Could Michael Kors' Struggles Drag Down Its Parent Company?

When Michael Kors' company decided to buy luxury brands Jimmy Choo in 2017 and Versace in 2018, the goal was to create a luxury powerhouse that could grow the company's weak sales and create real value for shareholders.

In some ways, that's working out, as the two acquired brands have seen higher sales, giving an overall positive spin to the company's total revenue. However, the main Kors brand is still suffering, and although the company remains optimistic about its prospects, there's no light at the end of the tunnel just yet.

A more optimistic quarter for the luxury goods company

Overall, Capri Holdings (CPRI 1.09%), the new name for the multibrand luxury retailer, had a good quarter that should make shareholders happy. In the third quarter of fiscal 2020, revenue grew 9.2% to $1.57 billion, and adjusted gross profit was $934 million as compared to $874 million last year. Net income was $200 million, a 5% increase year over year, although adjusted net income decreased 4% to $254 million.

Image source: Getty Images.

The company has seen excellent growth since it made its acquisitions, even accounting for the original extra revenue due to the merger.

Data source: Capri Holdings Quarterly Reports.

The Versace brand performed better than expected this quarter, which is a coup considering the fashion icon's fans were initially skeptical of the sale.

Shareholders still aren't embracing what they see as an unpredictable company, and even though the share price rose after the better-than-expected earnings release, it's still down 20% so far in 2020.

The luxury goods market is growing

The global market for upscale merchandise was about $291 billion in 2019 and is expected to reach $384 billion by 2025. Right now, it's split almost evenly between the Americas, EMEA (European, Middle East, and Africa), and Asia markets, but that's expected to increase to 50% in the Asian segment and decrease to 25% each to the Americas and EMEA.

A 2019 Bain study found that accessories, which represents 65% of the Kors business, is the largest and fastest-growing category in luxury goods.

What's the problem with Michael Kors?

Capri's buyouts of Versace and Jimmy Choo have proved to have been prescient efforts, as they've been holding up the company while the Kors brand has been in decline. This is Kors' revenue over the past six quarters:

Data source: Capri Holdings Quarterly Reports.

Part of the problem is the stratification of buying trends to the high-luxury or low-cost categories, whereas Kors was always a low-luxury mall brand. Kors is doing everything by the new rule book, with its three pillars of product innovation, customer engagement, and brand engagement, and 45 million potential customers engaged with the company through social media platforms. But it's still trying to find its footing.

By way of these endeavors, including aggressive branding and multichannel digital developments, Capri expects to grow Kors to $5 billion of annual revenue and turn Capri Holdings into a growth stock.

What's the way forward?

During the third-quarter conference call last week, CEO John Idol spoke about "synergies" that the company is engaging in to cut costs and improve efficiency. In the near term, these include the areas of design, materials, supply chain, and manufacturing. Longer term, the company will continue to invest in the business, repay debt, return cash to shareholders, and in a very forward-thinking idea, make more acquisitions.

With Capri's strong focus on Asian markets, uncertainty about the effects of the novel coronavirus on sales in and around China is a big factor in the company's outlook. Capri lowered its 2020 revenue expectation by $100 million and earnings-per-share guidance from $0.45 to $0.40.