Shares of branded apparel outfit PVH Corp. (PVH) have been laggards for about a year now, underperforming the broad-based S&P 500 Index. The out-of-favor status is likely due to a highly promotional retail environment, particularly in the core North American market. Additionally, earnings have been hampered by heavy investment spending that has been needed to revitalize and expand the Calvin Klein businesses acquired in the 2013 Warnaco deal. Still, things have been looking up lately, with the company posting better-than-expected results for the July interim. (Fiscal years end on the Sunday closest to February 1.) What’s more, we envision an acceleration in share-net growth as we head into fiscal 2015, thanks to continued strong Tommy Hilfiger sales, the rollout of new Calvin Klein products, an improved inventory situation in the channel, and a gradual, mix-driven expansion of the gross margin. Acquisition-related savings should also help matters, as integration of the Warnaco assets progresses. With these factors in mind, should investors build positions in this apparel name? Or is the brightening earnings picture we see already baked into the stock price? In this brief article, we will attempt to address these questions by taking a look at PVH’s operations and performing an easy-to-follow SWOT analysis of the company, evaluating its strengths, weaknesses, opportunities and threats.
The business
New York City-based PVH Corp., formerly Phillips-Van Heusen and dating all the way back to 1881, is among the largest branded lifestyle apparel manufacturers in the world. The company has grown rapidly via acquisitions since the start of the new millennium, buying Calvin Klein in 2003, Tommy Hilfiger in 2010 and The Warnaco Group in February of 2013. These multibillion-dollar deals were transformative, giving PVH a diversified product portfolio that is represented globally -- not just in North America but in markets throughout Asia and Latin America -- in the wholesale, retail, e-commerce and licensing channels. Today, led by the Calvin Klein and Tommy Hilfiger labels (these two brands account for around 85% of total operating profit), PVH generates annual revenues above the $8 billion mark.
Strengths
Attractive Brands: With Tommy Hilfiger and Calvin Klein, the company possesses a couple of the more-recognizable, better-positioned lifestyle brands in the world. Tommy Hilfiger has been expanding rapidly of late, with label sales up 9% during the second quarter, led by strength in the wholesale channel both at home and abroad. But Calvin Klein ought to emerge as a major growth catalyst before too long as well. While that business generated a modest top-line advance of 1% in the July period, prospects appear bright, and investments in the jeans and underwear lines, under PVH’s direct control since the Warnaco transaction (prior to that deal, Warnaco was the biggest licensee for Calvin Klein products), should soon begin to bear fruit. In particular, we have high hopes for a new jeans collection that has helped boost bookings for the important Spring 2015 season, despite the likelihood that promotional activity will remain elevated in the domestic apparel space. CK jeans have had their share of troubles, especially in Europe, hurt by merchandising missteps and a spike in markdowns. The new products will likely spark a turnaround, however, along with a deeper push into the department store channel (the addition of Warnaco really helps in this endeavor) and tighter execution by the company’s veteran management team.
Improving Balance Sheet: Debt levels have finally begun to come down after rising in the aftermath of the large Tommy Hilfiger and Calvin Klein acquisitions. In fact, we think that the debt-to-capital ratio will be in the 15% to 20% range by the 2017-2019 time frame, down from closer to 45% today. This deleveraging should support earnings increases by reducing PVH’s interest burden. In the meantime, the company should continue to pay a small dividend, amounting to $0.15 a share annually. (A payout hike is certainly a possibility, though debt repayment is clearly the top priority.) And we would not be surprised to see more action on the M&A front, given management’s excellent track record in this area and PVH’s upgraded financial positioning.
Weaknesses
The Heritage Brands: This still-sizable business ($3.7 billion in 2013), including private labels, licensing goods, and the company-owned Arrow, Izod, and Van Heusen lines, among others, has been struggling, mostly due to its reliance on out-of-favor mid-range department store chains, such as Kohl’s (KSS) and JCPenney (JCP). The legacy Heritage brands, often targeting the value-oriented consumer with competitive price points, are also pretty sensitive to macroeconomic fluctuations, and have been operating in a challenging environment since the last U.S. recession. Going forward, management plans to deemphasize the Heritage division, at least at home (wider international distribution still looks to be in the cards), and instead focus on paying off debt and building out the higher-end Tommy Hilfiger and Calvin Klein labels. To this end, the company recently sold its shoe brand G.H. Bass & Co. to G-III Apparel Group (GIII). And we look for more divestitures of underperforming properties to follow, which should be good for margins and create a welcome bottom-line tailwind.
Opportunities
Cost Cutting: PVH has been attempting to streamline its overhead, as evidenced by its efforts to shutter underperforming stores, divest noncore assets and shore up profitability at the legacy Heritage division. Moreover, the company is beginning to realize ample cost savings related to the Warnaco acquisition, a transaction that not only opened up new geographic markets and resolved pesky ownership-structure issues but also laid the groundwork for PVH to make big improvements in the critical areas of product sourcing and supply chain management. In fact, run-rate synergies stemming from the Warnaco deal should eventually reach $100 million. This gives us confidence that annual share-net growth can approximate at least 10% over the next 3 to 5 years.
Emerging Markets: The accretive Warnaco deal greatly enhanced PVH’s distribution capabilities and overall infrastructure in developing parts of Asia and Latin America. Thus, the opportunities to leverage both the Calvin Klein and Tommy Hilfiger businesses in these underpenetrated regions are plentiful, and we would expect sales and market-share gains abroad to be a compelling chapter in this growth story. These advances ought to more than offset any softness that arises in the U.S. and Europe, where prospects for GDP growth are not quite as bright and promotional pressures are typically more intense.
Mix Improvements: The operating margin, while apt to take a step back in fiscal 2014 because of all the investment spending, is poised to widen nicely as we head toward late decade. Indeed, we see profitability levels rising over time, as the Heritage business is downsized and sales ramp across the high-margined Calvin Klein and Tommy Hilfiger lines. Declining global cotton prices, which are currently near a five-year low (a strong U.S. dollar has taken a toll on most commodities), should be a positive for gross margins, too.
Threats
Competition: Apparel is one of the more cutthroat industries, especially in the U.S., where PVH still derives the lion’s share of its profits. This renders results susceptible to fashion gaffes and rivals’ discounting. We think that the company is better positioned than most of its sector peers, however, owing to its diversity and higher-end orientation. Notably, the Calvin Klein and Tommy Hilfiger businesses have a lot of brand equity around the world, and pricing power across these lifestyle brands remains relatively healthy.
Execution: The wave of activity on the acquisition front, while great for the company’s growth profile, means that financial results could falter if management takes its eyes off the ball and fails to successfully follow through on outlined integration and expansion initiatives. That said, PVH has an impressive track record in this regard, as we’ve already suggested. And the consolidation of purchased businesses has gone smoothly thus far.
Conclusion
There’s a lot to like about the PVH story, with the company’s strengths and opportunities appearing to handily outstrip its weaknesses and threats at present. The large-cap stock is no longer a bargain, but the recent quotation still seems to be an attractive entry point. What’s more, there are several catalysts that could prompt us to become even more bullish on this name, from a sharper-than-anticipated expansion of the gross margin to a powerful rebound in the acquired Calvin Klein operations. All in all, we think that this apparel issue would make a fine addition to most diversified equity portfolios, and encourage investors to consult our report in The Value Line Investment Survey.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
