Michael Kors Has a Sales Problem

When Jefferies downgraded Michael Kors (NYSE: KORS  ) earlier this week, the stock took a sudden hit, falling 3% in minutes. But then, almost as quickly, the company bounced, finishing the week on a positive note. Kors also announced its second-quarter results release date this week, giving investors even more to look forward to. With that in mind, let's look at what the market is expecting, and what investors can look forward to.

What's around the corner for Michael Kors
The Jefferies downgrade had such a small impact due to the fact that it was based on market movements, not fundamental business issues. The firm noticed that puts had outnumbered calls in a meaningful way, leading the company to predict weaker market sentiment. For its own part, Kors has other plans in mind.

In its last earnings call, management said that it was expecting a 15% to 20% increase in comparable-store sales for the second quarter. That would be a drop down from the brand's first-quarter success, when it put up a 27.3% comparable-store sales increase over the previous year. If the company is right, it should pull in earnings per share of between $0.62 and $0.64. That would be a 26% to 31% increase over last year's earnings in the second quarter.

All that would be excellent news, if it weren't for the fact that Kors seems to be hitting the brakes. As you can see in the chart below, comparable sales growth has been on a steady decline for the past year. If the company only hits 15% next quarter, it will be barely half the rate at which it grew in the first quarter.

Source: Michael Kors

Michael Kors' growth problem
While it's still not entirely fair to call 15% comparable-sales growth a problem for the business -- Coach had a 1.7% drop in comparable sales last quarter -- it is a problem for investors. Kors currently trades at a trailing price-to-earnings ratio of 33, which is well above the sector average. That means that Kors needs to be delivering big gains each quarter.

To get those gains on the bottom line, Kors is using three techniques. First, it's increasing its footprint to drive more sales through more locations. Through the 12 months to the end of last quarter, the company opened 75 new stores. Second, after it grows its store base, it generates comparable-sales growth in those locations to keep revenues rising. Then, finally, it manages expenses to generate as much income per share as possible.

Store expansion is fine, except that it eats up cash; eventually, Kors will have to cut back. We've already seen that comparable sales are headed the wrong way. What about margins?

Michael Kors' operating margin last quarter was 32%, which was a four-point increase from the previous year. That's good news for investors, as the strong margin means that Kors has more room to price goods competitively to drive foot traffic if it needs to.

The bottom line
Right now, it all hinges on comparable sales. For such a pricey stock, Kors needs to be driving meaningful income growth each quarter. With weak comparable sales, it's not going to be able to keep up with the market's high expectations. On the plus side, Kors has a history of beating internal guidance, so it may still come out ahead this time around. Michael Kors announces its second-quarter results on November 5. Be sure to check back with the Motely Fool for all your Kors insights and analysis.

Changing priorities
Kors may be having some trouble with sales, but at least it's not getting left in the dust when it comes to customer interaction. The retail space is in the midst of the biggest sales shift since mail order took off. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free for readers; just click here to read more.

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