An Ideal Pick for Growth Investors

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

Luxury retailer Michael Kors (NYSE: KORS) reported second quarter earnings for fiscal year 2013 two days ago. The stock slumped more than 6% despite it beating both revenue and earnings forecasts. The retailer reported an EPS of $0.49 that beat forecasts by $0.09, and revenues of $532.9 million that beat forecasts by $13 million. But the stock took a toll from the company's revised guidance of revenues for full year which now stands between the range of $1.86-$1.96 billion. Analysts expected revenues of $1.98 billion.

The approaching fiscal cliff, investor skepticism, and consumers deferring purchases of big ticket and luxury items in the wake of a likely economic crunch all pose a threat to luxury retailers. However, Michael Kors sees growth opportunities like no other (I'll get to that in a bit). The retailer showed stellar growth in its latest second quarter results.

  • Revenues in the quarter grew 74% to $533 million.
  • Wholesale net sales increased 75% to $271 million and retail net sales grew 82% to $242 million with 45% increase in comparable store sales globally. 
  • Gross margins went up by 200 basis points to 59% for the quarter.
  • Operating income grew 126% to $158 million compared to the same period last year. 
  • Net income increased 141% to $97.8 million compared to $40.6 million in second quarter last year.
  • 16 new stores were opened in the latest quarter.

Finally! Some Good News Coming from Europe

Michael Kors reported very strong growth in North America and Japan, and appreciable growth in Asia. But the kind of growth we saw coming from Europe is undoubtedly laudable. Despite the fact that the European economy is weakening, Michael Kors received a warm welcome from all the countries in the region--even Germany and Spain.

Europe revenues increased by 97% to $57 million, with a comparable store sales increase of 50%. The company owes its success in the region to its brand awareness campaign carried out through advertising, and especially its interactive social media presence on Twitter (with over 1 million fans) and Facebook (with over 2.6 million fans).

Four new stores were opened in this quarter, and now the company has its foothold in 34 retail locations across the continent. Italy is one big market where the retailer has only one store and sees big opportunities of growth in future. Overall, the company intends to open 10 to 15 retail stores annually in the European region. Management believes that this region can support about 100 retail stores and wholesale doors in the long run.

The Moat

Michael Kors' ready-to-wear segment for women may be becoming the new growth story, but that's not where their competitive advantage lies. It is the accessories segment--footwear, watches, jewelry, eye wear, bags, and related products that made 79% of Michael Kors product mix in the latest quarter. 

  • Watches: Michael Kors had its licensing revenues increasing by 13% to $20 million, driven primarily by the strong success of its watches. Michael Kors gets its watches from its distributor Fossil (NASDAQ: FOSL), which reported its latest quarter earnings earlier this month. Fossil beat earnings but missed revenue estimates. Interestingly enough, the dent in revenues came from the very region where its buyer Michael Kors is winning--Europe. 
  • Handbags: What's more interesting is that although watches bring in more licensing revenues, but its small leather goods and handbag line is growing at a faster pace than the watches line, despite the stiffer competition it faces from international luxury handbag brands--Louis Vuitton, Chanel, Hermes and the famous US brand Coach (NYSE: COH). Coach remains the most sought after handbag brand this year. This is essentially because of its cheaper prices and younger target market. Michael Kors typically caters to the older, more fashion-savvy aesthetes. However, the company is now making efforts to bring a young feel to its small leather goods which are more affordable to younger girls than its handbags.
  • Jewelry & Eyewear: Kors' jewelry line is relatively new and this quarter marks its one year anniversary. The company recently launched jewelry in certain stores in Europe and its reception was better than the management had expected. In the future, I expect Kors to further expand its jewelry offerings and I see the jewelry line as being a source of significant growth going forward. The eye-wear business also performed well. All of these accessory lines are doing well, and management remains very optimistic about their future growth.

Future Growth Opportunities

  • Michael Kors Fragrance Line: Michael Kors is new to the fragrance business and has partnered with Estee Lauder (NYSE: EL) to formally develop this line. I see a great growth opportunity here. Expect a major push into this segment by next fall season.
  • Men's Leather Products: Kors introduced men’s leather products at some of its stores in the US and internationally. Management received a positive initial feedback from consumers on this line. It may be underdeveloped at the moment, but I cannot ignore this as another of Michael Kors' potentially profitable lines in future.
  • Men's Clothing: Michael Kors' men's sportswear and tailored clothing business in the US is over $100 million. It's still small compared to the women product lines, but is slowly making progress. The company is currently very slowly rolling out its men's wear to Europe, where its men's line had a positive reception. I see a strong growth potential in Kors' overall men's wear. 
  • Asian Markets: Michael Kors has only 10 retail stores in China. Contrarily, its competitor Coach is quite well established in that market. Emerging markets of China and India, and countries in the Far East region where the company hasn't yet reached or is still under-established, are all prospective markets of future growth. 

Making the Call

Michael Kors has beaten estimates in all three of its post-IPO quarters since December last year. The full year consensus EPS estimate for KORS is $1.52. A forward P/E of 31.65 gives KORS a fair value of $48.11, the price around which it is trading this morning. The company is in initial high growth phase (double to triple digit growth in financials), hence the high forward P/E ratio. KORS is an ideal investment for growth investors in the luxury retail sector. I'm bullish on the stock and very optimistic about its future growth prospects. Wait for a dip for a reasonable entry point. 

PalwashaS has no positions in the stocks mentioned above. The Motley Fool owns shares of Coach and Fossil. Motley Fool newsletter services recommend Coach and Fossil. 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.

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