These Luxury Brand Names Still Look Promising

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

Sometimes, a brand name says it all. What you wear tells people what image you want to project, how successful you want to look in the eyes of others. Some luxury brands particularly serve to this purpose of indicating socio-economic status. Companies like Michael Kors (NYSE: KORS), Coach (NYSE: COH), and Tiffany (NYSE: TIF) seem well poised to benefit from this conjunction as disposable income grows, especially in emerging economies. Holding strong brands, these firms deserve a closer look.

Michael Kors: Customers consider worth the extra price

Michael Kors makes luxury apparel, footwear, and accessories and markets them through retail, wholesale, and licensing channels. Its strong brand name makes customers willing to pay a premium for its products. This has provided the firm with wider margins than most of its peers. Actually, all of its metrics excel those of its competitors.

So, trading at 31 times its earnings, almost double the 17x industry average, is this firm a buy? I'd say that, offering a consensus projected EPS growth rate of over 28% per year over the next half decade, this stock offers an alluring entry point for long-term investors (as evidenced by the numerous institutional buys over the past few months).

One of the keys to Kors' success relies on its strong and long-standing management team, led by CEO John Idol, who used to run other high-end apparel companies like Ralph Lauren and Donna Karan. Some of its growth strategies were questioned in the past, but have proven very effective. Reflecting a good balance between profitability, asset management, and financial leverage, the company's return on equity and return on assets testifies management's efficacy.

Last quarterly results further back management´s initiatives and portray an encouraging outlook for the times ahead. Earnings rose 123.9% to $0.50 per diluted share, revenue increased 57.1% and sales 36.7%. After closing fiscal 2013, management provided its guidance for FY 2014. Comps are expected to grow 15%-20% and earnings around 23%-25%. With a three year average annual EPS growth of 111% and a history of beating consensus estimates for six consecutive quarters, this target looks achievable.

The strange thing about Kors is that, unlike most of its peers, it still derives most of its revenue and sales growth from the U.S. market. Furthermore, markets like Europe and Asia are highly under-penetrated and contribute with less than 15% of the total revenue, thus providing plenty of growth opportunities.

Coach: Another strong brand name in the luxury segment

Coach is one Kors' main competitors in the luxury products industry. Although trading at half of Kors´ valuation, at 15.6 times its earnings, its growth prospects also look more limited. Analysts expect Coach to underperform the industry in terms of EPS progress, delivering an average annual growth rate of around 12%. So, offering outstanding profitability and growth metrics while trading at discount to its peers, but anticipated to provide lower-than-average development rates, is Coach's stock a buy?

Well, just like Kors, Coach holds a strong brand name for which customers are willing to pay a premium. Actually, its products compete with worldwide leading names like Louis Vuitton or Chanel. This has provided the firm with high client loyalty, pricing power, and returns on capital (of more than 50% over the last year). Moreover, last quarterly results came in ahead of consensus projections, standing as proof of the company´s moat and profitable business model.

Store and product innovation, alongside a cost-effective global sourcing model, should serve as growth catalysts in the long-term. Another one of Coach´s main growth drivers for the upcoming years can be found in under-penetrated or not fully efficient international markets.

However, generating over 30% of its revenue outside the U.S., the company is susceptible to currency fluctuations. Furthermore, targeting “aspirational” customers through its moderate prices, while offering high-end products, makes it highly sensitive to discretionary spending power variations.

Offering slower growth prospects and several competitive challenges, including new industry entrants and fashion-related risks, Coach looks like a hold case for now -- especially if compared to Kors -- and its valuation, pretty fair. (Nevertheless, for those looking for stable companies with sustainable growth ahead of them, which also return value to investors, Coach could be a pick, yielding about 2.30% in the form of dividends).

Tiffany: Price for luxury 

Tiffany is probably the most well-known jewelry retailer in the world. For decades, its brand name has been a synonym for luxury and an indicator of socio-economic status. This has provided the firm with a fair moat and plenty of client loyalty. However, the company´s stock doesn´t look like a buy at the moment; trading at 23.9 times its earnings, a 37% premium to the industry mean, while offering below average expected EPS growth rates of about 12% per year, the shares look quite overvalued.

The main concerns about Tiffany´s future growth comprise the effect of macroeconomic headwinds and a sluggish recovery in the U.S. and Europe; its sensibility to input costs, especially those of diamonds and precious metals, its high exposure to fluctuations in foreign currencies due to its strong international presence, its contracting gross margin, and its high dependence on its New York and, to a lesser degree, Japanese businesses.

Nevertheless, some strong points in its business and operational model make this company worth keeping an eye on. For starters, its massive diamond purchases allow the firm to leverage over suppliers and supply chains, thus widening margins -- its operating margin of 18.2% is over double the industry average. Moreover, several capital investments in distribution, manufacturing, and diamond sourcing processes should start paying out soon, contributing to further widen the firm´s margins.

In addition, revenue and net income have been consistently growing at a very fast pace over the past couple of years, doubling and tripling industry means.

Bottom line

Both Tiffany and Coach seem poised to deliver sustainable EPS growth rates over the next half decade, yield generous dividends regularly and trade below average valuations. However, Kors is my stock of choice, even in spite of its much higher valuation. Offering compelling growth prospects for the long-term, moated and poised to outperform its peers, this is a value stock at the moment.

Michael Kors is one of today's hottest high-end fashion brands, and that's translated into one of the best-performing stocks in retail. But with all that growth, has the stock finally become too expensive, or is there still room left to run? The Motley Fool's premium report on Michael Kors gives investors all the information they need to make the right decision, covering the must-watch areas, opportunities, and threats to the company that investors need to know. To claim your copy, simply click here now for instant access.

Damian Illia has no position in any stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus