Don't Buy Into This Luxury Growth Story

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In spite of the weak economy, Michael Kors (NYSE: KORS), a front-runner in the apparel sector, produced tremendous results during the last quarter. It is expected that Michael Kors would report its second quarter fiscal numbers by Nov. 13.

Unfortunately, its stock is trading at too high a price, even for these wonderful results. This stock’s high valuations should dissuade investors from buying until it descends closer to those of its peers. Investors should look to other, more reasonably-priced stocks for apparel store investments.

A Luxury Story

Michael Kors sells branded footwear, accessories, and luxury clothing for men and women. Though it is based in Hong Kong, over 90% of its customers come from countries like the United States and Canada. The company has witnessed extraordinary sales growth during the past few quarters, independent of the economic slowdown.

Michael Kors set earnings guidance higher to $0.38-$0.40 cents per share in September. Revised figures suggest earnings growth of between 65%-74% year-over-year. This is phenomenal relative to its peers. The net income of rival firm Coach  was a paltry 4% and that of Ralph Lauren plummeted by 12%. Shares of Michael Kors have doubled since its IPO last year, easily beating the 20% capital appreciation of the Apparel-Clothing Manufacturing industry group.

Baird analysts revised the price target of Michael Kors to $65 from $61. They also forecast a 7% average annualized growth rate through 2014.

Shopping Around

Certainly, Michael Kors has enjoyed enviable growth. Unfortunately, its shares have doubled in price, pushing its valuation multiples, well above its mid cap and large cap peers. Investors can buy more revenue per dollar from the S&P 500, since this index has a price-to-sales ratio of 1.3, while this stock has a much higher 7.2 ratio. Shares of Michael Kors are trading at an indefensibly high 61.2 price-to-earnings ratio.

The current valuations for Nordstrom (NYSE: JWN) are much more reasonable. At $56 per share, this stock trades at a 1.0 price-to-sales multiple, a fraction of the S&P 500's average. Nordstrom’s 17.9 price-to-earnings ratio is higher value than the 14.2 average of the S&P 500 index, but much lower than Michael Kors' P/E.

Nordstrom also provides income when Michael Kors does not. The 1.91% dividend yield of Nordstrom is sustainable because the company pays out 0.31 of earnings as dividends, so earnings could drop considerably before dividends must be cut.

Investors who want to bet on value-oriented apparel purchases instead of luxury clothing can find valuations that are more reasonable than those offered by Michael Kors. Ross Stores (NASDAQ: ROST) stock is richly priced at roughly $62 per share. Ross' shares currently trade at a high 19.2 price-to-earnings ratio, a higher value than the 14.2 average of the S&P 500 index. The firm's 1.5 price-to-sales ratio is in line with today's prevailing market multiples. This apparel firm is a on the pricey side, but it’s still cheaper than Michael Kors.

A much more interesting value investment is presented by Guess' (NYSE: GES). The share price of this a mid cap apparel store chain has fallen to $25 on bad earnigns results. After reporting same-store sales were down 8.5% in North America, shares of this stock have dropped 14.5%, and they now trade at attractive valuation multiples, both on an absolute basis and also relative to other mid cap apparel stocks. At a value of 0.81, this stock trades at a fraction of the S&P price-to-sales average multiple. Guess' shares are valued at a compelling  9.8 price-to-earnings ratio, a value which is significantly lower than the 14.2 average of the S&P 500. The firm's reasonable 0.01 debt-to-equity ratio demonstrates that it's not over-leveraged or suffering from a weak balance sheet. Investors should consider buying stock in Guess’ because its growth trends in the medium term are attractive and its valuations are compelling.

Guess’ is also an attractive stock for dividend income. Shares pay a dividend yield of 3.21%, which is much higher than the 1.82% yield of the 10-year treasury bond. Future dividend payments are likely because the company pays out 0.32 of earnings as dividends, so earnings could drop considerably before dividends would have to be cut.

Guess’ is also an interesting alternative to Michael Kors because it is a stealth play on the Asian consumer growth. In its most recent quarterly filing, Guess’ revealed that net sales were down for developed markets, but that the Asian segment is still experiencing growth:

<table> <tbody> <tr> <td> <p><strong>Net revenue:</strong></p> </td> <td> <p><strong>Q2 2012</strong></p> </td> <td> <p><strong>Q2 2011</strong></p> </td> <td> <p><strong>% Change</strong></p> </td> </tr> <tr> <td> <p>Europe</p> </td> <td> <p>246,917</p> </td> <td> <p>288,818</p> </td> <td> <p>-14.5%</p> </td> </tr> <tr> <td> <p>North American Retail</p> </td> <td> <p>253,012</p> </td> <td> <p>261,053</p> </td> <td> <p>-3.1%</p> </td> </tr> <tr> <td> <p><strong>Asia</strong></p> </td> <td> <p><strong>66,826</strong></p> </td> <td> <p><strong>55,283</strong></p> </td> <td> <p><strong>20.9%</strong></p> </td> </tr> <tr> <td> <p>North American Wholesale</p> </td> <td> <p>41,628</p> </td> <td> <p>43,868</p> </td> <td> <p>-5.1%</p> </td> </tr> <tr> <td> <p>Licensing</p> </td> <td> <p>27,010</p> </td> <td> <p>28,137</p> </td> <td> <p>-4.0%</p> </td> </tr> <tr> <td> <p><strong>Total Net Revenues</strong></p> </td> <td> <p><strong>635,393</strong></p> </td> <td> <p><strong>677,159</strong></p> </td> <td> <p><strong>-6.2%</strong></p> </td> </tr> </tbody> </table>

These results are not bad enough to warrant Guess’ bargain valuations. They would be cause for alarm if shares were trading at high valuations that have priced in growth; but fortunately, they trade at attractively low valuations. An overall year-over-year drop of 6.2% in net sales with growth pockets should not scare away value investors.

Conclusion

Investors should be skeptical of growth stories and huge valuation multiples. The Michael Kors growth story is about the rise of the affluent in China, a very popular macroeconomic phenomenon. Unfortunately, stories like this one sometimes increase stock multiples beyond reasonable levels. Instead of buying shares in Michael Kors, investors should consider Nordstrom or Guess’ as alternatives with reasonable valuations.


BillEdson11 has no positions in the stocks mentioned above. The Motley Fool owns shares of Guess?. Motley Fool newsletter services recommend Guess?. 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.If you have questions about this post or the Fool’s blog network, click here for information.

blog comments powered by Disqus