What's Wrong With Michael Kors Holdings?
Michael Kors Holdings shares have lost 7.6% of their valuation in the last three months, while the S&P 500 index has gained 4.5% in the same period. Given its growth this might sound strange, but when considering the driving force and how it compares to peers Coach and Kate Spade , are investors wise to fear Kors?
What's wrong with Michael Kors?
If you take a look at the fundamental performance of Michael Kors, it's really hard to find a negative. The high-end designer/retailer grew revenue 53.6% in its most recent quarter to $917.5 million. Its comparable-store sales increased 26.2% in the quarter, while European revenue soared a whopping 125% year over year.
However, investors have seemingly ignored this performance in recent months due to concerns of margin pressure. The company's gross margin decreased from 60.1% last year to 59.9% in its most recent quarter, leading analysts to go on the defensive.
What are the analysts saying?
Sterne Agee summed up the problem fairly well by saying:
Top-line momentum can't be denied, but with margins potentially peaking, there are fewer ways to win going forward.
Wells Fargo added, "It's going to get a little bit harder from here" in regard to future margin performance. Herb Greenberg has also turned bearish, saying there are cracks at Kors and implying on CNBC that it's now being forced to discount more aggressively.
Meanwhile, some analysts looked past the margin troubles to focus on the growth, including Buckingham, which said that concerns about the company's margins are overblown. Also, Baird is bullish, and Canaccord Genuity raised its price target to $123.
In fact, Credit Suisse might be the most realistic, saying its operating margin of 30.5% might decline 300 basis points over a period of years due to investments aimed at boosting its infrastructure. However, global expansion gives Michael Kors the potential to more than double in size and reach revenue of $7 billion annually. Therefore, it's a give-and-take with the big question being whether margins or growth will have a greater long-term impact on the stock.
Let's put this in proper perspective
As you can tell, analysts are a bit fickle when it comes to Michael Kors. However, it might be good to use a little common sense when valuing the company and to put the fundamentals in perspective. First off, despite having one of the most impressive comparable growth rates in retail, Michael Kors trades at just 19 times next year's earnings.
Coach is much cheaper at 15 times earnings, but the fundamental difference is that its revenue declined 7.6% in its last quarter. Moreover, Coach's comparable sales in North America declined 21% in the same period; and if you're concerned with Michael Kors' operating margin, then Coach's 540 basis point decline to 23.9% must be an even bigger concern. Not to mention, Coach just recently held its analyst day, and in its presentation the company said that revenue could fall at a low double-digital rate in fiscal 2015. Clearly, Coach is trending against Michael Kors.
With that said, Kate Spade is more on the same level as Michael Kors with revenue growth of 33.5% in its last quarter. However, it too saw margin weakness during its last quarter with a decline of 210 basis points. Over a five year period Kate Spade's operating margin has been inconsistent with three of the five being in negative territory. Meanwhile, Michael Kors has seen its operating margin increase each and every year during the same five year period. Nonetheless, Kate Spade trades at a much higher 54 times next year's earnings despite more significant margin pressure and less impressive overall revenue growth.
In retrospect, a 20 basis point decline to gross margin is hardly something to fuss about. Considering the fact that Michael Kors has an operating margin of 30.5%, far better than either Coach's or Kate Spade's, who cares if it sees some pressure so long as it continues to grow larger?
With all things considered, 19 times forward earnings is hardly pricey, matching the premium of several large-cap secular companies, meaning there is essentially no premium awarded to Kors for its exceptional growth. Therefore, margin pressure may be the cause of its stock weakness, but given the reality of the situation, it's highly unlikely that shares remain discounted for too long.
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The article What's Wrong With Michael Kors Holdings? originally appeared on Fool.com.Brian Nichols owns shares of Michael Kors Holdings. The Motley Fool recommends Coach and Michael Kors Holdings. The Motley Fool owns shares of Coach and Michael Kors Holdings. 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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