Michael Kors: Conservative Guidance Continues To Be Taken As A True Forecast

Aug. 5.14 | About: Michael Kors (KORS)

Summary

Michael Kors beat guidance by a significant amount for the 10th straight quarter.

Guidance appears to remain very conservative. However, many are still taking guidance as a true forecast rather than as a lower bound of expectations.

Q1 beat revenue guidance by 9%. Even a 5% beat versus guidance in Q2 will push revenue above $1 billion.

Despite soundly beating expectations for Q1 2015, Michael Kors' (NYSE:KORS) share price took a hit on concerns about lower margins, rising inventory and Q2 guidance that fell slightly below consensus. However, Michael Kors has historically been quite conservative with its guidance, so there is a high probability that its guidance represents the very low end of its expectations rather than an attempt at an accurate forecast of how things will go. It appears that many are taking Michael Kors's guidance as an accurate forecast though, and using those trends as a basis for longer-term pessimism.

A Quick Review Of Q1

In Q1 2015, Michael Kors delivered revenue of $919 million with earnings of $0.91 per share. This significantly exceeded analyst expectations for revenue of $851 million and earnings of $0.81 per share. I had noted in an earlier article that Michael Kors had a history of providing conservative guidance, and based on past history of guidance versus actual results, I expected revenue of $940 million to $970 million and earnings of $0.87 per share to $0.93 per share. Revenue wasn't as high as I had expected (but still was 9% above guidance), while earnings were within my range of expectations. It appears reasonably safe to assume that Michael Kors is still providing guidance that it can easily deliver.

What to Expect for Q2

Since Michael Kors has always delivered well above its guidance, I'm a bit surprised that its guidance often still is taken at face value. For example, its Q2 guidance for $0.85 to $0.87 earnings per share and revenue of $950 million to $960 million per share may appear to be low compared to consensus expectations for earnings of $0.89 per share and revenue of $960 million per share.

However, Michael Kors has previously achieved revenue that has averaged 13% above quarterly guidance, and 7% above quarterly guidance for the two previous Q2s. Michael Kors' previous smallest beat on revenue versus guidance was 6% in Q2 2014. If Michael Kors beats its guidance by 5% in Q2 2015, that would result in revenues of $1.003 billion, well above current expectations. That level of revenue should also allow it to achieve earnings of around $0.90 to $0.95 per share.

On Margins And Inventory

While Michael Kors has increased inventory substantially (+65% versus last year compared to +44% sales growth during the same period), it does not appear to be an area of concern. Management explained that the increased inventory is due to a combination of timing, retail expansion and the e-commerce launch. I'm somewhat perplexed at why inventory expansion is seen as a concern for a company that has consistently delivered sales growth above both guidance and analyst expectations. Certainly Michael Kors cannot maintain its tremendous growth forever. However, I would only really be concerned about inventory growth when it occurs in conjunction with sales growth deceleration that exceeds company and consensus expectations. So far the opposite appears to be true. Sales growth remains above guidance and expectations, so the inventory growth should be viewed as part of the plan rather than due to items piling up on shelves.

As well, much of the concern over margin seems overblown as well. Michael Kors mentioned on the conference call that its markdown position and number of SKUs on sale were similar to last year. It did have a problem with early fall items being brought out early and not moving as well as expected, but that appears to be a one-time misstep that is being resolved well. Those comments appear to contradict the speculation about increased discounting that was going on before the earnings release.

Guidance for lower operating margins appears prudent given the continued investment in the business. Operating margins in the 28% to 29% range are still very healthy, and probably represent the lower end of management expectations, given the propensity to be conservative with guidance. A small decrease in operating margins due to investment does not appear to warrant concern in itself. I would start to be concerned if and when sales growth starts to stall out completely, but comparable store sales in the high-teens is still very solid.

Conclusion

The current weakness in Michael Kors' stock appears to create a decent opportunity. The weakness appears largely due to guidance for lower margins and Q2 guidance that was slightly below consensus. However, Michael Kors has a strong history of easily beating guidance, and I believe that its guidance represents conservative estimates that it is very confident in achieving. This is similar to how Apple operated for many years, but given how consensus numbers for Michael Kors have closely matched guidance (and have substantially underestimated actuals) for 10 straight quarters now, it appears that only a minority have caught on to this so far. That being said, Michael Kors' share price may remain weak until it delivers above expectations again and again to put some of the concerns created by its conservative guidance to rest.

Disclosure: The author is long KORS. 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.