Big Growth Potential Ahead for This Fashion Company

Big Growth Potential Ahead for This Fashion Company

Fashion is a volatile and dynamic business, but at the same time it can be enormously profitable when it comes to well run companies positioned on the right side of the trend. Michael Kors is in fashion right now, and the company is well positioned to continue growing for years to come.

A quality company
Michael Kors is a high-end fashion company selling handbags, shoes, watches, jewelry and accessories through three different channels: retail stores, wholesale and licensing agreements.

Kors is an aspirational brand:famous movie stars walking the red carpet or the first lady herself in the White House have been seen in the media wearing the products. This is probably the best kind of free advertising the company can hope for, but Michael Kors also offers flexibility and a wide variety of price ranges in order to cater to different kinds of clients.

The company is firing on all cylinders with sales increasing 67.4% annually in the last three years and earnings per share rising by more than 107.5% per year over the same period. Profitability is remarkably high compared to industry averages; Michael Kors has a gross margin above 60% and an operating margin in the area of 30% of revenue.

Strong performance in a tough environment
Kors delivered outstanding financial results in the last quarter. Total revenue increased 54.5% to $640.9 million and performance was strong across the different segments. Retail sales increased 51.5% to $325.7 million driven by a 27.3% increase in comparable-store sales and 75 net new store openings. Wholesale net sales increased by 59.3% to $290.6 million and licensing revenue grew 40.7% to $24.6 million for the quarter.

Competitors have not been doing so well over the last quarters, and this makes the company's results even more impressive. Notably Coach , one of its closest competitors, is having trouble when it comes to sustaining the growth rates it has delivered in previous years.

Coach reported a decline of 1.7% in comparable store sales in North America for the last quarter. Disappointing North American sales have been a recurrent problem for Coach for some time now, as the company is clearly feeling pressure and losing market share to Michael Kors.

Another high-end fashion company disappointing investors during the last quarter was Polo RalphLauren , which reported a decline of 1% in consolidated comparable store sales for the quarter. The company reaffirmed its guidance for the rest of fiscal 2014 with an expected increase of between 4% and 7% in consolidated net revenue, but management characterized the current global environment as "uneven."

Vera Bradley , which sells more affordable handbags and accessories is trading near its lows for the year as the company reported disappointing results on Monday: Total sales were up by 1.9% in the last quarter, but same-store revenue fell 3.7%. Management attributed the weakness to a soft consumer environment, and forward-looking guidance was also below analysts' expectations.

The current environment has been quite challenging for fashion retailers, but Michael Kors seems to be the exception to the rule, and this makes the company´s financial performance particularly remarkable.

Opportunities and risks
Kors has plenty of room for expansion, both in the U.S. and abroad. The company opened 75 net new stores in the last year, 24 of which were opened during the last quarter. The company ended the quarter with 328 company-owned global retail stores and 442 stores including licensed locations.

Management is planning to open 50 new stores during this year in North America, and believes there is potential for 400 locations in the region. When it comes to international markets, the opportunity is still practically untapped; Kors opened its first stores in Brazil and in India during the last quarter.

Watches and jewelry are particularly promising for the company. Management believes it will be able to open approximately 500 shop-in-shops globally for watches and jewelry versus a current base of 60 shop-in-shops for those products.

Kors has ambitious plans for growth and, judging by the spectacular sales performance and abundant room for expansion, there is no reason to believe the company should slow down anytime soon.

On the other hand, shares of Michael Kors are trading at P/E ratio of more than 33 times earnings for the last year. That´s a considerable premium versus industry peers like Coach, Polo Ralph Lauren and Vera Bradley which trade at P/E ratios of 15, 21 and 12 respectively.

Bottom line
The company deserves a premium due to its superior growth prospects and financial performance, but investors need to be aware of the fact that Michael Kors is priced for growth, and any slowdown could create material volatility in the stock.

Michael Kors is a high-quality company with a strong track record of growth and a profitable business model. The company is outperforming its peers by a wide margin in a challenging scenario, and it still has plenty of room for growth in the middle term. Even if the stock is a bit pricey, Kors is positioned to outperform.

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Andrés Cardenal owns shares of Michael Kors and Coach. The Motley Fool recommends Coach. The Motley Fool owns shares of Coach. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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