McGough: Tapestry Can Get More Expensive

Key Concepts

• Tapestry (TPR): A company operating in the handbag space, with its primary brand being Coach.
• Earnings Revision Cycle: A period where a company's expected future earnings are repeatedly adjusted upwards.
• Pods (Pod 1, Pod 2): Refers to specific segments or product lines within Tapestry that are showing positive inflection and acceleration.
• Inflection: A point where a trend changes direction, in this context, indicating positive growth.
• Brand Lane: The strategy of each brand within a company maintaining its distinct market positioning and price point.
• Gross Margin: The percentage of revenue that remains after deducting the cost of goods sold.
• Operating Margin (EBIT Margin): The percentage of revenue that remains after deducting operating expenses, including cost of goods sold, operating expenses, and depreciation.
• Asset Turn: A measure of how efficiently a company uses its assets to generate sales.
• Cash on Cash Returns: The annual return an investor receives on their cash investment.
• Basis Points (bps): A unit of measure equal to one-hundredth of a percent (0.01%).
• SG&A (Selling, General, and Administrative Expenses): Costs incurred by a company in the process of selling, distributing, and managing its business.

Tapestry (TPR) Investment Thesis

The primary focus of the discussion is Tapestry (TPR), with a strong positive outlook presented. The speaker expresses a liking for the stock, having previously recommended it at $60 and believing it had the potential to reach $90 due to an upward earnings revision cycle and positive inflection in its "pods." The stock has since surpassed $90 and is currently trading at $116.

Key Points and Supporting Evidence:

• Positive Pod Performance: The core argument for continued strength lies in the "pods" (specific business segments or product lines) still inflecting positively, with revenue increasing. This indicates ongoing growth momentum.
• Brand Strategy and Competition: A significant positive aspect highlighted is Tapestry's brand strategy, particularly within the handbag market. The brands, including Coach, Capri, and others, are described as "staying in their lane."
  • Capri: Positioned at approximately a $250 handbag price point.
  • Coach: Moving from a $300 bag to a $400 bag, showing strength in higher price points.
  • This strategy prevents brands from directly competing with each other, fostering a less aggressive competitive environment where each brand understands and maintains its market niche.
• Upcoming Quarter Performance: The speaker anticipates Tapestry will "crush the quarter" that is about to be reported.
  • Consensus Earnings Growth: Currently projected at 23%.
  • Speaker's Expectation: Over 30% earnings growth.
  • The argument is made that even if the stock appears "expensive" based on current multiples, such significant earnings growth justifies a higher valuation.
• Fundamental Catalyst: The upcoming quarter is expected to provide a fundamental catalyst by demonstrating to short-sellers that "pod one and pod two are still accelerating."
• Financial Health and Operations: Tapestry is described as having a "great balance sheet" and actively "buying stock," indicating sound financial management and shareholder-friendly actions.

Margin Expansion Potential

A detailed discussion on margin expansion is presented, addressing a question about the potential for further margin improvement given Coach's already "stellar margins."

Key Points and Supporting Evidence:

• High Margin and Asset Turn Business: The handbag category is characterized by high margins and high operating asset turn, leading to "really high cash on cash returns."
• Current Margin Levels:
  • Gross Margin: Approximately 70%.
  • Operating Margin (EBIT Margin): Approximately 20%.
• Projected Gross Margin Improvement:
  • Potential Increase: 200 to 300 basis points (2% to 3%).
  • Comparison to Luxury Peers:
    • Hermes and LVMH: Operating at around 72-73% gross margin.
    • Prada: Achieves an 80% gross margin.
  • While Tapestry may not reach Prada's level, a 200-300 basis point increase is considered achievable.
• EBIT Margin Runway:
  • Driver: Gross margin expansion without increased SG&A expenses will directly translate to higher EBIT margins.
  • Projected EBIT Margin: Runway exists to reach the "mid-20s" (25-26%).

Conclusion and Takeaways

Tapestry (TPR) is presented as a compelling investment opportunity driven by strong underlying business fundamentals. The company's positive earnings revision cycle, accelerating "pod" performance, and disciplined brand strategy are key drivers. Furthermore, significant potential for margin expansion, particularly in gross margins, offers a clear path to increased profitability and higher EBIT margins. The company's solid balance sheet and share buyback program further bolster its investment appeal. The speaker strongly believes Tapestry is poised to outperform expectations in the upcoming quarter and deliver substantial value to shareholders.