- KORS is a combination of both growth and value.
- Cash holdings are ballooning and debt is nonexistent.
- KORS has room to expand not only in U.S. but also internationally.
- Revenue grew 59% and income grew 76.6% from increased margins last quarter.
- Brand awareness is high on social media.
Michael Kors (NYSE:KORS) provides the much sought after value combined with growth. Kate Spade (NYSE:KATE) or Coach (NYSE:COH) does not give investors that desired combination. KATE has exceptional growth but leaves more to be desired with its balance sheet and has a longer time frame for its shareholders to benefit from its growth. COH has a fortress-like balance sheet but its earnings and revenue growth are stagnating. KORS provides an option in which investors can pay a fair price for a company with above average growth and a superior balance sheet.
The Latest Quarter Blew Away Estimates
The number of Michael Kors retail stores grew 39.5% in the December 2013 quarter from 195 in December 2012 to 272. KORS has plans to expand further not only in the United States but internationally as well. Comparable store sales increased 23.9% in North America, 18.2% in Japan, and rose a staggering 72.7% in Europe. The company is now foraying into the Chinese market where COH has a strong presence. The company has far from saturated the North American market let alone the Asian or European markets. It is conceivable that KORS is in the middle of its growth stage here in America but it is in its infancy in Asia, Europe, and other parts of the world. Further, KORS is not totally dependent on the economies of the countries in which it generates revenue, evident in its success in the stagnant economies of Japan and Europe as well as its outperformance in the U.S. and North America.
John D. Idol, KORS Chairman and CEO summed up KORS December 2013 quarter nicely with the following statement:
"Our results reflect broad-based strength with significant revenue growth across our retail, wholesale and licensing segments as well as in our North American and international markets. Revenue in North America grew 51% and comparable store sales increased 24%, with performance driven primarily by accessories and watch offerings. In addition, our North America wholesale segment generated another quarter of strong sales growth, particularly in our accessories and footwear categories, and we continued to benefit from shop-in-shop conversions in department stores. In Europe, revenue grew 144% in the third quarter, with exceptional comparable store sales growth of 73%, which we believe was driven by growing brand awareness and demand across regions. Lastly, in our licensing segment, revenue increased 59%, with continued demand in watches and eyewear. Looking ahead, we remain confident that Michael Kors' distinctive positioning in the global luxury market will enable us to achieve strong long term growth for our shareholders."
Along with a 59% increase in total revenue, KORS's gross margin expanded to 61.2% in December 2013 from 60.2% in December 2012. The gross margin expansion combined with a contraction in operating expenses led to net income growing 76.6%, even more than the revenue expansion. The EPS of $1.11 and revenue of $1.01 billion far exceeded Wall Street estimates of $0.86 and $859.5 million, respectively.
The company expects to generate between $790 million and $800 million in revenue for the last quarter of its 2014 fiscal year, leading to total revenue for 2014 being between $3.18 billion and $3.19 billion. The company's assumptions were that its aggregate same store sales increased 15% to 20% in the fourth quarter and about 25% in 2014. Also, KORS believes its diluted EPS for the quarter will be between $0.63 and $0.65 and $3.07 to $3.09 for the entire year. The company's assumptions and projections are conservative, however, and KORS has surpassed not only its own estimates in the past but also Wall Street's.
The following table shows the trailing P/E, forward P/E, and 5-year forward PEG according to average analyst estimates for KORS, KATE, and COH.
Source: Yahoo Finance
The forward P/E and 5-year PEG ratio give insight into the valuation of a stock relative to the company's future expected growth. Famous investor Peter Lynch advocated not purchasing stocks whose values were out of sync with their companies' growth rates. In other words, he warned against buying stocks whose P/E values exceeded the earnings growth of the underlying companies. Considering Lynch's advice, you should buy a stock with a forward P/E under one and certainly buy one with a 5-year PEG under one. It is clear from the chart that in the short and long term KORS is a better investment compared to its peers KATE and COH.
KATE gets a lot of attention for its high growth rate, 60.9% last fiscal year, and so does COH for its lack of one. According to KATE's PEG, however, that high growth is overpriced over a five-year period while KORS's is fairly priced. If you believe valuations matter, then what does it matter if a company is growing earnings 50%, 100%, 200% or even 1000% if you're paying for it or worse, overpaying for it? Paraphrasing Warren Buffett, price is what you pay and value is what you get. With KORS, the price you pay is parallel with the value you receive. With COH, the value is not totally in line with the price and the discrepancy widens even more with KATE.
KORS's returns on assets, equity, and capital have been truly amazing over the past three years. They are as follows:
Here are COH's return metrics over the same time period:
COH's returns over the past three years have been great in their own right. The difference is the uptrend in KORS brought on by its rapid growth and increasing margins. It is important to note that COH pays a dividend and its declining metrics are mostly a result of stagnating growth and a decrease in margins. KATE is a newly organized company from Fifth & Pacific, so it's inappropriate to compare their return metrics from the past three years to COH and KORS.
KORS has been generating exceptional cash from operations and excess cash as well with $356 million from operations and $226 million in free cash flow in 2013, respectively. Those figures represent increases of 210% for operations and a whopping 737% for free cash flow from 2012. In its latest quarter, KORS nearly doubled operational cash flow from $135 million to $268 million and more than doubled its free cash flow from $100 million to $208 million. This strong cash flow is financing the company's expansion in lieu of debt with a surplus left over for KORS's shareholders.
Not even considering its increasing ROE or current P/E, if we forecast KORS's earnings five years from its last quarter using its lowest ROE of 43.4% from the past three years and a P/E multiple of 15, which is lower than the industry average and the market, we get an enticing result:
Equity Per Share
Using the $314.22 price of KORS from the projections and its current market price of $88.00, we get a five-year compounding return of 20.8%. Remember, this return is garnered from assuming KORS's lowest ROE in the last three years and a P/E multiple that is lower than its industry's average and even lower than the market. The projection also assumes a dividend will not be initiated and this is likely if ROE continues to grow; the lower of the three ROE figures can be looked at as factoring in if KORS starts to pay a dividend. Nonetheless, if you are a long-term investor, KORS looks like a great investment at this point.
KATE's financial position differs from KORS tremendously and its high growth is not just good but essential to its future viability. KORS, on the other hand, could have its growth slow down considerably and still be in an envious position financially. KATE does not have wiggle room to experience any financial difficulties going forward. The company has almost $400 million of long-term debt on its balance sheet with $130 million of cash on hand. COH, like KORS, is in an envious position financially with close to $800 million of cash in the bank and less than $1 million of long-term debt. KORS, the stellar one of the bunch, has more cash than COH, over $800 million, with zero long-term debt. So, KATE may grow faster than KORS but it must with its dubious balance sheet. KORS's growth accrues solely to the company's shareholders while KATE's growth must service debt holders before funneling to its shareholders.
KATE's questionable solvency is compounded by its low liquidity. The chart shows KATE's liquidity metrics from the latest quarter in relation to KORS and COH.
It's clear to see that KORS is flush with cash and liquid assets and can be agile in its business endeavors. COH is in a good position as well but KATE is in a poor position with its quick ratio under one, signifying that the company has low values of cash and receivables compared to its liabilities due within the year. Any downturn in the overall market for its products could ding KATE and send it scrambling for liquidity. Conversely, KORS has the luxury of trying to figure out what to do with its extreme liquidity and how to allocate its stockpile of over $800 million in cash.
COH has lost market share to KORS in the past couple of years but it still enjoys twenty-two percent of the luxury handbag market in North America, making it the number one handbag maker according to market share. KATE has two percent of the market and KORS has nine. There is an opportunity for both KORS and KATE to take a greater share from COH, but COH will not give it up without a fight. COH is gearing up to recapture its lost share of the luxury handbag market and KORS has the financial might to match its more senior competitor. KATE, on the other hand, does not and it may have to spend money maintaining the share it already has in the face of increased competition in the sector.
The popularity of these brands can be inferred not only from revenue and earnings numbers but also from their Facebook and Twitter followers, especially in the digital age. Their popularity also sheds light into the future viability of these brands in the fickle fashion industry. Kate Spade is liked by 1.5 million users on Facebook and Coach is liked by 5.2 million users. The popularity of the aforementioned are dwarfed by Michael Kors, however; Kors currently has 13.4 million likes on Facebook, almost double the likes of Kate Spade and Coach combined. On Twitter, Kors has 1.95 million followers while Kate Spade has 600,000 and Coach has 546,000, once again possessing more clout than Kate Spade and Coach combined. The Facebook and Twitter figures convey the brand awareness of Michael Kors not only in aggregate but also compared to its competitors, thereby hinting at Kors's profitable future as a luxury fashion designer and retailer.
Expansion and New Markets
KORS is expanding into both new markets and new products. The company has teamed up with Luxottica Group (NYSE:LUX) and will release a line of glasses and other eyewear under the Michael Kors name. The first eyewear line will be coming to market in January 2015 and is another product that KORS's shareholders will benefit from as the company expands globally and into other merchandise. LUX is the home of the Ray-Ban, Oakley, and Vogue brands. It has found success in licensing deals in the past like the current one with KORS with other luxury fashion brands such as Giorgio Armani, Burberry, Chanel, Dolce & Gabbana, Prada, and Versace.
The company has traditionally been focused on women but it is increasingly capitalizing on the growing men's luxury market. The men's business is currently about $150 million in sales and could reach $1 billion in the next couple of years; men's sales account for less than five percent of total sales currently. KORS is also gearing up to launch a new e-commerce site that will capitalize on its customers who like to shop from home and use their mobile devices. The company brought its online presence in-house so it could better the user experience. KORS did this because the search volume for the company and its products online has increased by double digits worldwide along with the number of visitors to its current site. Taking control of its omnichannel experience will allow KORS to increase its margins and profits as it will not have to source its online presence to third parties.
Betting Against KORS Is A Mistake
David Einhorn of Greenlight Capital has garnered much attention lately due to his recent call that technology stocks are in a bubble soon to pop. In the same report in which he makes the call to his hedge fund's investors, Einhorn admits that he made a mistake on KORS by betting against it. Greenlight lost 114% on its short trade against KORS on a time adjusted basis and totally exited the trade after the loss. Einhorn believed that KORS would miss earnings like most other retailers due to a sluggish retail environment. Betting against great companies like KORS is a tough proposition and can sting even the most successful of investors.
Now is not the time to sour on KORS. The company has growth like its competitor, KATE, while thankfully neglecting the baggage of the latter's poor balance sheet. Like COH, KORS's financial position is envious - but unlike its more mature competitor, KORS is experiencing incredible growth. KORS overshot growth estimates even in the face of a difficult retail environment due to a sluggish economy and bad weather. In essence, taking the good qualities of KATE and COH and then joining them together gives you KORS. Or, said in a more playful way - if you took Kate Spade flying Coach and then upgraded her to first class, she would see Michael Kors sitting in the seat in front of her, seat back enjoying the ride.