Chit Chat Stocks - Sean Emory | Capri Holdings (CPRI)

Episode Date: December 3, 2020

On the 3rd day of Christmas Sean Emory gives to you, Capri Holdings the multinational fashion company. Chit Chat Money and Sean evaluate how Capri grew from just Michael Kors to owning and operating multiple large luxury brands around the world. Visit our website: https://www.chitchatmoney.com/ Subscribe to 7 Investing with the code "CCM": https://7investing.com/subscribe/ Follow Chit Chat Money on Twitter: https://twitter.com/chitchatmoney Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to 25 Stocks of Christmas presented by Chitchat Money. Today we have Sean Emery on the show, founder and CIO, I believe. I got those credentials right. Avery & Co. It's a big investment fund. He feels overqualified to be on our show, but we appreciate it anyways. We are glad to have him. They're based out of Miami. They've been around for about five years. Really, check them out. They have a lot of good content that they do for free. And they're very transparent as well. Yeah. So great guy to have on. And then next we got to talk about our partners before we started at 7investing. So you want to talk about the promo program? Yeah. I mean, this is my sales pitch. And so we get emails every day with the affiliate program.

So you guys are doing your job. Whenever someone signs up, it's usually after my shows. I don't mean to brag, but so I think I'm a better salesman here. So it's $10 off your first month. Yeah, I know that sounds appealing. So it's only $7 and you get seven stock picks from very qualified lead advisors over at 7investing. Just use our code CCM at checkout. Now it's time for the show. Here you go. Welcome to Chit Chat Money.

On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investment. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are not financial advisors. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guest is not formal advice or a recommendation. Now, please enjoy this episode. Today, we are welcomed by Sean Emery, the CIO and founder of Avery & Co., an investment

fund based in Miami. Am I getting all that right? You are. You are. Awesome. And so the company I think we're talking about today is Capri Holdings. How'd you come across this? How'd you find this?

Yeah, I think it really starts with how do we think about the investment landscape? I mean, maybe I just level set with our research mission, which is discovering value in a world of innovative growth. If you kind of take that statement, it takes growth, innovation, value all in the same sentence. I don't think that's a normal phrase for most, but it's deliberate. It's really how we think about investing. We look for structural growth stories, so innovators that are disrupting legacy incumbents

and then also transformation stories where companies are looking to really kind of disrupt themselves and are uniquely kind of positioned to unlock value through transformation. And that's ultimately where Capri comes to kind of our investment process. is through the transformation. There were once a growth story over kind of several decades. And over time, it became pretty obvious that this company was in need of a transformation.

And ultimately our investment is based and premised on that transformation taking place. Okay. And for anyone that doesn't know what Capri Holdings is, what do they do? And I think it's sort of a conglomerate, right? they have a lot of different uh parts of the business yeah but with one with one focus right yeah yeah look it's a global fashion luxury house um and it consists of three main brands today

for a long time it was simply michael kors they changed their names to capri a year and a half ago so capri is not necessarily a common company to most that because it's only a year and a half whole um but michael kors was the company for uh what is it 17 years now or 16 years i guess before the trend the transition when they actually transitioned the company to acquire two other brands to make it a complete house um and so it's jimmy chu versace michael kors are the are the three brands underneath michael kors leading uh the company in revenue um at roughly four and a half billion dollars uh versace on a one rate basis at around a billion nine hundred million or so and then jimmy true is the third brand in terms of revenue but but to define it is is really

a global luxury house um okay okay and then before you this may be part of your investment thesis but do you have any thoughts on management i know during transitional periods a lot of times a company switches the executive team around and specifically with this company the biggest concern that we saw was possibly the debt load that they have versus, you know, struggling within the 2020 year? Is the CFO really important for a company in this financial situation as well? Yeah, look, I mean, so you're starting with John Idol, who's the CEO. And in some aspects, you could say the founder, despite not actually being the founder from day one. He became the CEO in roughly 2003, Michael Kors was doing $20 million in revenue then. To take it from $20

million to, I think at peak, roughly $5 billion in sales for one single brand. To put that in some perspective, Lululemon's doing $4.5 billion in sales. If you just think of a super mainstream brand compared to uh michael kors uh here you have uh a ceo slash kind of quasi founder um that has successfully built and in some aspects overscaled this business to the point where there was brand um uh degradation over time just given the fact that uh you put too much product into the market uh and then you have inventory challenges uh like three four five years ago um that forces you to promote the product and then um uh take uh kind of promotional activity and that obviously can lead to brand disruption and so on so you had a ceo that was

very very successful in operating and growing this business uh and then at the same time ran into a a point in time where i think it was in 2016 here we had a company doing 4.7 billion dollars in revenue you had a company with roughly 700 million dollars in cash and 1.2 or so billion dollars in operating cash flow they had to make a decision they said do we take this pristine balance sheet and cash flow position to acquire companies that we think are under invested in or do we simply stay as a single brand and they chose to do a kind of acquisition the acquisition route and look at companies in which they thought they could scale up again with the focus being this team has proven they can scale up um and this is the right leader to do so

and they have the balance sheet to do so and then when you you you think about the capital structure of how to get there it's do you use uh cash uh do you use uh cash and debt kind of how you fund these these uh new businesses uh both on the acquisition side and then on the ongoing basis and from their point of view it was it made a lot of sense to uh fund it through uh both cash and and then and debt um and they did just that so they acquired uh jimmy choo first and then versace and it was kind of a quasi levered kind of buyout type strategies right kind of buy them up get them into better shape and then use the operating cash flow of your core business to really fund that and that's ultimately what they've been doing and and during 2020 i think

for us when we're looking at the success of or kind of trying to understand how they fared during this they've given us essentially a soft guidance of cash flow positive in 2020 right so you take a brand that is predominantly breaking order and a company that is essentially going to produce operating cash flow in arguably the hardest time ever for a retail business, specifically one that is not desired day-to-day, right? Like we don't think of buying ready-to-wear clothes for runway shows during COVID. So to really think about how this company has been able to operate, again, is another feather in the cap for John Idol and his team. Now, stepping back for a second, too, is also the and i think this is really important to the story is you have kind of the leading ceo

then you have michael kors who's the leading designer of michael kors sandra choy who's the leading designer of jimmy chu and and donatella versace which is essentially one of the leading designers for versace so you have uh best in class uh designers and best in class operators with a financial model, right? Like in a normal year, this company won't do the operating cash flow that they're going to do this year, but they can do north of 700 million, a billion.

And when we speak about the debt, which is roughly like 1.7, which is actually less debt than they had pre-crisis, which is hard to believe, right? You're thinking of a company that has been able to actually lower their debt during COVID. That means it seems somewhat counterintuitive, the ability to do that.

um and that was a big question in march was was the debt burden um even for ourselves we there was debt coming due roughly like 300 400 million dollars in december um we reached out and spoke with uh plenty of institutions um just to get an understanding of likelihood of of a refinance uh or push out um of this debt and again if you have a company doing 1.2 billion dollars in operating cash for them, a creditor isn't inclined necessarily to take on that asset to issue some sort of default, right, and let that asset essentially crumble. And sure enough, they were able to push that out to 2023, and they have a clean kind of maturity wall, and they can essentially begin to reinvest back in their business, reinvest

back into Versace, Jimmy Choo, Michael Kors, and we're seeing just that. So it's definitely a question, right? I think prudent people don't love debt, but at the same time, $1 billion in operating cash flow on a normalized basis is a good start to pay down your debt. Yeah. And I think the other thing that can be concerning about taking some of the companies I've had to take on debt during COVID is that, you know, when you need the money, that's the worst time to ask for the money because you're getting worse terms. And it sounds like Capri is in a position where they don't have to do that. Am I right in that thinking? Yeah, right in the thinking of Capri and also right, we're right there with you in terms of we want to stay as

far as possible from companies that need to fund their operations through debt or equity during this time um and they didn't have to do that right they just went through their working their inventory that turned into additional working capital for themselves uh again we have uh high quality brands um it you can sell through your inventory right this isn't a flash in the pan type product um and can some of their inventory can be repurposed for later date um so luxury happened to be something of desire or was desired during COVID periods when people are locked up and want to feel good about something and they go online and they're making purchases and you're seeing companies like Farfetch and some others just see explosive growth that's at the marketplace level

but but at the same time some of the brands underneath are at least surviving despite having 70 80 percent of their um their operations closed and i think that speaks to a lot of uh them but also looking out into the world and saying uh supreme get acquired by pbh and some others so yeah um so i guess the next question which is sort of the crux of the discussion if you will is your thesis and you've already sort of touched on this but just i guess this is the pitch uh what is it that you like about capri as an investment yeah so partially staying away from simply the valuation which the valuation is by any standard cheap um right so is it a value or value trap right i think that's the generally and we don't look at it through those lens right again

we look at structural growth storage and transformation storage so it's either that or that it's not growth or value um and ultimately there's kind of a three-prong way of thinking of is starting and saying first is they're really well positioned for social selling that's kind of number one two for us is really that just given their little scale they're they're well positioned for omni-channel global omni-channel distribution and then three is really around their strategy through acquisitions with a management team that's shown its unique ability to grow brands. And again, if we level set our views on the world, we think the future of commerce will drive right through social platforms. It is really our view that Instagram is the new

wall. It is digital. It has a billion times more traffic than traditional walls. Omni-channel distribution will be the selling motion, but brand identification needs to take place through these platforms right so if you think of capri well positioned uh through a series of acquisitions and through their own doing um leaving them with over 45 million followers on instagram one of the leading kind of house of brands right you think of someone like lbmh which has nearly 90 but they also have 90 more brands right so they're at like 50 of the follower count uh but along just three brands um so we think they're well positioned through those channels and i think we all know it's not easy to get uh five followers as much as it is to get 26 million like uh um like versace

right so these are competitive digital moats that they're building through time um that we think are really really powerful um and again if you start to think of that landscape of a digital kind of influencer led strategy uh you have a brand uh like versace that is extremely defensible um if you go to any brick and mortar place location um what are you going to find you're going to find some of the most prolific brands sitting on that mall and when you go online your your omni channel right approach here is you're want to be well positioned You're going to be on the corner of the best block in a mall, but then you're also going to want to be well positioned within the digital world. And we think Capri as a fashion house is just that.

And then scale. Again, it's not easy to sell $6 billion of merchandise anywhere. And ultimately what comes with that is specifically in a world that goes consistently to more e-commerce. there's a lot of logistics and cost of shipping goods and simply put it the more volume you can put through a system the lower that price per unit can be so a scaled out kind of retailer or brand conglomerate does have that pricing power on some of the logistics providers that are out there as opposed to trying to be a single brand and selling a million dollars of goods and trying to work with ups and trying to get them to essentially um sell so it's really those three

aspects that we we're thinking about here is their their scale their social selling and the positioning there then their management team's ability to uh grow brands and we think that's going to be the story on a continued basis um and and that's really the crux of of the argument is whether you think they can grow those brands uh can they grow versace and all evidence is suggesting so um and can they stabilize the michael kors brand um to a point and again i'm looking for uh four billion dollars uh in sales for the michael kors brand which is they're doing 4.5 today at least on a trailing 12 um covid's kind of obviously throw the whole wrench in everything in terms of just looking at numbers like that but uh and at the end of the day these

are 60 operating or gross margin businesses i think people don't really see that uh they think typically think retail you think low margin high volume this is high margin high volume business which is uh an impressive uh thing to do and what are you paying for you're paying four five six seven times cash flow depending on what you normalize for yeah i think uh maybe some people that aren't as attuned to social medias sometimes look at the follower number like who cares but it can really help an omni-channel strategy having a huge uh following on whether it's instagram or twitter because it's a direct customer funnel yeah and people roll their eyes at the eyeball thing you know they're like oh they're just scrolling through it but it does

help like it's like a it's like organic marketing that's almost i mean it's like a really efficient way to market and keep those margins up for sure i i agree i mean that's the uh that's the name of the game is if if you really are trying to sell on the channel you have to be everywhere and um you definitely for the next kind of kind of decade of our lives right you're gonna have to be on the social channels and if it's not you organically you have to have a brand that will interest an influencer to the point where you have the capital to pay them and the attention of of them to essentially um want to work with you right so i don't think having uh jennifer lopez wearing your dresses at the super bowl uh and then doing instagram um um posts around your brand

one that's not cheap and neither is it easy to even uh have that individual pick your thing your item for their big day um and again that's like further evidence of uh what what's being Is that good? You all good? Yeah, that's good for the first half. We're going to hit a quick break, and on the second half, we're going to try to poke some holes in Sean's thesis here. Cox Panoramic Wi-Fi includes advanced security

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Included with Cox Panoramic Wi-Fi. Advanced security must be enabled in the Panoramic Wi-Fi app. Restrictions apply. Welcome back in. Next, we have Devil's Advocate. This is basically our counterpoints to Sean's thesis. And I'll go first. And you already sort of touched on this.

So my first counterpoint would be the debt load, which you have already sort of touched on. But if there's not a return to in-store shopping, so obviously they are in a much better situation when consumers can come into the store and buy stuff because there's sort of that brand notoriety and they have all those physical stores to begin with. If that doesn't return to what it used to be, they're going to have a much tougher time paying off that debt load. Yeah, look, there's always the consideration. And if you weren't thinking about a shift to digital selling pre-COVID, in theory, you shouldn't have been in those investments to begin with, right? All these companies should have been thinking about this previously. And Michael Kors specifically, which is their main brand, has a large database of 40 plus

million contacts as they have a loyalty program called Kors VIP. And they've seen a lot of success there from their user base. So they do have a core audience that is consistent purchases of theirs. And they do have a digital relationship. So when you do remove some of the brick and mortar channels, which I think they have shown that that's the strategy, the negative of COVID is that it forced them to shut things down. And I don't like saying it, but the positive is it's giving them the opportunity to not reopen. and we're seeing that where they even on their last earnings call guided to 25 operating margins and they were doing like 19 at that brand pre-covid now they think the sustainable operating

margin rate is 25 on a lower revenue base so you kind of get to the same place from major's cash position cash flow standpoint right lower revenue but much higher operating profit margin um and that leads to dollars that are uh semi-equivalent to where they were before um and that's an interesting phenomenon that is taking place there and again it's the combination of them already having 20 plus kind of million social followers which gives them that audience that we were talking about then you have a loyalty program and an app again if you go out and try to look at i'd say i mean we've already done the exercise go look at all the different brands out there that are kind of mid-luxury and up

and look for an app to download. You won't find one. Coors successfully launched one kind of like two years ago. And they have traction, right? I mean, they have a user base and they have their modality program that's embedded there.

They have made a commitment to 2022 to re-platform their entire fashion house in terms of their digital e-commerce. Mind you, it's 2022, but it's really 2021. um in terms of uh our calendar years their fiscal year um and so there is that uh uh focus definitely on on being digital first uh but then having kind of the store and footprint uh across channels uh in the in the physical world um to kind of further sell uh into the market so they do think having a physical presence is important um but it's this omni-channel relationship that

they're having with with with um uh their clients in a sense right so i think uh it's definitely a critical a really good question and something that we all need to pay really really close attention to um over time oh one other note is we just got uh data uh it was really on like last early last week and seeing the Michael Kors and actually all the three brands and seeing their web traffic and Michael Kors web traffic is up 35 percent year-over-year to their site and to the purchasing so is there a perfect correlation between that and revenue no but it's but it's the highest number we've seen probably in several years so there's something taking place there that's leading to that that traffic that then is leading to potentially

hopefully a conversion but we'll see so would you be a i mean i guess if you talked about the physical stores uh closing down if some of those permanently closed down and sort of trimmed some bloat if you will and it kind of became more of a digital presence uh along with it and so they shut down some of those stores would you like that or do you think those stores need to be around to kind of keep up the brand recognition? Yeah, it just depends where they are. So the ones that are closing are not profitable, right? And or dilutive to margin, right?

So they're closing things that aren't where they want to be anyways, but they had long leases and things like that where COVID allows you to rethink that and say, hey, do we need the startup cost again to get this thing up and running? Or do we simply just walk away from this lease, from this area um and the reality is is that's a from a both from an economic move and and also

just uh thinking about it as reasonable people that that just seems pretty prudent um and there's a lot of bad malls i think there's plenty of data that supports that we're over uh indexed to square footage in retail um and again you go around miami where we are um there's some of the best malls that are out there in the world and then there's some that are not so good and you can tell which ones aren't good or bad and one of them has a Michael Kors store and I can't imagine that one's doing very well relative to the one at Dayland Mall which is an extremely high traffic mall and I suspect in three years as the the malls around them like the B malls right start to uh close um it'll even attract i would assume that those the remainders

the remaining malls and in the the better kind of a a malls um may produce even better right because you're starting to concentrate some of the traffic to different areas once again and that may be five years out right because who knows how um this will all transpire but that therefore you need to have that digital presence to to kind of bridge that gap here okay and then another you mentioned this a little bit but it seems like the data supports that this may not be a huge concern but i think when people think of these brands they talk about you know the new work and lifestyle changes we all know about work from home and then the current recession may hurting people's pricing power or not pricing power uh the ability to you know buy

discretionary items, they might think that the market for luxury clothes is not going to be growing for the next few years or may even see a decline. Yeah. I mean, I guess you're asking for my views on that. Yeah. So luxury spending has consistently held up through COVID. And there's a lot of factors to that one being that china is uh and the asian markets have fared better um and due to that they're roughly 50 of the buyers right so people feel realize that when most of the luxury spending uh and i say most it's roughly like 40 of luxury uh spending globally comes from Asia and that is a market that is a little bit more open today and they've also have been not able to cross borders right so usually what you historically

would see is those travel to Europe those travel to North America and you would get a lot of kind of travel spend and luxury travel spend so the luxury travel market is is extremely weak right because no one's traveling and you're definitely not going to the mall the larger malls i mean the larger airports and buying a uh a gucci bag or something uh on your way to some town um so that's staying actually inside of uh their respective regions um but that's also because of the savings rates, and we see all the numbers, whether it's in the mid-teens now, but it ballooned to roughly 30 plus percent at the peak of COVID in terms of savings rates here in the U.S. And what did you see during that time? You started to see people spend on Farfetch, Farfetch traffic soared higher.

You started to see different types of traffic at many of these other brands out there. And people are starting to spend to feel good i guess uh which is what most people uh anecdotally have taken away um and over the next kind of decade we believe that luxury spending will continue to uh perform well and i think one is they're making it more accessible uh than they historically have uh generally you buy luxury through a mall that probably many the average person doesn't go to um and now you're going to marketplaces and or um direct to their channels and and purchasing directly right so there's that kind of expansion taking place along with product expansion so you're seeing companies like louis vuitton make price points lower so they can capture the younger

populations and then build them up into their brands so there's there's multiple things taking place but then there's also the companies adapting to their environments and saying hey how do we capture more share and the social channels and things like that so i think when you think about all of that combined um it still takes execution at the brand level for sure um so not we're not trying to get away from that but uh luxury in general uh is expected to grow kind of over the next uh decade by almost double um and we think that will take place is this a business that um i guess this is just sort of a follow-up question that came to mind is this a business that's susceptible to uh the macro environment so if the market's down and sort of maybe luxury spending

decreases am i along the right line yeah or is it more like a ferrari where it's almost recession proof yeah so luxury is historically being viewed as very durable during recession so if you go back and look at like 2008 um luxury spending held up very nicely uh that's generally the cohort that can still spend two thousand dollars on a something uh of the population right uh when when stimulus checks go out now the whole population can kind of spend their two thousand dollars on something um and that's ultimately what you saw but yes that that is a good point i mean that's the you could question whether like michael kors which they have a really high-end like runway luxury uh part of that business but then they have the more mid-luxury accessible

luxury um part of their business that that kind of lower end not lower but mid-luxury section that they try to uh place themselves into that's obviously not uh something where it's as durable to macro conditions all right um i guess most people this our next question is about selling and we like to think about sort of the flip side of it's always fun to think about buying but there's sometimes a reason to leave a business what would that reason be for you yeah for me it's really the versace brand i think that is the the thing you have to be watching closely um one that's that that's proven their success of right if you believe or we believe that this is going to be a fashion house that's going to go beyond these three brands uh they

need to prove that they can grow the two brands that they require um or at least stabilize them to a point where when i say stabilize i mean uh increase the margins to a point where they think they can take them beyond that so the goal that like versace is to get this from 180 stores to 300 to get it on par with what um other luxury like true luxury brands are in terms of real estate so that's the crazy part here is that they're on they're trying to grow the base of physical locations in versace um and then that just shows you obviously 180 locations isn't very much in in the world um and it would be the versace brand um seeing uh any sort of weakness on kind of uh their plans to continue to add locations um on the margin side and things like

that so that's really the brand of focus uh their goal there is to take it from 1 billion to 2 billion in sales kind of had mid-teens to high high teens operating margins everything that they've historically ever done has shown that they can do that um so it's just tracking that extremely closely to make sure there's obviously then some issues on the michael kors side just ensuring that that four billion dollar target doesn't continue to creep lower and lower and that 25 operating margin stays kind of where they think they can get it in the kind of low 20s to mid 20s um right so we're looking at everything to see if if management team is executing and that means web traffic that means we track social media followers daily growth um so all these

all these avenues that really fulfill this story that we're we've built um we just can't have holes being plucked into them that um are damaging enough right it's not like this company's trading uh um at lemon levels in terms of valuation and this company has to continue to grow at some sort a rapid pace. This is all about a transitional story and making sure that transition is taking place. Okay. Yeah, that makes sense. It's trading really, if you look at Lululemon, quite the opposite from a valuation level. But I guess our last question is, if you say you were like king of the day for Capri Holdings, you got to make any changes to either management team or how they're operating the business, what they're investing in, what is one change you would like

to see them make if you could yeah it's tough right because there's so much stuff going on and i feel like all of it has to work together for it all to work so there's not that many changes per se i mean maybe just fast tracking kind of getting the versace brand on a digital app or something like that um and fast tracking some of those initiatives but right now is not the time to fast track like a pretty intense initiative um such as that um but i mean those are the things and then you question kind of do they need to but um fast track uh digital initiative or kind of like versace but um again i i want at some moments in time they've they've mentioned um the kind of goal of building this fashion house and and i think uh given their

their history that they can continue to grow brands and i think uh it doesn't necessarily have to be uh accessories which is what ultimately when they're buying these companies they what they're trying to do is essentially walk in there and uh build out an accessories line so handbags and glasses and things like that um which is what they're historically really really good at um but if you look at the history and success of like an lvm age i think you can go across categories um again i think having like five brands and a real stable core where nothing is more than kind of 15 20 percent of your overall uh top line or even bottom line for that matter um i think thinking at some point beyond the the accessory parts of the business

uh and thinking they own kind of uh different types of businesses on the image right not just simply um right there's the jewelry which is the tiffany acquisition that is being contested pretty aggressively um and some other things so that's kind of how i would want them to explain but again focusing on the year now i think is also just as important so and uh lvmh that's louis vuitton really hennessy right am i getting that right yeah they own if you pull up a list of the brands it's kind of 90 100 brands underneath this conglomerate um and super super dominant uh right because now you have channel partners and then these channel partners you let this brand in or like you have to let this brand in and this brand in um and so you become kind of

this factory for uh any sort of company that's trying to create any sort of distribution right marketplaces and you're just super important you have so much leverage at that stage um which is why look these companies do caring group and and ldmh i mean if you if you look underneath the surface 30 35 operating or even on margins um right i mean we're talking about 20 25 operating margins here um that we're shooting for and and it's very very clear that versace has upside to that jimmy choo has upside to that uh those numbers um she's being conservative on that line um but these are powerful powerful brands and they show up again economic modes only as good as if it shows up in the economics right and it shows up in those economics there right all right

well that is going to do it uh that was capri holding with sean emory sean uh for anyone that wants to get in touch with you or find your work what's a good place to look uh look for you yeah i mean two places is uh twitter um it's underscore sean david s-e-a-n uh d-a-v-i-d uh that's my my twitter handle and then you can shoot me an email if you want sean at uh averyco.com a-v-o-r-y-c-o.com so all right perfect okay and do you want to you have any more questions i was just going to say good luck with the uh the fund and or you know the management company and how that's going and we know there might be some new things coming down the line so we're excited to see what you guys keep doing cool all right guys i appreciate it and always good talking with you yeah quick

reminder for all the listeners. This is We Are Not Financial Advisors. Anything we say or discuss here on Chit Chat Money is not formal advice or recommendation. Thank you guys for listening. We'll see you tomorrow.