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Summary

  • Michael Kors Holdings Ltd. had hit a bit of a rough patch over the past 3 quarters, with decelerated growth pace and flat financial results.
  • I will analyze Michael Kors's past profitability, current capital, and operating efficiency, in addition to looking at which institutional investors have recently bought the company’s shares in the last quarter.
  • Michael Kors has managed to pick up its pace in the luxury retail industry once again, making me feel bullish about its future.

Michael Kors Holdings Ltd. (NYSE:KORS) had hit a bit of a rough patch over the past three quarters, with growth decelerating its previous pace and financial results comparatively flat. While this caused many investors to back out of their positions as shareholders, a position I can certainly understand, the wind is now blowing in a different direction and Q3 of fiscal 2013 showed some impressive results. In fact, Q3 of 2013 marked a historic first moment for the company, as it reached the $1 billion quarterly revenue mark.

As a luxury lifestyle brand retailer, Michael Kors has traditionally operated in three separate segments: retail, wholesale, and licensing. However, the retail business has been the firm's main growth driver over the past decade. Also, management has generally focused on customers in North America and Europe, which constitute 99% of revenue, leaving ample room for expansion in emerging nations. Thus, the company recently launched its new flagship store in China, as well as two stores in Brazil. Over the next several months, investors should expect the brand's presence in Latin America and the Asian-Pacific region to grow substantially, which will contribute to top and bottom-line growth looking forward.

So, in the article below, I will analyze Michael Kors's past profitability, current capital, and operating efficiency, in addition to looking at which institutional investors have recently bought the company's shares in the last quarter. This information will give us an accurate picture of the company's revenues, operating metrics and quality of earnings, determining whether to invest in it or not.

Profitability Analysis
Profitability is a class of financial metric used to analyze a business' ability to generate earnings compared with expenses incurred during a specific period of time. In this section I will study several profitability metrics, such as return on assets, quality of earnings, cash flows and revenue, allowing us to elucidate if the company is really making money. In addition, I always compare a company's revenue growth and operating cash flow growth. Operating cash flow is the cash generated from the operations of a company -or revenue- minus all operating expenses (depreciation charges not deducted).

Over the past three years, Michael Kors's operating cash flow has increased significantly by 23%. The company augmented its operating cash flow from $110 million to $356 million, which is a very positive sign. I advise to generally look for companies with strong cash generation profiles.

ROA - Return On Assets = Net Income/Total Assets
ROA is an indicator of how profitable a company is relative to its total assets. It gives us an idea as to how efficient management is at using its assets to generate earnings, or in simple terms, tells you what earnings were generated from invested capital. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage.

I am encouraged by the fact that Michael Kors's ROA increased from 14.24% to 40.49% in the past 3 years, because it indicates that the company is generating more from its assets than it did in 2010.

Quality of Earnings
Quality of earnings is the amount of earnings attributable to higher sales or lower costs, rather than artificial profits created by accounting anomalies - such as inflation of inventory. In order to assess Michael Kors's quality of earnings, we will compare its level of income with operating cash flows.

The company generated an impressive profits growth of 75% over the past two years, vastly surpassing that of the operating cash flow. This implies that earnings could not have been created by accounting anomalies.

Working Capital
Working Capital is a measure of both a company's efficiency and its short-term financial health. In other words, it indicates whether a company has enough short-term assets to cover its short-term debt. While a ratio below 1 indicates negative W/C, anything over 2 means that the company is not investing excess assets. Therefore, most believe that a ratio between 1.2 and 2.0 is sufficient.

Michael Kors's current ratio (working capital measurement) strongly increased from 1.92 in 2010 to 6.02 in 2012, which shows that the company has a strong balance sheet and can pay off its obligations. Looking for companies with current ratios above 1 is a must for long-term investors.

Common Shares Outstanding
I like companies that buy back their own shares, diminishing the number of outstanding shares. In Michael Kors's case, the amount of common shares has increased from 188 in 2010 to 202 in 2012. However, I think it is very important to find companies that decrease the number of shares and clearly, this retailer is not one of those.

Gross Margin: Gross Income/Sales
The gross profit tells an investor what percentage of revenue/sales is left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors -and overall industry- is more efficient. Investors tend to pay more for businesses with higher efficiency ratings than their competitors, as these are capable of making a decent profit as long as overhead costs are controlled.

Over the past three years, Michael Kors's gross margin has increased, jumping from 55.5% in 2010 to 59.9% in 2012. An increasing margin indicates that the company has, in fact, gained efficiency.

Asset Turnover
Asset turnover measures a firm's efficiency in using its assets to generate sales or revenue - the higher the number the better. It also indicates pricing strategy: companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover.

The fact that Michael Kors's revenue growth has outpaced its assets growth (10% growth) on a percentage basis, indicates that the company is making money on its assets.

Institutional Sponsorship
It is important to check which hedge funds bought the stock in the last quarter and at what price they did so. I assume that if a prominent institutional investor put money into Michael Kors, the stock will pass strict fundamental standards. So, last quarter, both investment gurus Jim Simons and Steven Cohen invested in the stock, at an average price of $77.55.

Analyst Outlook
Currently, many analysts are bullish regarding Michael Kors's future. While MSN money is predicting that the firm's EPS of $3.12 in 2013 will grow to an EPS of $3.85 for FY 2014, analysts at Bloomberg are estimating revenue to grow significantly from 2013's $3.221B to $4.06B for FY 2014. Moreover, on 23/12/2013, Wedbush gave Michael Kors a rating of "Outperform" with a target price of $104.57.

Conclusion

As seen in the analysis above, Michael Kors has managed to pick up its pace in the luxury retail industry once again, leaving me bullish about its long-term future. With most of its balance sheet back in shape, I believe the firm will be able to successfully compete once more against rivals like Coach, Inc. (NYSE:COH) and Ralph Lauren Corp. (NYSE:RL). Also, investors should expect growth to continue at a solid pace, given management's renewed focus on store expansion in Latin America (40 stores to open by 2017) and Asia, as this market is still vastly untapped by the company.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Michael Kors: A Safe Bet For Long-Term Profit