Fitch Ratings has upgraded Tapestry, Inc.'s ratings, including its Long-Term Issuer Default Rating (IDR) to 'BBB-' from 'BB' and its unsecured revolving credit facility and notes to 'BBB-' from 'BB'/RR4.
The Rating Outlook is Stable.
The upgrade of Tapestry's IDR to its pre-pandemic rating reflect its improving topline trajectory and sustainable cost reductions, which led to fiscal 2021 (ending July 3, 2021) EBITDA of approximately $1.4 billion, similar to pre-pandemic levels. EBITDA improvement alongside Tapestry's recently announced intention to repay $400 million of unsecured notes due July 2022, have improved Fitch's confidence in Tapestry's ability to sustain adjusted leverage around 3x, appropriate for the 'BBB-' rating.
Tapestry's ratings continue to reflect its strong brand positioning at Coach (around 90% of segment EBITDA), and its leading market share within the U.S. premium handbag and small leather goods market. The rating also considers the fashion risk inherent in the accessories and apparel space.
Key Rating Drivers
EBITDA Rebound: Tapestry's fiscal 2021 EBITDA of $1.37 billion is modestly above the $1.3 billion achieved in fiscals 2018/2019, the result of sales rebounding from the pandemic trough to nearly pre-pandemic levels, good cost control and inventory management. Revenue in fiscal 2021 was $5.7 billion, above the $4.6 billion trough in calendar 2020 and only modestly below the $6.0 billion achieved in calendar 2019. Fiscal 2021 EBITDA margins were approximately 24%, above the approximately 22% prior to the pandemic on cost reductions and lower inventory, which has reduced markdown activity.
Fitch projects revenue could approach pre-pandemic levels of $6.0 billion over the next 24-36 months on low-single digit topline expansion, with Coach brand sales modestly above pre-pandemic levels and Kate Spade and Stuart Weitzman revenue modestly below given pre-pandemic brand challenges at each. EBITDA is expected to trend around $1.4 billion with margins declining to the 23% range assuming some topline investments and markdowns are reintroduced over time. Fitch recognizes a number of unknowns continue to exist, including the levels of pent-up and pull-forward demand which may have benefitted 1H21 apparel and accessories sales, and the potential impact of rising delta variant cases on consumer behavior.
Longer Term Pandemic Impacts: Tapestry's initiatives and competitor actions during the pandemic could benefit leaders in the apparel and accessories space such as Tapestry. Tapestry and other scaled players with good infrastructure and cash flow used the past 18 months as an opportunity to accelerate omnichannel investments, eliminate unproductive expenses, streamline processes to improve corporate speed and agility, prune real estate portfolios and reorient internal functions like marketing to align with broader changes in the consumer landscape. At the same time, the retail landscape has seen store closures from strong and weaker players as well as larger scale retrenchment by, or even elimination of, struggling industry participants.
Tapestry's internal initiatives and some reduction to the competitive landscape should improve the company's revenue prospects in the medium term. Cost reductions both support margins and permit incremental opportunities for topline investments. Finally, reduced industry square footage should lead to lower industry-wide inventory levels of apparel and accessories, which could structurally reduce industry markdown activity.
Demonstrated Financial Conservatism and Flexibility: Tapestry's good credit profile is underscored by its actions and financial flexibility since the beginning of the pandemic. The company maximized near-term cash flow through payables negotiations, lower inventory buys and material reductions to discretionary operating and capex. Tapestry paused share buybacks and eliminated its dividend to further support liquidity. Since the end of 2019, the company has net closed 125 stores, or around 8% of its total fleet, reducing its longer-term rent burden as sales shift online. Finally, the company announced the repayment of its $400 million in unsecured notes prior to their July 2022 maturity, which would yield a remaining capital structure with $1.2 billion in unsecured notes.
Tapestry's good financial flexibility was supported by FCF of approximately $1.2 billion during fiscal 2021, resulting in $2 billion of cash on hand as of July 3, 2021, and uninterrupted access to its $900 million unsecured revolver. Fitch expects these factors to continue to benefit Tapestry's credit profile over the next two to three years, including Fitch's projections of $550 million to $650 million in annual FCF beginning fiscal 2022 following the resumption of cash dividends, neutral working capital and higher capex levels.
Leading Position in Competitive Industry: With its Coach ($4.3 billion pre-pandemic revenue) and Kate Spade ($1.4 billion pre-pandemic revenue) brands, Tapestry is one of the largest global handbag and accessory players. Coach is essentially tied with Michael Kors (owned by Capri Holdings Limited, 'BBB-'/Stable) for leading market share in the U.S. handbag market. Tapestry's scale relative to smaller, less cash-generative competitors provides key benefits, including a greater ability to invest in revenue-driving activities like design, merchandise, and marketing.
Coach Brand Stabilized Pre-pandemic: The Coach brand demonstrated stabilized operations prior to the pandemic. Over the past five or so years, the company has undertaken a number of actions, particularly in North America, to position the brand for long-term growth. Topline began to stabilize in fiscal 2016 and brand comps generally trended in the 1% to 2% range from fiscal 2018 through the end of calendar 2019.
Kate Spade's Topline Challenges: The Kate Spade brand (21% of fiscal 2021 revenue) has experienced topline dislocation since its acquisition by Tapestry for $2.4 billion, or 9x EBITDA, in July 2017. Comparable store sales fell 7% in both fiscal 2018 and fiscal 2019; Fitch expects topline weakness is the result of a combination of incumbent brand challenges and Tapestry's efforts to reposition the brand by elevating product quality and reducing both promotional flash sales and its wholesale presence.
Kate Spade's pre-pandemic trajectory could prevent Tapestry from returning revenue to its $6 billion calendar 2019 peak if its topline issues are not fully addressed. In March 2021, the company announced a new creative organizational structure at Kate Spade, indicating brand changes are not yet complete.
Derivation Summary
Tapestry's upgrade to 'BBB-'/Stable reflects its improving topline trajectory and sustainable cost reductions, which led to fiscal 2021 (ending July 3, 2021) EBITDA of approximately $1.4 billion, similar to pre-pandemic levels. EBITDA improvement alongside Tapestry's recently announced intention to repay $400 million of unsecured notes due July 2022, have improved Fitch's confidence in Tapestry's ability to sustain adjusted leverage in the low-3x, as appropriate for the 'BBB-' rating.
Tapestry's ratings continue to reflect its strong brand positioning at Coach (around 90% of segment EBITDA), and its leading market share within the U.S. premium handbag and small leather goods market. The rating also considers the fashion risk inherent in the accessories and apparel space.
Capri Holdings Limited's BBB-/Stable rating reflects its improving topline trajectory and sustainable cost reductions, which led to LTM June 2021 EBITDA of approximately $1.1 billion, similar to pre-pandemic levels. EBITDA improvement alongside continued debt reduction, including approximately $870 million of paydown in the fiscal year ended March 2021, have improved Fitch's confidence in Capri's ability to sustain adjusted leverage in the low-3x, as appropriate for the 'BBB-' rating.
Capri's rating also reflects its strong positioning in the U.S. handbag market, historical growth at its various brands and its commitment to debt reduction. The rating also considers the fashion risk inherent in the accessories and apparel space.
Levi Strauss & Co. (BB+/Stable) is of similar size and profitability to Tapestry and competes in a space (clothing) that is susceptible to fashion risk. Based on EBITDA declines, adjusted leverage increased to approximately 6.0x in fiscal 2020 (ended November 2020) from 3.1x in fiscal 2019. Fitch expects that EBITDA will approach pre-pandemic levels in fiscal 2021 (ending November 2021) based on a rebound in revenue, good cost control, and channel shifts toward the more profitable direct-to-consumer channel. As such, Fitch expects adjusted debt/EBITDAR (capitalizing leases at 8.0x) to improve below 3.5x in fiscal 2021.
Kohl's Corporation (BBB-/Stable): Kohl's ratings reflect its position as the second largest department store in the U.S. and its well-developed omnichannel strategies, with digital sales expected to contribute to approximately 35% of revenues going forward. Kohl's off-mall real estate footprint provides some insulation from mall traffic challenges. Assuming a sustained topline recovery, EBITDA could return to 2019 levels of $2.5 billion and adjusted debt/EBITDAR could return to under 3x in 2022.
Nordstrom, Inc. (BBB-/Negative Outlook): Nordstrom's ratings reflect its historically good market position in the apparel, footwear, and accessories space, with its differentiated merchandise and high level of customer service enabling the company to enjoy strong customer loyalty. However, the Negative Outlook reflects concerns that recent pre-pandemic operating challenges could suggest some combination of execution shortfalls and increased susceptibility to secular headwinds in the department store space, which could limit the company's ability to return revenue and profitability close to pre-pandemic levels.
Nordstrom's ability to sustain its 'BBB-' rating would depend on the operating rebound potential through 2022, with increased confidence in Nordstrom's ability to achieve Fitch's projections and bring adjusted leverage to under 3.5x through both EBITDA expansion and debt reduction.
Key Assumptions
Fitch projects Tapestry's revenue could grow low-single digits in the medium term. Fiscal 2022 should benefit from a continued recovery in apparel and accessories spending, somewhat mitigated by the loss of a 53rd week from fiscal 2021. Revenue could approach pre-pandemic levels of $6 billion over the next two to three years, with the Coach brand modestly outpacing its pre-pandemic sales volume and Kate Spade and Stuart Weitzman modestly below, given pre-pandemic brand challenges.
EBITDA could trend near the $1.4 billion level recorded in fiscal 2021 with margins moderating modestly toward 22% from nearly 24% in fiscal 2021. This assumes some reversal in the recent pullback to discretionary operating expenses and markdown activity over time.
FCF (after dividends) could be in the $550 million to $600 million range annually, assuming neutral working capital and capex of around $250 million, similar to pre-pandemic levels. The company will begin paying a $0.25 per share dividend in 2Q22 and Fitch assumes the company will pay approximately $225 million in dividends in fiscal 2021 and around $325 million in fiscal 2023 given annualization and some modest growth in dividends per share. The company has targeted $500 million of share repurchases in fiscal 2022 and Fitch assumes this level could continue annually. Tapestry has also indicated plans to repay its $400 million of unsecured notes due July 2022, which could be done with cash on hand, given $2 billion in cash balances as of July 3, 2021.
Adjusted debt/EBITDAR (capitalizing leases at 8x) was approximately 2.9x in fiscal 2021, modestly below the 3.3x recorded in fiscal 2019 prior to the pandemic on lower rent levels following store closures. Assuming steady EBITDA around $1.4 billion, adjusted leverage could trend close to 3x following the repayment of the 2022 notes maturity.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
A positive rating action could result from EBITDA growth toward $1.6 billion with low single digit revenue growth and EBITDA margins in the mid-20% range, which would yield total adjusted debt/EBITDAR (capitalizing rent at 8x) sustaining below the high-2x range assuming flat debt levels following the repayment of the 2022 maturity.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
A negative rating action could result from ongoing weak operating trends, yielding EBITDA below $1.1 billion and consequently adjusted debt/EBITDAR (capitalizing rent at 8x) sustained above the low-3x range.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Adequate Liquidity: As of July 3, 2021, Tapestry had $2.0 billion in cash and short-term investments and no borrowings on its $900 million unsecured revolver maturing October 2024. The company's debt structure includes three tranches of unsecured notes totalling $1.6 billion, including a $400 million tranche maturing in 2022 and two tranches of $600 million maturing in 2025 and 2027. On Aug. 19, 2021, the company announced its intention to repay its 2022 maturity with cash on hand.
The company suspended its regular quarterly dividend effective the June 2020 quarter and suspended its share repurchase program in April 2020. On Aug. 19, 2021, the company announced the resumption of both programs in fiscal 2022. Tapestry expects to purchase around $500 million of equity in fiscal 2022 and pay a quarterly dividend of $0.25 per share (modestly below the $0.3375 per share prior to the pandemic), or approximately $300 million on an annual basis.
Issuer Profile
Tapestry is a leading global manufacturer and retailer of accessories and leather goods, primarily handbags, and footwear. Historically, the company operated solely as the Coach brand. In 2015, however, the company began to pursue an M&A strategy to diversify its operations. The company's current brand portfolio consists of Coach, Kate Spade and Stuart Weitzman.
Summary of Financial Adjustments
Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation and exclude non-recurring charges. For the year ending, July 3, 2021, Fitch added back $64 million in stock-based compensation, $37.7 million in impairment charges, and $89.6 million in Acceleration Program costs. Fitch has adjusted the historical and projected debt by adding 8x annual gross rent expense.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
RATING ACTIONSENTITY/DEBT RATING PRIOR
Tapestry, Inc. LT IDR BBB- Upgrade BB
senior unsecured
LT BBB- Upgrade BB
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TAPESTRY, INC. 
