Inflation Isn't Slowing Down This Undervalued Luxury Stock

While some investors may not be familiar with the name Tapestry (NYSE: TPR), it is the parent company of three brands in the "affordable luxury" segment: Coach, Kate Spade, and Stuart Weitzman. Coach is by far the largest of the three in terms of sales, making up 75% of the company's 2021 fiscal-year revenue.

Tapestry has been growing sales year over year in a challenging environment as it battles inflation concerns, supply chain challenges, and China's COVID lockdowns. In fact, the company grew revenue across all three of its brands by double digits in the most recent quarter despite these challenges. But these headwinds have still conspired to push the stock down 30% from its 52-week high and 23% year to date. However, looking past these challenges, Tapestry is positioning itself well over the long run and deserves more credit based on how it has navigated through the challenges so far.

Woman with designer handbag.

Image source: Getty Images.

Pricing power

While investors are concerned about inflation hurting demand, Tapestry has so far been able to flex its pricing power. CEO Joanne Crevoiserat reported that the company has seen "no negative impact on customer demand from these price increases, highlighting our value proposition, brand relevance, and the increasing traction of our product offering." The momentum of several new product offerings means the company can exercise further pricing power if it needs to offset rising costs.

China: From headwind to tailwind

In addition to inflation and supply chain challenges, the lockdowns and restrictions in China are two of the primary reasons shares of Tapestry have declined. These measures have forced store closures and hurt sales in a country where Coach enjoys popularity and maintains a significant physical retail presence. But management thinks that these restrictions will start to ameliorate by June and expects that the situation should eventually start to normalize.

Further out, Bain & Company predicts that China will grow to 46% of global luxury sales by 2025, up from 33% in 2019. This would transform China from a headwind for Coach in the short term into a major long-term growth driver.

Digital transformation

Another investor concern is the closure of department stores putting a damper on Coach's sales. But the company has been successfully growing its online sales, which not only can help to mitigate sales lost from store closures but also cut out the middleman by selling directly to the consumer. On the lastearnings call Crevoiserat highlighted the fact that Coach grew digital sales by over 20% in the quarter year over year and that online sales now make up about 30% of its total revenue. This growth is even more impressive when looking further back as it is five times what it was just three years ago. She forecasts that the company can hit $2 billion in online sales for fiscal 2022 and that there is more runway beyond that going forward.

Affordable luxury with a bargain bin stock price

While the company is growing revenue, the aforementioned investor concerns have created a buying opportunity based on Tapestry's favorable valuation. Shares trade at just 11 times earnings and a very attractive eight times next year's projected earnings.

Furthermore, the company has $4.18 of cash per share sitting on its balance sheet making it an even more attractive value proposition. Looking at the price/earnings-to-growth (PEG) ratio, which seeks to incorporate a stock's earnings growth into its valuation by dividing the stock's price-to-earnings (P/E) multiple by its earnings growth rate, Tapestry trades at a PEG ratio of just 0.5. A PEG ratio of 1 or below is widely accepted as a sign that a stock is undervalued.

Returns to shareholders

In addition to this attractive valuation, Tapestry is also appealing because of its returns to shareholders. Tapestry pays a quarterly dividend, and the shares currently yield over 3%. The company suspended its dividend in 2020 and resumed it in late 2021 due to the COVID-19 pandemic, but it generates sufficient cash flow and should be back on track as a solid dividend payer going forward.

Additionally, management is forecasting it will buy back $1.6 billion worth of stock over the course of fiscal 2022, with $1.25 billion of shares already repurchased. This is a massive amount of stock to buy back for a company with an $8.4 billion market cap. Share buybacks are another way to return capital to shareholders; taking these shares off the open market decreases shares outstanding and increases earnings per share. Share repurchases can also be a sign that management believes shares are undervalued.

Is Tapestry a buy?

Tapestry has worked hard to position itself to navigate through the current climate successfully and to emerge as a growth story on the other side of it. Valuation looks favorable, and the company is returning a considerable amount of capital to shareholders. Shares of Tapestry look like a sensible buy.

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Michael Byrne has no position in any of the stocks mentioned. The Motley Fool recommends Tapestry. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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