Reasons to Avoid this Luxury Stock

By Sandeep Gupta - September 10, 2012 | Tickers: COH, M, JWN, SKS, TIF | 0 Comments

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A difficult environment for the domestic high-end consumer is anticipated in the later half of this year as sales trends across luxury have begun to slow. Soft European tourism will also serve as a drag on the same store sales ahead. The Conference Board Consumer Confidence Index improved slightly in July (65.4) after declining sequentially month over month from April to June. However, the Consumer Confidence Index (CCI) took a beating in August and is now at its lowest level since late last year.

The confidence of consumers earning over $50,000 (the highest bracket provided by the Conference Board) is also on a declining trend over the last 5 months. Lower confidence suggests that consumers are likely to reign in their spending. Thus, retailers with a significant exposure to the high income consumer (as the average household income of its customer is over $200,000/year) can see declining sales trends in August and September.

Tiffany (NYSE: TIF) and Coach (NYSE: COH) are a few luxury retailers who can cope up with declining domestic high-end spending due to their vast international presence. However, Saks Incorporated (NYSE: SKS) appears to be vulnerable as it generates most of its revenues in the domestic market and thus, faces a tougher challenge. Though, Saks posted were better than feared Q2 results, its earnings per share was still negative (-$0.05). The company will no longer report monthly same store sales which is understandable considering that the luxury consumption is highly volatile; typically rising and declining at a faster rate than the overall economy.  I would suggest investors to avoid this stock due to the following reasons.

High Valuation poses risk

The company is also trading at a 41%-94% premium to its peer group of Macy’s (NYSE: M) and Nordstrom (NYSE: JWN). At such a high valuation, there is very low margin for error. If sales growth fails to match expectations in near-term, Saks’ stock can take a serious beating. Also, the company is also going through a series of infrastructure and systems enhancements slated to take place over the next several years. To support its Omni-channel and IT initiatives, Saks will invest one-third of its $120 million CAPEX on Project Evolution. Though, these investments will deliver incremental sales and improve margins over time, but they are likely to restrict EPS upside in the near-term.

Slowing NYC store is a big concern

Saks’s NYC flagship, with a huge exposure to foreign tourists (Tourism accounts for 20-25% of sales at the NYC flagship), accounts for around ~22% of its total revenues. Thus, the company relies too much on this one particular store.  However, the sales growth at its NYC store slowed in the second quarter and was below the full line average in the quarter (for the first time since 2009). Going forward, I believe there is a big risk associated with NYC store as the tourism traffic seems to be declining.

Increasing Inventory Levels

The company’s inventory levels are also not in good shape. Inventory increased 8.7% year over year in 2Q and was well below the sales growth of 5.1%. Given an expected slowdown in the second half and elevated inventory levels currently, I believe that the company’s gross margins could be at risk.

Thus, a slowdown in domestic consumption of luxury goods is expected and Saks with a huge exposure to domestic market and lofty valuation stands at risk of correction. I recommend investors to avoid this stock in the near term.

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