Idea of the Week: Michael Kors Soars in Slow Times

Michael Kors (KORS) posted results that sparkled in a relatively slow retail environment, as we noted in this video. The company beat on EPS, Revenue, Same Store Sales (SSS) for the quarter and fiscal year results. They beat expectations in a time when the luxury industry itself has been suffering from weak tourism,  slow mall trends and FX headwinds, including a strong dollar.

According to StarMine, KORS has healthy credit and its earnings are coming from sustainable sources as its cash flow and operating efficiency look good. What’s more, the stock has been soaring, trading as high as $45.75 a share. Still, the StarMine model suggests it is trading at levels that are slightly undervalued. The StarMine IV model places fair value at $59.10 per share. In contrast, the market price at the last close was $42.72 with market implied growth rate of 0.1%. However, StarMine’s Intrinsic Valuation model projects a 5.1% growth over the next five years.

Exhibit 1: KORS StarMine Model Scores

Source: Thomson Reuters Eikon

Strength in China

Kors sells different merchandise at various price points, and knows the high-end consumer resides in Asia. As a result, it opened a flagship stores in attractive locations, including Beijing, and Tokyo, where it saw double-digit comp growth.

What’s more, it completed its acquisition of its Greater China license, which will give it more control on expanding its stores in the area.

Weakness in North America

Still, the bulk of the revenue is generated in North America (exhibit 2). The company said in their earnings call on June 1 that the department store channel remained challenged due to steep promotions which is hurting the brand image. As a result, Chairman and CEO John Idol said they will be actively decreasing “exposure to the wholesale channel by reducing inventory levels to focus on a higher level of full-price sell-troughs and a lower level of markdowns” (Source: KORS earnings call, 6/1/2016)

The company recognized that this strategy might decrease net sales, but in the long term will help build the brand image again.

Exhibit 2: Kors Revenue Segments

Source: Thomson Reuters Eikon

Lowered Outlook

Total operating expenses grew 20.9% as the company continues to invest in tech, e-commerce, opening new stores and hiring talent. The company is also building more distribution centers in Europe. As a result, it is incurring more expenses and lowering its current quarter and full-year guidance.

One theme this earnings season is that more companies are investing in tech/e-commerce and omni-channel presence. These costs are not cheap and are eating profits. More and more retailers are talking about the importance of directly communicating with their customers to offer them what they want online. Likewise, KORS will be doing the same:

In parallel, “we are investing in talent and technology in order to incorporate learning from the customer insights we are gaining. We will continue to capitalize on our CRM capabilities and Michael’s voice to gain a competitive advantage by evolving our customer-centric marketing” (KORS Earning Call, 6/1/16). It’s a strategy that shows Kors is taking steps to remain competitive in the online space.