Michael Kors Looking Very Cheap Right Now

Aug. 4.14 | About: Michael Kors (KORS)

Summary

KORS is firing on all cylinders, grabbing market share.

Recent weakness in the stock is an opportunity for growth investors.

At 17 times forward earnings KORS is very cheap given growth opportunities.

Michael Kors (NYSE:KORS), the popular designer and distributor of apparel and accessories, has had an enormous run since going public in late 2011. Since that time shares have traded from $25 to $82, where they are as of this writing. The enormous success of KORS has been well-publicized and well-earned; KORS is a tremendous success story. However, some technical weakness in the chart and the idea that nothing can growth into the stratosphere forever has knocked KORS shares off of their highs this year by about 20%. In light of this, does KORS represent a broken stock or a value opportunity? In this article, I'll attempt to answer that question.

Click to enlarge

To do this I'll use a DCF-type model you can read about here. In essence, the model uses inputs such as earnings estimates, which I've sourced from Yahoo!, dividends, which I've set to zero for the foreseeable future, and a discount rate, which I've set at the 10 Year Treasury plus a risk premium of 6.5%, to compute the present value of the company's future earnings and capital returns. It's important to note that all models have subjective elements so your estimates may not look like mine.

 

2013

2014

2015

2016

2017

2018

2019

Earnings Forecast

             

Prior Year earnings per share

 

$3.22

$3.96

$4.73

$5.82

$7.15

$8.80

x(1+Forecasted earnings growth)

 

23.00%

19.40%

23.00%

23.00%

23.00%

23.00%

=Forecasted earnings per share

 

$3.96

$4.73

$5.82

$7.15

$8.80

$10.82

               

Equity Book Value Forecasts

             

Equity book value at beginning of year

 

$8.87

$12.83

$17.56

$23.38

$30.53

$39.33

Earnings per share

 

$3.96

$4.73

$5.82

$7.15

$8.80

$10.82

-Dividends per share

 

$0.00

$0.00

$0.00

$0.00

$0.00

$0.00

=Equity book value at EOY

$8.87

$12.83

$17.56

$23.38

$30.53

$39.33

$50.15

               

Abnormal earnings

             

Equity book value at begin of year

 

$8.87

$12.83

$17.56

$23.38

$30.53

$39.33

x Equity cost of capital

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

=Normal earnings

 

$0.80

$1.15

$1.58

$2.10

$2.75

$3.54

               

Forecasted EPS

 

$3.96

$4.73

$5.82

$7.15

$8.80

$10.82

-Normal earnings

 

$0.80

$1.15

$1.58

$2.10

$2.75

$3.54

=Abnormal earnings

 

$3.16

$3.57

$4.24

$5.05

$6.05

$7.28

               

Valuation

             

Future abnormal earnings

 

$3.16

$3.57

$4.24

$5.05

$6.05

$7.28

x discount factor(0.09)

 

0.917

0.842

0.772

0.708

0.650

0.596

=Abnormal earnings disc to present

 

$2.90

$3.01

$3.27

$3.58

$3.93

$4.34

               

Abnormal earnings in year +6

           

$7.28

Assumed long-term growth rate

           

3.00%

Value of terminal year

           

$121.40

               

Estimated share price

             

Sum of discounted AE over horizon

 

$16.69

         

+PV of terminal year AE

 

$72.39

         

=PV of all AE

 

$89.08

         

+Current equity book value

 

$8.87

         

=Estimated current share price

 

$97.95

         
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As we can see the model produces a fair value of $98, much higher than the $82 KORS is trading for today. That would suggest shares are very cheap at the moment so let's investigate why to understand if we should be buying KORS.

To begin, the model produces a fair value and not a price target. This is an important distinction to make as the model is saying the present value of KORS' future earnings is currently nearly 20% higher than shares are trading for. Thus, KORS should be a good buy at any price below $98 given current assumptions for growth and the other inputs I described above.

I mentioned technical weakness in the open and I think it's worth noting, although there is much more at play here than just a chart. Below is a view of just the past year and we'll take a quick look at the chart now.

Click to enlarge

After warnings of margin pressures hit the stock in July, shares punched through the 200 DMA and have remained below ever since. This has caused the slope of the 200 DMA, which was once very steadily moving upward, to flatten out. My only note on the chart is to watch the 200 DMA and if it turns downward, we could see pronounced weakness in shares. We aren't there yet and it's possible for shares to pick right back up where they left off but this kind of weakness is worth noting considering the unrelenting uptrend we've seen from shares to date.

Another risk to shares is simply the growth rates predicted by analysts. A look at the model above shows analysts are expecting ~20% earnings growth for the foreseeable future from KORS and while the company has had no trouble posting those numbers in the past, it cannot grow that quickly forever. There is some risk that sales growth will slow, margins will be depressed or simply the law of large numbers will come into play. KORS is firing on all cylinders right now so I am not worried about any of those events occurring just yet but in time, something will happen that will cause KORS' earnings growth to slow. KORS is small enough that we could continue to see 20% earnings growth for a while but know that any kind of slowdown in earnings will have an outsized effect on KORS shares.

On the plus side KORS shares are only trading for 17 times next year's earnings, a very cheap number considering the torrid growth and growing market share the company has experienced since becoming public. That means shares are very cheap, with roughly the same forward multiple as Coca-Cola (NYSE:KO) if you can believe that. In my view this provides a large margin of safety as we know KORS is going to grow earnings, even under a disastrous scenario, at 10% or more per year. A multiple of 17 is very reasonable given KORS' growth trajectory and I believe the market's pessimism is an opportunity.

Finally, the company's balance sheet is absolutely pristine. Many public growth companies, particularly those that are the result of an LBO, have enormous amounts of debt on their balance sheets that hamper earnings growth. KORS, however, has a perfect balance sheet with no debt and equity that continues to grow every quarter. This gives KORS tremendous flexibility in terms of liquidity and financing needs should it decide to expand its brand or buy a competitor, for instance. The company's balance sheet should be viewed as a tremendous positive as it sets KORS up for further success in the future.

Overall, I like KORS very much given the fact that it's 20% off of its highs of this year and that its earnings multiple is very reasonable. The brand is as strong as ever and while the chart is showing some cracks in the armor, I don't see any material weakness in the company's ability to continue to grow earnings. Fashion is a flaky industry to play in, particularly in women's apparel and accessories, but KORS has found its niche and is exploiting it to the fullest. I recommend taking advantage of the weakness in shares and considering KORS for your portfolio.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in KORS over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.