Luxury Brands in an Austere Market

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

Stocks of luxury brands Coach (NYSE: COH), Ralph Lauren (NYSE: RL), and Michael Kors (NYSE: KORS) have declined or have remained steady in recent months, reflecting divided opinion on these stocks. While the market believes these stocks need a correction, it may just be a blessing in disguise as discounted entry levels can be used to create fresh long positions.

Coach stock makes ground in China

Coach is a well known name when it comes to luxury accessories and gifts for women and men. Recovering from a debacle earlier this year, the stock surged in late April after posting encouraging results but has largely remained range-bound ever since. In fact, its monthly performance is marginally negative. Its shares have moved in the range of $45.3 – $62.1 over the past 52 weeks and are currently available at $58. The reason for this under-performance is that the pressure on margins from expanding operations have led to disproportionately high operating costs. 

In the nine months of the current financial year so far, the company managed to post a growth of only 3.3% in profits, even though it has negligible debt and sales grew 6.8%. The company is subject to diverging views among analysts as well. While analysts at BMO recently initiated coverage with an outperform rating and a price target of $70, analysts at Lazard downgraded it to neutral from buy. However, growth in the mature U.S. operations and emerging markets such as China offer some hope. China is fueling growth for other upscale retailers and there is no reason why Coach, through its 118 locations in China, will not be able to take advantage of the boom. The big presence in the world's largest country by population gives Coach a big head start. However, at a price earnings ratio of 23, investors are paying a premium for the China edge.

Five fingers are not equal

What works for Coach does not necessarily work for Ralph Lauren. Shares of this New York-based apparel and accessories company scaled a peak of $191 in May but have receded since then as a restructuring, undertaken last year in Asia Pacific, shrunk its growth in sales. Sales grew only 1.2% to $1.64 billion in the latest quarter and even though profits grew 35% to $127.2 million, the results spooked markets.

However, a closer look reveals this is just short term pain and will likely lead to better financial performance in the future. Ralph Lauren sold its American Living brand to J.C. Penney and reduced its shipments to certain European customers – factors that contributed to slim sales growth. The revenue miss was apparently too substantial to neglect but the company aims to focus on more profitable businesses. This approach very much explains a forward price earnings ratio of 17.7, which is a discount to competitors.

Michael Kors flying high

Michael Kors is another strong player in the segment. Unlike Coach and Ralph Lauren, this stock trades close to its 52 week high. This translates to a price earnings ratio of 32.6 but the same declines to 20 on a forward basis. The company does not pay dividends, but this is hardly a consideration for investors as long as the company continues to generate enough capital appreciation. Michael Kors has an average annual growth rate of 47% for sales over the last 5 years while earnings per share have grown more than 51%.

Analysts at BMO Capital Markets have set a market perform rating on the stock while Deutsche Bank  initiated coverage with a buy rating and a $70 price target, up nearly 10% from its current prices. The stock is certainly not an undervaluation play and some investors can actually term these valuation numbers as high; it remains to be seen whether a price earnings ratio of 33 is justified even for this growth company.

Foolish bottom line

Overall these stocks stand to benefit immensely from a recovering U.S. economy and a growing demand for luxury accessories in emerging markets. Investors may find Ralph Lauren appealing given its attractive valuation compared to Coach and Michael Kors.

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Jacob Wolinsky 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!

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