When women go shopping for the perfect purse, they often check out two top fashion brands: Michael Kors Holdings Ltd. (KORS.N) and Kate Spade & Co. (KATE.N). We check to see who’s got the hot handbag – and the best financials.
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Both luxury brands compete head-to-head in the pocketbook category, offering a premium product at a somewhat affordable price for the aspirational consumer. Among luxury bags, KATE’s baby bags rule while KORS doesn’t even offer them. They each market and place their products in different competitive ways. On its corporate site, KATE says that its “brands are intended to accent customers’ interesting lives and inspire adventure at each turn.” KORS focuses more on the jet-setting lifestyle brand. (Source: KORS and KATE corporate sites)
As predicted by StarMine, KORS beat its fourth quarter earnings, revenue and same store sales expectations. Still, the stock moved lower after the market open, because the market was focusing on the fact that the retailer missed on gross margin. This came in at 59.9%, slightly below its 60.23% final estimate, and also weaker than previous three quarters:
Exhibit 1: KATE vs. KORS Gross Profit Margin %
Source: Thomson Reuters I/B/E/S
Despite the miss, it’s important to note that both KATE and KORS posted gross margins above the industry average of 50.6%. When looking at the 26 large and mid-cap stocks within the textiles & apparel industry in North America, KORS has the biggest piece of the pie at 8.6%, followed by Coach and KATE at 5.9%, and 2.0%, respectively.
Both brands understand that social media and luxury perception are huge for product placement. In terms of social media share, KORS has three times more followers than KATE. However, the Kate Spade brand is kept fresh and trendy through product placement on two popular television shows — New Girl and The Mindy Project. However, Michael Kors also has made a name and reputation as a fashion guru through his role as a judge on Project Runway.
Financial models vs. runway models
StarMine models indicate that KORS might be financially stronger in growth, credit and cash flow:
1) A stronger balance sheet and no long-term debt.
2) A richly valued stock price, but the growth to back it up.
3) Earnings projected to grow 27.7% in the next four quarters.
4) Implied ROE stronger than the industry average.
When looking at the balance sheet, KATE has $128.5M in cash, but three times that amount ($390.8 million) in long term debt and $306.4 million in current liabilities. Meanwhile, KORS has no long-term debt, and its cash balance is three times its liabilities. KORS definitely has the stronger balance sheet, and earnings go straight to shareholders. KATE must pay off its debts before posting a profit.
StarMine’s SmartRatios Credit Risk model, ranks KATE in the lowest decile for all North American stocks, which may make investors think twice before jumping in. Its leverage component gives the retailer an anemic score of 3.
Exhibit 2: KATE vs. KORS Balance Sheets (as of last reported quarter)
Source: Thomson Reuters I/B/E/S
Stock price vs. purse price
KORS’ stock also looks luxurious when examining its intrinsic value. Our StarMine Intrinsic Valuation model accounts for the systematic biases that our research team found in sell-side estimates. Namely, the faster the expected growth rate, the more optimism bias. And, farther-out estimates are more optimistically biased than nearer ones. The strong tendency of rapid growth rates to revert to the mean is frequently underestimated, which is especially problematic when attempting to value growth stocks.
For KORS, after adjusting FY1, FY2, FY3-FY5 and LTG estimates for optimism bias, StarMine’s Intrinsic Valuation model arrives at a forward 10-year compound annual growth rate (CAGR) of 14.4%, placing fair value at $58/share. In contrast, market expectations are considerably higher. Plugging in today’s price and solving for growth suggests that investors are a bit more optimistic.
KORS’ market implied 10-yr CAGR is 19.9%. Investors seem overly optimistic about KATE, with a 40.5% market implied 10-yr CAGR vs. StarMine’s forward 10-year EPS CAGR of 17.3%. Perhaps handbags will result in an escalating market for KORS and KATE. Or perhaps market expectations are just too high. Lastly, on average, KORS is expected to see a 20.67% EPS growth over the next 4 quarters vs. KATE’s slower growth (Exhibits 3 and 4).
Exhibit 3: KORS Earnings 2013 Actuals and 2014 Estimates
Source: Thomson Reuters I/B/E/S
Exhibit 4: KATE Earnings 2013 Actuals and 2014 Estimates
Source: Thomson Reuters I/B/E/S
In terms of same store sales, both KATE and KORS are expected to see double digit comps in the next four quarters. Still, KORS’ same store sales projections are stronger than KATE’s.
Exhibit 5: KATE vs. KORS Same Store Sales
Source: Thomson Reuters I/B/E/S
Return on equity vs. returns at the store
Digging deeper into the data, we look at ROE, a measure of how well retailers use capital to generate profits. Industry-wide, ROE is a robust 20.7%. The analysts’ mean forecast is that KORS will generate a 36.2% return on equity this year, while a highly rated StarMine analyst with a very accurate rate suggests a figure closer to 45.9%. That’s considerably stronger than the rate at which KATE will generate profits on its balance sheets. The ROE estimate for KATE is -142.10%.
KORS appears to be leading the luxury market from a position of relative strength. Its StarMine ratings look robust, with a score of 71 on the StarMine Analyst Revisions (ARM) Model, indicating that there is a modest chance that analysts will boost their estimates for the retailer’s earnings. However, KATE sports a higher score at 81, a clear sign that analysts might become bullish and boost earnings estimates.
Exhibit 6: KORS ROE
Source: Thomson Reuters StarMine Professional
KORS has continuously mentioned that they are well positioned for long-term growth. Accordingly, StarMine does show ROE growth above the 20.7% industry level in the upcoming five years.
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