Michael Kors: A Diamond in the Retail Rough?

While other retailers struggle, Michael Kors has thrived. But does this mean that it's a good investment?

Mar 20, 2014 at 3:37PM

The entire retail segment has faced intense pricing pressure, especially teen retailers like Aeropostale (NYSE:ARO) and American Eagle Outfitters (NYSE:AEO). This noted pressure has even trickled down to the luxury space, in designers such as Vera Bradley (NASDAQ:VRA) and Coach (NYSE:COH). In fact, the only exception might be Michael Kors Holdings (NYSE:KORS), and it's this fact that could make it a diamond in the retail rough.

Pricing pressure galore
The Department of Labor disclosed that apparel and clothing prices declined 0.3% in the last month. This unexpected decline -- many believed prices would recover in February following a well-documented decline in prices over the holiday -- added to a 3.6% annualized drop in prices.

Over the last year pricing competition and e-commerce have taken most of the blame for such low prices, as retailers have had to sacrifice margins to attract consumers in stores. Teen retailers Aeropostale and American Eagle have been among the hardest hit, seeing one-year stock declines of 57% and 33%, respectively.

Essentially, Aeropostale has been unable to cut costs at the rate of revenue declines. In the company's last quarter, revenue fell a whopping 16%, while the gross margin declined 680 basis points -- clearly not a recipe for retail success.

American Eagle saw an unprecedented 930 basis-point decline in its gross margin during the fourth quarter. Meanwhile, comparable-store sales fell 7%. Like its peer Aeropostale, the company noted weather and promotional pricing as the main culprits, although management remains very skittish looking ahead. Given the latest data regarding prices last month, investors can likely assume that such problems will persist.

Then, aside from teen retailers there are luxury retailers, or designers, which are about as far left as teen retailers are right. Coach and Vera Bradley are two market leaders that have struggled in recent quarters; Coach posted a very shocking 13.6% decline in North American comparable sales during the holiday months.

While Vera Bradley's stock rocketed higher by 7% following its quarter, the company reported a comparable sales decline of 10.2%. Essentially, investors were prepared for the worst, including a 500 basis-point decline in the gross margin.

One diamond emerges
In spite of all the weakness, which has weighed on the sector in nearly all segments, Michael Kors is one of the only companies that apparently has faced no pricing pressure.

In the company's last quarter, its revenue grew 57%. Furthermore, its comparable sales increased 28%, showing Michael Kors is not falling into the same traps as other retailers. Next, and most impressively, gross profit increased 100 basis points to 61.2%, showing increased strength in a metric where Michael Kors already has market-leading performance.

Hence, Michael Kors is in a world of its own, one that's not affected by bad weather, competitive pricing, or a limited amount of discretionary income. In fact, the company specifically said that it didn't feel the need to be promotional and that its very few markdowns were in connection to late deliveries rather than competition.

Final thoughts
Investors have a choice: They can bet on the turnaround of other retailers or capitalize on the unstoppable force that is Michael Kors. Some value investors might think that Michael Kors at 33 times earnings is too expensive versus Coach at 15 times earnings. However, growth warrants a premium; and when Coach management admits that rivals such as Michael Kors have stolen market share, it is hard to make a long case for such companies.

Not to mention, we don't know how deep the fundamental losses will become in the retail space. We're talking about companies that have thrived in the past due to being trendy brands. Once once consumers no longer consider them trendy, the fundamental declines on top of the macro conditions can create for an unexpectedly steep decline.

In the case of Michael Kors, it still has a global market to monetize, as the majority of its revenue and growth comes via North America. Hence, it could maintain explosive growth for many years to come, making its 33 times earnings multiple appear rather attractive. Basically, Michael Kors has become the quintessential diamond in the retail rough.

The changing face of retail
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Brian Nichols owns shares of Michael Kors Holdings. The Motley Fool recommends Coach and Michael Kors Holdings. The Motley Fool owns shares of Coach and Michael Kors Holdings. 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.

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Jun 12, 2015 at 5:01PM

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