All Luxury Brand Growth in China Is Not Created Equal

Growth of aspirational-luxury accessories is set to take off in the Far East and investors should profit, but not necessarily those who own shares of Michael Kors.

Apr 14, 2014 at 9:56AM

Your handbag, your shoes, and your watch may speak volumes about your status and your hopes and aspirations. Have you arrived at the top so you can afford a $50,000 watch and pricey purse, or are you hoping to get there? Along the way, those who can't write a check for a $5,600 Louis Vuitton Capucines bag can satisfy the need to have logo-worthy accessories by buying products from companies like Michael Kors (NYSE:KORS), Coach (NYSE:COH), and Kate Spade (NYSE:KATE).  Michael Kors is one of the biggest and best growth stories in the sector with huge revenue growth over the past three years underpinned by amazing comparable-store sales and increasing margins.

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Raw data from the company SEC filings

Growth in revenue has come largely from increasing same-store sales, and a smaller percentage stems from the addition of new retail stores. The same-store sales increases have been driven by double-digit growth in traffic, which indicates that the company doesn't depend much on price increases. Comps gains from increasing traffic rather than higher prices are the best indicator of strong brand demand and a successful retail presence. 

Images

Raw data from the company SEC filings

Kors' margins 

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Raw data from the company SEC filings

The most recent quarter (the third quarter includes Christmas) showed that Michael Kors was still at the top of its game. Total revenue increased 59% with retail up an impressive 51%. Comparable-store sales growth was 28% for the third quarter. This was in stark contrast to Coach's Christmas quarter -- its same-store sales were (13.6%) and revenue declined 6%. Kors' North American revenue alone jumped up 51%, while Coach saw its North American business shrinking.

What's not to like?
Michael Kors looks like the perfect aspirational-luxury retailer for an investor to own, and maybe it is -- at least for now. In the near-term, there will be no stopping Michael Kors, but what lessons might be learned from Coach's fall from grace in North America?

China is fast becoming a growth opportunity for accessible- or aspirational-luxury brands like Coach, Kate Spade, and Kors. Coach's revenue in China last quarter was up 25% with a double-digit same-store sales increase and until the company works out the fashion misses in North America, China remains its best bet for growth. A similar argument could be made for Michael Kors. Should the company see its North American sales cool, there is always the vast, untapped Far East for maintaining momentum.

But wait -- investors won't be part of retail sales opportunities the Far East represents for luxury and aspirational goods. That part of the business was siphoned off before the IPO in 2012 to insiders, including Michael Kors himself.  The entire Far East is now hands-off for the shareholders of the publicly traded KORS, except for royalties.

In 2012,  Michael Kors agreed to give subsidiaries of Michael Kors Far East Holdings exclusive rights to retail sales not only in China, but also to Hong Kong, Macau and Taiwan.  The agreement lasts through  March 31, 2041. That's not a misprint -- the agreement was granted for 29 years of what's sure to be a boom in China, and that's a long time for investors to be cut out of the potential for high retail growth in the Asian markets.

Can investors take comfort in a fast-growing revenue stream from royalties? Not yet. For the nine months ending Dec. 28, 2013, Michael Kors was paid only $800,000  in royalties while collecting $1.2 billion from its retail sales and $1.1 billion from wholesaling. Revenue growth comes from the retail stores not licensing agreements and revenue growth/store growth is a key metric important to investing in Michael Kors. 

The future
It will most likely be years before Michael Kors' growth in North America declines unless a new trend hits big and Kors loses its luster, much like Coach did in 2013. There are a few contenders for the throne, including Tory Burch and Kate Spade.

The revitalized and reorganized Kate Spade has left all of its retail operations intact and it has not licensed them to third parties in the Far East representing growth  investors will be able to share. Kate Spade's expansion into Asia includes store openings in Japan and China and the company estimates that eventually 66% of revenue will come from markets abroad -- growth investors can look forward to.

Kate Spade's retail operation has 76 US stores and only 22 foreign specialty stores which gives it room for substantial expansion. With Spade brand revenue up 61% in 2013 and fourth-quarter same-store sales of 30%, Michael Kors is not the only growth story in affordable luxury. 

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J.A. Graham has no position in any stocks mentioned. 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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