Here's Why Michael Kors' Recent Drop Is a Buying Opportunity

Michael Kors dropped on margin concerns after fourth-quarter results, but this is a blessing in disguise for investors.

Jun 17, 2014 at 4:12PM

The Michael Kors (NYSE:KORS) juggernaut has finally hit a wall. Since going public in December 2011, Kors shares have gained close to 300%. The company has reported terrific growth quarter after quarter, taking market share away from Coach (NYSE:COH). However, Kors dropped 5% on the announcement of its fourth-quarter results as analysts saw operating margin weakness.

Competition in the apparel and accessories space is heating up as newcomers Kate Spade (NYSE:KATE) make their presence felt. In such circumstances, it isn't surprising to see why analysts were critical of Kors' margin performance. But, on closer inspection, it will become clear that Kors' drop is an opportunity in disguise.

Strong results continue
Michael Kors reported solid fourth-quarter results, topping consensus estimates. Total revenue increased 53.6% versus the year-ago quarter. Gross profit increased 54.2% to $549.4 million from last year. This was the 32nd consecutive quarter of same-store sales growth for Kors. However, operating margin fell 670 basis points, or bps, to 22%. 

The drop in the operating margin was primarily due to higher rent costs associated with store openings. According to Telsey Advisory Group, Kors was paying rent for stores that weren't operational. But, once a store was opened, the company saw strong sales. As Michael Kors is aggressively expanding its presence across the globe, these investments are necessary. So, investors shouldn't be discouraged by just one quarter of weak margins as the company is setting itself up for long-term growth.

Impressive expansion plans
The company is putting in efforts to increase its brand awareness globally. Its initiatives have yielded positive results in the U.S., Europe and Japan. According to management, the solid performance of Kors in the previous quarter was a result of the various growth strategies adopted by the company.

It opened four new retail stores in North America to expand its reach in this region, and also converted 163 department-stores into branded shop-in-shops across the world. The company opened stores at four new locations in Europe and two locations in Japan. Michael Kors is also making solid moves in the Far East and opened nine new locations in the region in the previous quarter.

The company now has around 1,560 global shop-in-shops that deal in accessories, footwear, women's wear, and men's wear. Moreover, Kors plans to open of 500 new shop-in-shops globally this year. The company expects these shop-in-shops to be a strong growth driver.

Kors also plans to open 45 North American retail stores in 2014. The company is confident that the North American market can support 400 stores in the long-term. It cites increasing demand for its luxury products and foresees solid opportunities for expansion. To tap increasing demand for its products, Kors is getting ready to open its new SoHo flagship store, which will be its largest store till date at around 21,000 square feet.

Apart from the U.S., it plans to open 55 new stores in Europe and 10 in Japan, while it is also making good progress in China. 

Kors' product offerings such as luxury watches, jewelry, fragrances, and eyewear are gaining good traction. Now, the company is looking to expand its product portfolio. It has signed a 10-year licensing agreement with Luxottica, which is known for Ray-Ban sunglasses. Kors management believes that Luxottica is an ideal partner for the Michael Kors brand as it is focusing on globally expanding its eyewear business.

Comparing with competitors
Kors is giving tough competition to Coach. The arrival of Kors on the apparel and accessories scene has brought difficult times for Coach, which reported a 20% drop in North America comparable-store sales in the third quarter. Kors gained considerable market share from Coach as customers have changed their buying preference. According to an analyst at ITG Investment Research, "Coach customers are becoming Kors customers." 

However, Coach is counting on China for growth. The company's sales in China increased 25% to $540 million in the previous quarter, driven by strong demand for its handbags. Coach is taking away market share from luxury brands such as Louis Vuitton in China with its sub-$400 handbags. However, Coach might not have a free run in this market for long.

Kors is serious about China and recently opened a 6,000-square-foot location in Shanghai. In addition, Kate Spade is also targeting this market aggressively with its bright colors and bold designs. Kate Spade has strengthened its distribution mechanism in China and surrounding countries aggressively in the last two years. It directly controls its operations in Hong Kong, Macau, and Taiwan, while it has distributors in countries such as Singapore, Malaysia, and Indonesia. Moreover, Kate Spade plans to have 300 distribution points in China by the end of the decade. 

The bottom line
Michael Kors has a lot going for it. The company's strategies look impressive and its growth is outstanding. In addition, Kors' earnings are expected to grow at a solid annual rate of 24% for the next five years, which makes the stock a solid investment prospect at just 20 times forward earnings. Investors should consider using Kors' recent drop as an opportunity to buy more shares.

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Yaggyaseni Mittra 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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