GMU Palo Alto Networks Incorporation Final Project Report and Excel Valuation General Guidelines
As noted in the course objective, the main learning objective is to provide each of you with the experience of doing fundamental research and valuation analysis on a company and then selling your recommendation to a discerning and perhaps somewhat skeptical audience of your peers. Each student analyst will search through the stock universe within their respective sector to identify a stock (or stocks) that is potentially undervalued by the market for inclusion in the portfolio. The student will conduct his/her due diligence and analysis of the company, write a research report and present it as a “buy” recommendation to the class. Also, understand undervaluation alone is not a catalyst for a positive return; a company’s shares can remain undervalued for an excruciatingly long time (aka “Value Trap”). So you must dig deeper and try to surface what the true “catalyst” is, what’s the story, and why you expect the stock to outperform its sector ETF in the next 6 – 12 months. Following the presentations by students of their stock recommendations, each student will be asked to vote as to whether the recommended stock should be purchased and whether all 1 of the available funds allocated for the sector should be invested. Each student, including the presenter, will have one vote. It should be understood by each of you that the intent of a “yea” vote is that you believe that the presented idea will positively impact the fund as a whole. This means that the corresponding stock from the time of purchase will outperform the sector ETF and contribute to the overall fund outperforming the benchmark.
Final Project Report
The written investment report is your most important activity in this course. The report will analyze a particular company/set of companies in detail and provide an investment recommendation. Your analysis will consist of an Investment Thesis, Company Description, Industry Analysis, Financial Analysis, and Valuation Analysis. In addition, some focus should be placed, in the report and certainly in the presentation, on identifying 2-3 key drivers or “catalysts” that you believe will likely boost the stock price. The report will be individually prepared and submitted by email, along with the valuation analysis in Excel, to the entire group and to the instructors prior to the presentation date. In the written investment report, the analyst should take time to address how the proposed stock fits with the rest of the portfolio and the other stocks currently held in the same sector (see sample analyst report for ideas on how to generate the write-up). The analyst will also prepare a PowerPoint presentation in support of the investment thesis and buy recommendation. Since a big part of your future management careers is to sell your ideas successfully to clients, colleagues, employers, and employees, it is important that as part of your in-class presentation, you present arguments that are well constructed and convincing.
Things to consider in the report and analysis:
1. Outline the characteristics of a business and their business model, e.g, evaluate cyclicality, understand and evaluate the overall business quality using qualitative metrics, e.g., Return on Invested Capital (ROIC), Return on Assets (ROA), Return on Equity (ROE), profit margin.
2. Analyze the Balance Sheet: Evaluate the appropriateness of the company’s balance sheet structure, especially considering their business model using quantitative metrics, e.g., Debt/Equity, Times Interest Earned, Equity Multiplier.
3. Apply valuation techniques and metrics to determine the intrinsic value of a business, e.g., Price to Earning (P/E), Price to Book (P/B), Price to Tangible Book (P/TB), 2 Price to Cash Flow (P/CF), Enterprise Value to Earning Before Interest Taxes Depreciation and Amortization on (EV/EBITDA), Discounted Cash Flows (DCF), industry and competitor comparative analysis.
4. Apply macro-valuation techniques to come to a recommendation on sector net exposure.
We have Technology and Telecommunication Sectors. We have decided to sell our shares in PayPal and buy shares in Palo Alto Networks. All the valuation should be done using multiples Price/Sales as the multiple for the next 5 years (the valuation analysis should be done in Excel). I have attached a final report that was done last semester. TAPESTRY, INC. STOCK PITCH
Group 4: Fabio Morlando, Ryan Morris, Riqui Zhang
GEORGE MASON UNIVERSITY 18 November 2019
Recommendation Overview
Recommendation
We recommend buying Tapestry, Inc. because it is undervalued by 21.59% and its value could
increase significantly over the next 6-12 months.
Investment Thesis
The market has incorrectly priced Tapestry by undervaluing the impact of its expansion in China
and by overestimating the effect of the US-China trade war on its free-cash flow.
Valuation
The company’s intrinsic value is between $27.47 and $38.91 per share, and even if we are wrong
about these factors, TPR is fairly priced at $26.92.
Catalysts
Catalysts in the next 6-12 months include the rollback of tariffs and better than expected Q2 and
Q3 earnings.
Risks
Risks include escalating trade tensions between China and the US and the possibility that new
strategic initiatives cause earnings to worsen before they improve.
These risks are mitigated by the fact that Tapestry has a 5.0% dividend and a $1B stock buyback
plan.
Company Background
Tapestry Inc. is a luxury fashion company comprised of three main brands: Coach, Kate Spade,
and Stuart Weitzman. Tapestry had revenue of $6.03B in fiscal year 2019, has a market cap of
$7.38B, and has a P/E Ratio of 10.77.1
Coach
Coach definitely serves as Tapestry’s cash cow. Coach is a brand specializing primarily in handbags
and other women’s accessories and has been around since 1941. It accounts for 71% of Tapestry’s
revenue, and its same-store sales have now increased eight quarters in a row. That being said,
Coach has provided a reliable cash flow for Tapestry that has allowed the company to reinvest
capital while still returning a significant amount to shareholders.
Kate Spade
Kate Spade is another brand which is focused on handbags and accessories, but is more vibrant
and appeals to a younger demographic. Kate Spade was purchased by Tapestry in 2017, and
accounts for approximately 23% of its total revenue. Kate Spade has underperformed
significantly since the death of its founder in June 2018, and most fashion experts believe this is
due to the fact that they have prioritized craftsmanship over the “fun” designs which made the
brand so popular.2 Newly appointed designer Nicola Glass is attempting to make products more
aligned with the target market’s preferences.
Stuart Weitzman
Stuart Weitzman is a luxury footwear brand that was also purchased by Tapestry in 2017. It
accounts for a mere 6% of Tapestry’s revenue and has had a negative impact on Tapestry’s net
income over the previous two fiscal years. Tapestry is currently focused on expanding Stuart
Weitzman into a multicategory brand with the expansion of handbags and other accessories.
Overall, Tapestry’s competitive advantage is derived from its supply chain, its brand awareness,
and its high profitability.
Supply Chain
As a luxury fashion company, Tapestry has a much higher profit margin when it sells directly to
consumers. In Q1 2019, Tapestry sold 89% of its products directly to consumers and 11% through
wholesalers. Tapestry is continuing to work on increasing the percentage of its products that are
sold directly to consumers but has strategic relationships with discount wholesalers (such as TJX
and Ross) that act as a backup plan.
Brand Awareness
Generating respect and awareness for its three main brands is also a vital part of Tapestry’s
strategy. In the luxury fashion industry, brand awareness often serves as a company’s main (and
1
Unless otherwise noted, all data is taken from Tapestry’s 10K and Q1 2020 Investor Presentation, found at
https://www.tapestry.com/investors/.
2
https://www.barrons.com/articles/tapestry-stock-could-come-back-into-fashion-after-a-nasty-fall-51568418667
sometimes only) competitive advantage. Coach’s brand awareness remains steady and strong,
while Kate Spade’s and Stuart Weitzman’s have been weak in recent years.
Profitability
Because Tapestry operates within the luxury fashion industry, it has relatively high profitability
measures. Tapestry currently has ROE of 16.9%, ROA of 7.1%, and Operating Margin of 11.73%.
Each of those numbers is significantly higher than the average for consumer discretionary (see
table below), and both Tapestry’s ROE and ROA are much higher than its main competitor, Capri
Holdings. (See Figure 1) Looking at the ratios of Tapestry and comparing them to their median
among the companies of the Consumer Discretionary sector, it appears clear that the firm is more
profitable than the average. However, these very good profitability measures (ROE, Operating
Margin) are not exclusive only for Tapestry but are common in the whole luxury industry: indeed,
if we compare those values with more similar companies, Tapestry is in line with the competitors
(see Figure 2 for a more detailed look at competitor metrics).
Management
In September 2019, Jide Zeitlin was appointed as the new CEO. Mr. Zeitlin has a unique
background for a luxury fashion executive, as he spent 20 years at Goldman Sachs before
founding his own private investment firm. That being said, Mr. Zeitlin has been a member of
Coach’s Board of Directors since 2006 and has served as chairman of the board since 2014. Mr.
Zeitlin will look to bring a fresh perspective to Tapestry as he works to implement their strategic
goals.
Cyclicality
Tapestry is part of what is known as the “Accessible Luxury” industry. This industry includes
products that are still deemed “accessible” by those in the middle and lower middle class. As a
result of its exposure to this market segment, accessible luxury products are affected by
downturns in the economy more than companies in the Intermediate and Inaccessible Luxury
segments. That being said, being a luxury product makes Tapestry more inelastic than consumer
discretionary in general, which is a good characteristic to have as recessionary fears persist.
Balance Sheet Analysis
Looking at Tapestry’s balance sheet, cost of sales has remained stable at 30% (± 0.5% YOY). SG&A,
on the other hand, is at 44%, which is relatively high compared to other companies in the same
sector. This is because Tapestry includes certain distribution network cost within its SG&A rather
than in cost of sales. Compared to fiscal year 2018, operating income decreased 4.7% or
$46.5million, driven by an increase of Corporate expenses of $41.2 million as well as declines in
operating income in Stuart Weitzman of $29.9 million and Kate Spade of $11.0 million, despite
an increase in Coach of $35.6 million. The company’s effective tax rate decreased to 16.6% in
fiscal year 2019 compared to 33.4% in fiscal year 2018 primarily due to “Tax Cuts and Jobs Act”
which went into effect January 1, 2018.
Overall liquidity has improved over the past five years. The current ratio stood at 2.8x in fiscal
year 2019, compared to 2.3x in fiscal year 2014. The quick ratio stood at 1.7x in fiscal year 2019,
compared to 1.3x in fiscal year 2014. Both of these ratios indicate that Tapestry has a healthy
amount of liquidity. Debt to equity stood at 45.6% in fiscal year 2019, compared to 5.8% in fiscal
year 2014. Debt to capital stood at 31.3% in fiscal year 2019, compared to 5.5% in fiscal year
2014.
Tapestry now has a total of 1,540 stores worldwide. 108 new stores opened during the last fiscal
year, resulting in a net change of 7.5%. Net sales (in $Million) per store from fiscal year 2016 to
fiscal year 2019 is 447.5, 556.6, 277.6, and 417.8, respectively.
Coach has total stores of 986 as of fiscal year 2019, the growth rate of total new store opened
from fiscal year 2015 to fiscal year 2019 is (22.3%), (11.6%), (3.1%), 2.6%, and (0.1%), respectively.
The change in percentage of International stores from fiscal year 2016 to fiscal year 2019,
however, is 3.8%, 4.0%, 7.7%, and 1.7%, respectively. This statistic gives a strong indication that
Coach is focusing on the International market. As of fiscal year 2019, Coach has total 595 stores
Internationally, compared to 391 stores in North America.
Valuation Metrics
Tapestry has favorable valuation metrics compared to other companies in the industry (See
Figure 2). Due to the huge price drop that took place this summer, its current price gives to the
company a P/E smaller than competitors and a dividend yield of 5%, among the highest on the
whole market.
Investment Thesis
The market has incorrectly priced Tapestry by undervaluing the impact of its expansion in China
and by overestimating the effect of the US-China trade war on its free-cash flow.
Expansion in China and Asia
One of Tapestry’s most important strategic initiatives is its goal to increase market share in China.
Experts believe that by 2025, Chinese consumers will account for 46% of the global luxury fashion
market, up from 33% in 2018.3 This means that experts expect China to be the world’s largest
luxury fashion market in just over five years, and Tapestry is positioning itself to have a major
market share in that area. Although Tapestry experienced 0.0% net sales growth in North America
over the past year, it experienced a 9.1% net sales growth in China and a 7.4% net sales growth
in other Asia. As a result, Tapestry now earns 32% of its revenue from this market segment and
has implemented strategies to increase brand recognition and supply chain management in China
and other Asia.
This prioritization of the Chinese market is a very wise decision from Tapestry’s management.
From 2018 to 2025, analysts say that the luxury goods market will grow on average by about 4%
per year, but at the same time they estimate that the Chinese market annual growth will be
3
https://www.bain.com/contentassets/8df501b9f8d6442eba00040246c6b4f9/bain_digest__luxury_goods_worldwi
de_market_study_fall_winter_2018.pdf
around 8.8%, while the rest of the world will grow by only 2.1%.4 The company’s investment
there, even if riskier due to political tensions, can increase the company’s growth to levels higher
than those of competitors.
When you combine the expected growth in the Chinese luxury fashion market with Tapestry’s
clear focus on China and other Asia, Tapestry appears to have great competitive positioning. The
market, however, believes that Tapestry’s growth in Asia will be much lower than it has in recent
years. This is primarily a result of the trade wars between the US and China.
As you can see in Figure 3, world trade uncertainty is around an all-time high due to the trade
wars between the US and China. This has a direct impact on Tapestry, as nearly all of Tapestry’s
products are covered under the imposed List 3 tariffs and the proposed List 4 tariffs. Tapestry is
down over 20% YTD as investors have digested the impact of the tariffs on Tapestry’s Chinese
operation.
However, according to the current market price, investors are expecting flat growth in China for
the forecast period. This is an overreaction, as Tapestry has proven it can grow in Asia even with
the current tariff policy, as evidenced by its growth of 9.1% in China and 7.4% in other Asia over
the previous year. That being said, even in the worst-case scenario, our model indicates we can
expect modest growth from Tapestry’s stock.
Model
In order to get an intrinsic value for Tapestry, we have built a model to estimate and discount the
future free cash flows of the firm. In particular, we have estimated the cash flows in the next
seven years and used the last one to obtain a terminal value. Finally, we have discounted all these
values by Tapestry’s WACC5 and summed all the discounted results to obtain the firm’s intrinsic
value. To get the stock price, we removed the amount of debt outstanding from the firm value
and divided the equity value for the number of stocks in the market.
There are different scenarios we have considered in our estimation but the final result is that the
intrinsic value of the stocks is currently higher than the market price.
We have used values in line with the average of the last years as assumption for the growth of
the free cash flows, which is about 9.32% per year. In the most positive scenario, which we expect
to take place if China will lower its tariffs on American goods and Trump will reduce taxation on
the middle class, we have assumed a higher annualized growth (12% as the consolidated growth
in the best booming periods of the firm). This gives us an upper limit for our intrinsic-value range
of $38.91. The two negative scenarios assume that the market will keep on discounting Tapestry’s
shares around 10% and this would keep the stock price lower. These scenarios give us a lower
limit for our intrinsic-value range of $27.47, which is still above TPR’s current price of $26.94. This
situation is likely to take place if the firm fails to convince investors about the new value obtained
4
McKinsey. (April 1, 2019). Annual consumer expenditure on personal luxury goods in China and worldwide from
2008 to 2025 (in billion yuan) [Graph]. In Statista. Retrieved November 18, 2019, from
https://www.statista.com/statistics/977803/chinese-and-global-spending-on-luxury-goods/
5
WACC = 8.62%, Data from Bloomberg (11/16/2019)
from its Chinese investments. One scenario assumes the same growth as the latter one at 9.32%
but at a higher discount rate, while in the most negative one the value of growth is 4.76%, which
is the current return on equity times the median of the reinvestment ratio of earnings. For the
perpetual growth, we have assumed in all the scenarios a value of 4%.
Our model indicates that the intrinsic value of TPR is between $27.47 and $38.91, with an
average of $32.54 (See Figure 4).
In our opinion, the current market price is discounting too much the future cash flow that TPR
will produce because of two main uncertainties. The first one is the tension regarding tariffs and
worry that they could harm the result of the plans of Tapestry in China. The second market
concern stems from the poor results of Tapestry during the last fiscal year, as investors are
uncertain that the company will be able to maintain a dividend of $1.35 while continuing to grow.
However, there is a strong chance that the tariff situation improves significantly over the next 12
months. Further escalation in the trade war with China will hurt Donald Trump’s reelection
chances significantly. We believe there is a 90% chance that the announced 15% tariffs will be
pushed back until 2020, and a 60% chance that those tariffs are cancelled altogether. These
estimates are higher than the analyst consensus6, but we are confident that Donald Trump will
ease trade tensions with China as we get closer to the election to improve his chances at
reelection.
Worst-Case Scenario
In the worst-case scenario, the announced 15% tariffs go into effect on December 15, the trade
situation worsens, and Tapestry does not see any growth in China in the next 12 months.
Although this would obviously have a negative impact on Tapestry’s share price, Coach’s steadily
increasing North American growth will offset losses, and our model predicts that the share price
will drop to $23.74 if this happens, with a loss of 11.29% based on the current price.
Still, Tapestry has a 5.0% dividend yield, which is among the best in the entire market, and has
announced a $1B stock buyback plan. These two strategic initiatives will help mitigate losses.
Finally, Tapestry’s management has proved to be very responsible financially, which gives us
confidence that the worst-case scenario will not be very bad. Tapestry has announced that they
are committed to long-term organic growth and will not be pursuing any strategic acquisitions in
the near future. This, combined with its strong balance sheet, leads us to believe that Tapestry
has a high floor even if the trade situation does not improve.
Catalysts
Two events jump out as catalysts which will pull Tapestry’s stock price closer to its intrinsic value.
The first of these is a trade agreement with China. If President Trump announces a rollback of
6
https://www.cnbc.com/2019/10/13/trade-deal-morgan-stanley-warns-tariff-escalation-remains-a-meaningfulrisk.html
tariffs, investors will realize Tapestry’s strong competitive position in China. Even if a rollback
doesn’t occur, but tariffs are delayed and no new tariffs are announced, this will ease investors’
fears.
If this happens, Tapestry will beat market expectations for revenue and earnings during its
earnings calls in February in May. We believe these solid earnings announcements will increase
investor sentiment and bring Tapestry’s stock price closer to its intrinsic value of $32.54.
Risks
As mentioned above, the risks we foresee include worsening trade wars with China. There is a
possibility that trade wars escalate and more tariffs are announced, and this will obviously have
a negative impact on Tapestry’s expansion in China.
Also, it is impossible that Tapestry’s new strategic initiatives cause financial results to get worse
before they get better. Tapestry has long-term, sustainable, organic growth in mind, and this
long-term focus could result in sub-par results in near term.
Risk Measures:
VaR (5%, daily data from the last 3 years) = -2.89%
VaR (5%, weekly data from the last 3 years) = -8.29%
Implementation
In order to open a long position in Tapestry, we suggest selling our 125 shares of TJX. The main
reason is for diversification: both firms are part of the retail sector of consumer discretionary.
The forecasted growth of the two segments is expected to be very similar in the next 5 years 7,
but in the case of a recession, the apparel market is the one that is most likely to take the biggest
hit among the two and requires more time to bounce back.8 Selling TJX at the current market
price of $59.82 would grant the fund a 7.32% return ex dividend on the position 9. With the cash
obtained, we will be able to buy 280 shares of TPR at the current price of $26.7610, leaving the
portfolio and sector balance unchanged. (See Figure 5 for Suggested Consumer Portfolio
Structure)
7
Data from McKinsey “Unleashing fashion growth city by city”
https://www.mckinsey.com/~/media/mckinsey/dotcom/client_service/marketing%20and%20sales/pdfs/unleashin
g_fashion_growth.ashx
8
US Census Bureau. (April 4, 2019). Clothing and clothing accessories store sales in the United States from 1992 to
2017 (in billion U.S. dollars) [Graph]. In Statista. Retrieved November 18, 2019, from
https://www.statista.com/statistics/197640/annual-clothing-store-sales-in-the-us-since-1992/
9
TJX was bought at $55.74
10
Prices are taken from Bloomberg on 11/16/2019
Appendix A – Charts and Graphs
Figure 1 (Data from Gurufocus https://www.gurufocus.com/stock/tpr/summary (11/16/2019))
Key Profitability Measures for Tapestry, Capri Holdings, and
Consumer Discretionary
Operating Profit Margin
ROE
ROA
0.00%
2.00%
4.00%
6.00%
8.00%
Consumer Discretionary Average
10.00%
Capri
12.00%
14.00%
16.00%
18.00%
Tapestry
Figure 2 – Valuation Metrics (Data from Gurufocus
https://www.gurufocus.com/stock/tpr/summary (11/16/2019))
Market
Capitalization
Retail Cyclical
Median
P/E
Ratio
Price to Price
Book
to FCF
Ratio
EV/EBTIDA ROE
%
Operating
Margin %
17.08
1.33
13.90
10.55
5.29
3.51
Tapestry, Inc.
$7.38 Bil
14.39
2.48
14.83
10.71
15.98 11.79
Capri
Holdings
$5.57 Bil
16.59
2.32
11.63
9.6
14.53 14.30
Tiffany & Co
$15.11 Bil
27.25
4.77
52.14
16.96
18.07 16.88
Burberry
Group
$11.74 Bil
24.95
6.99
29.65
16.40
27.72 17.06
Salvatore
Ferragamo
S.p.A.
$3.34 Bil
35.81
4.09
14.48
16.87
11.41 11.37
Figure 3 – World Uncertainty Index (Taken from Economic Policy Uncertainty https://www.policyuncertainty.com/wui_quarterly.html)
110
Some of the key dates in the USChina trade negotiations
The US and China
agree to resume trade
talks.
100
World Trade Uncertainty Index
90
Uncertainty related …
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