Michael Kors (KORS 1.30%) is in the same aspirational luxury space as Coach (COH 3.28%), and while Coach's business in North America and Japan is stalling, Kors continues to see double-digit growth. Their competing products include handbags, shoes, watches, jewelry, and clothes, though clothing is the smallest segment for both.
Kors has a much larger wholesale percentage of total revenue than Coach. When Coach quit reporting wholesale separately in 2012 it was only 11% of revenue. Wholesale operating margins are around 4% lower than retail, and as Kors expands its retail segment it will see improving margins.
Percentages of revenue
(All tables courtesy of personal proprietary spreadsheets and raw data from Kor's SEC filings)
It plans to make retail 75% of the business, and margins will continue to expand.
Growth
While growth at Coach is mature and slowing in North America and Japan, Kors is in the early stages of transforming its business from wholesale to retail and is in the process of opening retail stores at a rapid clip. So far the stores are a resounding success, with high revenue growth and comps.
Annual growth combined
Kors' growth in revenue is largely from increasing same-store sales, and a smaller percentage is new retail stores. The same-store sales increases are from double-digit growth in traffic and not as dependent on price increases. Comps from increasing traffic rather than higher prices are the best indicator of strong brand demand and a successful retail presence.
Comps by geography show strong performance in North America and Europe--even Japan was in double-digits. Coach has seen a tremendous slowing in both North America and Japan, even as Kors continues to gain.
Same store sales by region
First quarter 2014
Revenue was up 55% and gross margins expanded to 62%. Operating income increased 77%, and Kors reached a 30% operating margin, beating Coach (26%) even with the lower margin wholesale at 50% of total revenue. Global comps came in at 27%, and it opened 24 new stores.
North American same store sales were 25%, with revenue growth at 46% and 18 new stores. It is targeting 50 new stores in 2014. Revenue in Europe increased an impressive 144% and comps were 56%. Japan's revenue was up 81% on 23% comps. Kors started 2014 with impressive growth in its first quarter.
Margins continue to expand, driven by no discounting and a better mix of products. Costs can be effectively leveraged across ever-increasing sales, adding to margins. It's a rare combination, stellar growth with expanding margins, and Kors should see the trend continue as retail grows to 75% of its business.
Kors margins
Annual combined (wholesale/retail)
Balance sheet and cash flow
The company has no debt and is increasing its cash every year. It ended the first quarter with $639 million in cash, up from $472 at the end of March. That prompted questions from analysts about what the company intended to do with it. The first use would be to bring licensing in-house. It would also consider share repurchases — there are 202 million shares outstanding. The company will not pay dividends.
Michael Kors Far East Holdings
Kors has granted retail licensing to a separate consortium known as Michael Kors Far East Holdings, or MKFEH, and that license is for an exclusive retail presence in China until 2041. What this means is that the public company can't open retail stores in the legally-defined territory of China. They can sell wholesale, but with China's fast-growing demand for aspirational luxury products, the bigger profits are in retail sales from a rapidly-expanding base of stores. The target 200 stores for the entire Far East seems low and may be a function of how much MKFEH can finance. Kors itself has a lot of cash that could be used for faster growth and a bigger store base. If Kors buys these licenses, that makes investment in the company more attractive.
Guidance
In 2014, the company expects total revenue to be between $2.8 billion and $2.9 billion for around 31% growth, assuming comp store sales increase 20%. Diluted EPS is guided between $2.67 to $2.69 ($1.97 in 2013) with a tax rate of 36% and $204.8 million shares outstanding. It will open approximately 100 retail locations, including 53 in North America, 40 in Europe, and seven in Japan. Kors has been busy doing in-store conversions at the department stores (Saks, Nordstrom's and Bloomingdale's) that buy wholesale, and that will continue. The response has been good and is pushing brand awareness and sales with comps exceeding even their own retail locations.
What's not to like?
If you believe value resides in low PEs and low price to sales, then Kors is not the perfect stock. The current P/E is 33, with Coach coming in at 15. Kors' forward P/E on $2.69 EPS brings its forward P/E to 27. Price to sales for Kors is six times, and for Coach it's three times.
Coach is highly successful in China and is seeing Kors-worthy numbers--China is 19% of its business and increasing. Kors can't sell retail in China, and that's a problem that could be rectified by buying the license back from Michael Kors Far East Holdings. Selling wholesale to MKFEH is not the worst alternative, but investors will be missing out on the enormous growth potential owning the stores could create.
Finally
Kors is in the early stages of retail and expects to open 400 stores in North America (249 now); Europe has 49 stores now and 200 are targeted. Japan will increase from 30 to 100, and the Far East will grow to 200 stores from 77 now. In most of its geographies, the greatest percentage of retail growth lies ahead. If it can keep the brand relevant and comps high, this growth will be profitable and the company should grow into its current valuation.
