With Luxury Spending Collapsing, Should Tapestry Investors Be Worried?

Tapestry Inc’s (NYSE:TPR) stock is currently trading around half its value at the beginning of the year. In comparison, the broader market (S&P 500) has declined only about 5%. And there is a good reason for it. Tapestry is among several retail chains offering non-essentials and luxury items, and their demand has plummeted disproportionately. Consumers are staying home and have pulled back discretionary spending in the wake of an economic slowdown, bankruptcies, and layoffs. Needless to say, this is a survival test that Tapestry might never have faced before. So how prepared is it to survive this demand shock? Does the company have enough cash or the ability to raise enough debt? Our dashboard Does Tapestry, Inc Have Enough Liquidity To Survive Covid-19 Demand Shock examines the company’s cash flow generation ability, the resilience of its cost structure and operational runway, and compares it to that of its peers.

Our overall assessment is that Tapestry is in a relatively good position compared to its peers to navigate the Covid-19 crisis. The company can stay out of the red even if its revenues shrink as much as 30% for the year, and it also has a reasonable 9 months of operational runway in the complete absence of demand/revenue. In addition, we expect that despite the current demand crisis, it has the capability to generate positive free cash flow this year.

Tapestry, Inc Can Manage Operational Profits As Long As Revenue Doesn’t Drop By More Than -33%

Let’s take a quick look at where Tapestry was in 2019.

• The company generated revenue of $6 billion and a net income of $643 million, which implies roughly 10% net margin.
• We estimate that variable operating expenses, which primarily include the cost of merchandise, freight charges, and direct payroll costs, stood at $3.7 billion in 2019, accounting for 70% of total operating expenses and 61% of revenues.

Based on this, we determine that operating income will decline to the break-even point (no profit no loss) if 2020 revenue falls by about 30% vs. 2019. In comparison, the break-even revenue change % figure for companies such as L Brands, Ralph Lauren, and Under Armour stand at around -10%. Clearly, Tapestry is in a relatively stronger position than its peers.

What Will Happen To Tapestry’s Free Cash Flow If Full-Year Revenue Falls 30%

Consider a case where the demand slump created by the pandemic fades by Q4 2020 and Tapestry sales bounce back to a good fraction of the pre-pandemic level.

• In this scenario, we assume an annual drop of 30% in revenue and a 50% capital expenditure cut to reign in cash flows.
• We also assume that Tapestry will not spend any cash on share repurchases.
• In such a scenario, we expect full-year net income to be $53 million on a revenue base of $4.2 billion, implying net margin dropping from 10% in 2019 to 1.3%.
• This is still good as it will effectively mean that Tapestry can generate free cash flow (before any payment to shareholders) of $64 million.
• While it may seem low, many other retail companies will have run out of cash in this scenario.
• Tapestry has closed many of its stores temporarily and used up around $700 million of its $900 million unsecured credit line. That only adds to its liquidity position.

Better Than Peers – Runway 9 Months In A No-Demand/Zero-Revenue Scenario

We estimate that Tapestry has 9 months of operational runway if there is no demand or revenue. This is, of course, an extreme situation that is highly unlikely, but it gives insights into the financial cushion. In comparison, some of the other retail companies are not as comfortable. For instance, Macy’s has a runway of just over 1 month in the absence of any demand or new debt financing.

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