Buy, Sell, or Hold: Michael Kors
Luxury retailer Michael Kors (NYS: KORS) has had a cartoonishly good year. The stock price has risen 49%, revenue is increasing, store count is up, and same-store sales are going swimmingly. But with massive growth, there is always the chance that a company is going to burn out or hit the wall. Let's look at Kors to see if it's strapping a rocket on its back, or if it's destined to finish 2012 with an anvil on its head.
The path already tread
Kors' great year can be chalked up to three main things: brand strength, same-store sales, and the "new toy" factor. Brand strength shows up on the income statement in a great gross margin. Kors reported a 58% increase in revenue last quarter, and a gross margin of 58%. Kors has clearly been able to hold on to its luxury status and charge whatever it wants for its products. That's as solid as watchmaker Fossil (NAS: FOSL) , but with much stronger bottom-line growth. Fossil has held on to gross margin at the expense of net margin, as profits are being cut into by operating expenses due to the company's expansion.
But Fossil hasn't had that almost comical same-store sales growth that Kors has had recently. In the last quarter, Kors increased same store sales by 36%. Fossil managed to grow sales, but by a much lower 8%. Kors has shown that it can increase sales, not only by expansion but by continuing to provide a great customer experience and product. Later, we'll look at whether or not this growth rate is sustainable.
The "new toy" effect is exuberance on Wall Street. Kors just went public in December last year, and investors have been very excited about the company's growth. So excited that they're now buying the stock at a trailing P/E of 52, whereas Gap (NYS: GPS) trades at 20. But so far, Kors' rich valuation has proved worthwhile.
The future of Kors
The downside to buying Kors is that you do pay a premium for the expectation of future growth. Considering the difference in valuation, you could get a lot more for your dollar by buying Gap. The company has made some good changes, and just released July same-store sales are up an extremely healthy 10%. If Kors starts to slow and Gap speeds up, you might make a huge mistake by paying up for Kors.
So the real question is: Can Kors keep going at this pace? In short, I think so.
Kors needs to do three things to keep growing at its current rate: expand into new locations, grow same-store sales, and maintain brand strength. It's no coincidence that the "to do" list looks like the "has done" list above. New locations will be the hardest piece of the puzzle. Last year, Kors opened 71 new stores, which was up from the 60 stores opened in the previous year.
Stores are still concentrated in North America, with only 46 locations existing internationally at the end of last year. However, both the Asian appetite for luxury goods and the ability of companies to move into Asia are growing. Kors has been especially strong in Japan, with licensing revenue growing 27% there last year. Even as Chinese growth slows, Kors should be able to step up its market penetration and grow through same-store-sales increases.
The only real unknown will be Kors' ability to keep its brand strength up. This is unfortunately the most important and the most unstable part of a Kors investment. I believe the brand will maintain strength long enough for investors to see a very nice profit. That doesn't mean forever, but it should stay strong for the next few years.
The bottom line
Kors shares got knocked with Coach's (NYS: COH) announcement of an upcoming "investment year" --whatever that means. The handbag maker is worried about macroeconomic growth, and has translated that into a soft sales forecast. While Kors will certainly be affected by those trends, I think the sales momentum the company has built this year will get it through a temporary slowdown. For me, Kors is a buy.
The things to watch that could change that rosy outlook are a fall in margin, indicating weakness in the brand, or a sustained pullback in macroeconomic growth. If you're worried about either of those, I'd hold off on making a purchase. With the global economy meaning so much to so many companies, the Fool has written a free report for readers: "3 American Companies Set to Dominate the World." These are companies that look great in most portfolios, and you can get all the details today.
The article Buy, Sell, or Hold: Michael Kors originally appeared on Fool.com.Fool contributor Andrew Marder does not own any of the stocks mentioned in this article. The Motley Fool owns shares of Fossil. Motley Fool newsletter services have recommended buying shares of Fossil and Coach. Motley Fool newsletter services have also recommended shorting Fossil (in a separate service). The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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