alpha

What next

I think the writing’s on the wall on this one. Despite its low P/E ratio, TPR isn’t one to buy right now. There could be some improvement in price in the current financial year as it undertakes a share buyback. Also, if inflation really does start coming down, its margins could benefit. Further, it’s currently undertaking an ‘Acceleration Program’ which aims to make it a leaner, meaner machine that’s yielded results in the last year in terms of customer acquisitions and in driving digital sales. Gains from this strategy could continue to show up next year as well. For now, though, I’d wait and watch.

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