Michael Kors Is Back En Vogue

Wall Street went sour on Michael Kors' stock, so why the turnaround?

May 11, 2014 at 7:00AM

After souring on the stock, Wall Street seems to think that Michael Kors (NYSE:KORS) is back in style. Even though Michael Kors has not done anything but execute flawlessly, Wall Street believed that it was time to cut back on Kors. Analysts believed that Kors could not continue to outperform at an increasing clip. Kors' last quarter and Nomura's rating on the stock say differently, however.

Wall Street changes its tune
Nomura initiated coverage on Michael Kors with a buy rating on May 2, 2014. The investment bank believes that Kors will expand its share of the luxury market and ramp up its licensing business. Nomura's price target for Kors is $116. As of this writing, Kors' stock traded at just under $94. Nomura also had a positive outlook on Kate Spade (NYSE:KATE), and it also initiated a buy rating on this stock.

A couple of days before Nomura's rating, Janney Montgomery Scott initiated its coverage on Michael Kors with a buy rating as well. Janney's price target for Kors is even higher than that of Nomura at $121. Previously, Citigroup and Barclays rated Michael Kors a hold and underweight, respectively. So what changed the sentiment on Wall Street? It has a lot to do with Coach (NYSE:COH) reporting less-than-stellar results for its latest quarter.

Coach going downhill
After Coach released its less-than-enticing results, analysts believed that Kors, and perhaps Kate Spade, was taking an increasingly greater share of Coach's business, especially in North America. Coach reported that its revenue declined 7% from the corresponding quarter last year from $1.19 billion to $1.10 billion. Its earnings per share declined even more from $0.84 to $0.68 for a 19% decline. On top of that, Coach's gross margin declined three percentage points from 74.1% to 71.1% in the quarter, and its operating margin fell almost six points from 29.3% to 23.9%.

Victor Luis, Coach's CEO, said that traffic to Coach's stores declined and the women's accessory and handbag business weakened considerably. He didn't mention the increasing competition from Michael Kors, Kate Spade, and others. Kors has not released its results for the latest quarter yet, but the company will most likely show increasing traffic to its stores and strength in its North American business.

Michael Kors on the rise
Michael Kors' last quarter was remarkable as it grew sales by 59% and income by an even greater margin of 77%. Kors earned $230 million on a little over $1 billion in revenue. Furthermore, Kors only has 9% of the luxury handbag market. The company has an excellent opportunity to eat away at Coach's larger share of 22%.

In comparison with Kate Spade, Kors is in a better position financially as it carries no debt and has a cash account of over $800 million. Conversely, Kate Spade has a little less than $400 million in debt and just shy of $100 million in cash. On a valuation basis, Kors trades at almost half of the P/E multiple of Kate Spade, 32 versus 57.

Also, Michael Kors is expanding into new products and markets in a recent deal with Luxottica Group. The two companies are introducing a Michael Kors eye-wear collection that will debut in early 2015. Michael Kors is also working to capture more share of the growing men's luxury business in addition to its bread-and-butter business of women's luxury fashion.

Fair value for a great company
The market has not valued Michael Kors at outrageous multiples and the company has not underperformed its own estimates or those of Wall Street. The latest ratings from Nomura and Janney show the real strength of the company going forward. The stock has pulled back from its all-time highs but not for any strong reason. Kors should continue to outperform and take more market share from its older rival Coach.

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Andrew Sebastian has the following options: long August 2014 $105 calls on 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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