We've described Dillard’s as an “idiosyncratic” brand in the past given its ability to put up stronger than expected results and exceed what the data suggests. This quarter (April-July) is a good example of that given the -3% comp vs. traffic (Placer) of down -22%. Cosmetics was the strongest performing category followed by home and furniture (interesting and definitely idiosyncratic). Ladies’ accessories, lingerie, apparel, and shoes were the weakest-performing categories as has been the trend for the market. The company's Q2 2023 press release quotes CEO William Dillard, II as saying, “The cautious consumer we noted in the first quarter continued in the first few weeks of the second, leading to a sales decline of -3%. We exited the quarter with inventory flat year-over-year while maintaining a strong retail gross margin.” Gross margin was down -110 basis points year-over-year and decreased significantly in women’s apparel and accessories.
Dillard’s stated that the traffic decline was related to the macroeconomic environment, and that both comparable sales and traffic were slightly less bad quarter-over-quarter, which is a plus. The 19-point difference between comparable sales and traffic suggests ongoing improvement in average ticket size, merchandising, assortment, service levels, and clienteling. Given the reasonable inventory levels, those contributors should continue as drivers in the second half of the year. The decline in traffic and the increase in ticket also reflect customer mix changes as the less affluent and the aspirational segments of the market have disengaged from discretionary goods since last fall.
That dynamic is also evident in the results from Ralph Lauren, whose Q2 2023 results provide a glimpse into coming Q2 updates for other apparel retailers. For Ralph’s North American business, comparable-store sales declined -5% in brick & mortar stores and wholesale revenue decreased around -8% due to lower retailer orders and deliveries. The company's Q2 2023 update described the consumer backdrop as choppy and cited continued inflationary pressures on our more value-oriented consumers. The traffic chart below shows Dillard’s and Polo Ralph Lauren’s declines as similar and consistent month-on-month. Shown here are Ralph’s outlet stores, not its big city premium stores, and their traffic declines reflects the disengagement by less-affluent and value-oriented consumer.
From LVMH’s and Richemont’s results, we know that aspirational and prestige luxury was worse in Q2 2023 compared to earlier in the year. Based upon that, the above, and other reports over the past month, we expect to see similar results when other department stores and fashion retailers report over the coming weeks (sales down year-over-year but sequential improvement quarter-over-quarter), but customer mix differences will be highly consequential and evident. For example, Bloomingdale’s traffic, while down year-over-year, was +500 basis points better than Q1 2023. By contrast, less affluent Kohl’s was -562 basis points worse. Another case in point of the concentration risk is our story last week on Revolve; namely, younger, aspirational consumers are out of the market for goods purchases. Lastly, the theme we have been tracking since last fall “value is in style when recession fears build” is going to drive big results for off-price retail for fiscal Q2 2023.
In a surprise to most, Tapestry (the parent company of Coach, Kate Spade, and Stuart Weitzman) agreed to acquire Capri (the parent company of Michael Kors, Versace, and Jimmy Choo) for $8.5B in cash, representing a 65% premium to the stock’s prior day closing price.
As to why would Capri sell now? We suspect that playing a significant part is the choppy consumer dynamics described by Dillard’s, Ralph Lauren, and other brands on their most recent updates. Capri’s highly aspirational customer mix and very discretionary product, combined with the forthcoming restart of student loan payments, present a challenging backdrop within the context of the company’s weaker financial results over the past year. Getting bought out now allows management and Capri shareholders to exit at a nice price with cash certainty.
Why did Tapestry buy now? The new release quotes Tapestry’s CEO Joanne Crevoiserat saying, “Tapestry is an organization with a passion for building enduring brands through superior design and craftsmanship and an unwavering focus on our customers. Importantly, we’ve created a dynamic, data-driven consumer engagement platform that has fueled our success, fostering innovation, agility, and strong financial results. From this position of strength, we are ready to leverage our competitive advantages across a broader portfolio of brands.”
The investor presentation accompanying the deal announcement suggests that Tapestry is trying to create an entity that is similar in structure Kering (the parent company of Gucci, Alexander McQueen, Bottega Veneta, Yves Saint Laurent, Boucheron, and others). Kering recently took a 30% stake in Valentino for $1.7B and there is a view that scale matters more than ever within the luxury category. Relatedly, Kering trades at a 25% premium to Tapestry on an enterprise value/ EBITDA multiple (9.7x versus 7.7x).
Separately, the management teams involved believe the combination can drive strong double-digit earnings per share accretion from Tapestry’s standalone model by Year 3 (which some analysts are penciling in at 20%+). Additionally, the acquisition takes out a near-competitor to Coach and Kate Spade in Michael Kors, which helps rationalize the market. (Driving Coach’s average unit retail higher has been at the center of Tapestry’s value creation and investor pitch over the past three years.)
The acquisition announcement release also provides the following rationale for the combination:
- “Expands portfolio reach and diversification across consumer segments, geographies, and product categories, including broadening Tapestry’s product offering through an increased penetration of lifestyle categories, notably footwear and ready-to-wear, where Capri Holdings brings extensive expertise with further opportunity for growth.” (Capri’s brands into Asia on “Tapestry’s rails” and Tapestry’s into Europe on Capri’s.)
- “Leverages Tapestry’s consumer engagement platform to drive direct-to-consumer opportunity, with the goal of increasing Capri’s direct-to-consumer penetration over time.” (Potentially signaling more stores for Versace and Jimmy Choo?)
- Significant cost synergies – $200M from corporate costs and supply chain
- Greater financial scale, see the slide below, to accelerate growth
Tapestry’s stock fell -15% with the deal announcement. Given expectations of roughly 20% earnings per share accretion, Tapestry’s P/E valuation multiple sunk by -35%. Why the negative investor reaction to the deal? In our opinion, it suggests that investors question the weight of consideration given to the risk of a meaningful pullback by Michael Kors’ younger aspirational female consumers in the U.S. who will soon be burdened by student loan repayments, especially as the financing for the deal increases the combined company’s leverage (net debt-to-EBITDA) to 4x Investors may also fear that Tapestry has tapped-out Coach’s growth as a stand-alone and that they needed Capri’s rails to extend growth into the European, Middle East, and Asia (EMEA) region to show growth as well as to drive the brand’s overall average unit retail (AUR) higher.
The acquisition was announced Thursday morning (August 10th). Later that day, Capri announced Q2 2023 results which showed revenue down -9.6%, stemming from a large -20% decline for Michael Kors in the U.S. and a near halving of profits for the brand. (The Michael Kors brand is where Capri makes the majority of its profits.) Given the acquisition, management pulled its outlook for the remainder of the year. Analysts were expecting the Michael Kors business to grow in the second half of 2023, and so absent the acquisition, management would have likely had to lower expectations again--the third time over the past year.