Michael Kors: New Management Needed

Aug. 6.14 | About: Michael Kors (KORS)


Michael Kors is growing by leaps and bounds, but growth comes at a cost.

If the company cannot access the right resources at the right time to support that growth, its brand image could suffer.

There are great opportunities for the company going forward, and adding experience would help Kors better harness those opportunities.

Michael Kors (KORS) is a global luxury lifestyle brand with a $16 billion market cap. The company is opening lots of stores, but its revenue from retail outlets is just as strong as its revenue from wholesale outlets. In addition, the global luxury accessories market is especially strong, so the industry is there. Going forward, the company is facing lots of competition. Including the Kors brand on a wholesale basis at luxury retailers will help increase brand awareness as will a range of licensing deals the company has in place, and taking control of its own website operations could also help add to the bottom line.

But the company is venturing into new territory. On the one hand, the company is growing so fast that managing inventory levels and distribution outlets is a challenge. On the other hand, Kors has limited operating experience at its current level. The company is a solid hold position but it needs experienced management to realize its goals.

All About Earnings

Kors astonished analysts Monday when the retailer announced fiscal 1Q15 earnings. Total revenue soared over 43% compared to the same quarter last year, coming in at $919.2 million up from $640.9 million. But, equally astonishing was what happened next.

The company's share price sank to a day low of $75.13 from an open of $79.18. The decline came on concerns that the popular clothing and accessories store had "grown too fast and is falling victim to the discounting and tough environment plaguing other retailers," explains Barrons. "Michael Kors' retail operating margin shrank to 29.7% from 31.7% amid price cuts that were needed to clean out fall merchandise the company said it put on store shelves too early. The retailer also forecast future declines and predicted that retail gross margins could drop for the year." Kors' outlook echoed this prediction. The company is forecasting to earn just 85 cents to 87 cents per share this quarter - that would put the company over the same quarter last year, when it earned 71 cents per share, but slightly under analyst estimates of 89 cents EPS.

Kors did boost its estimates for FY15. The company is now expecting to earn $4.25 billion to $4.35 billion, or between $4 and $4.05 per share, this fiscal year - up from previous forecasts of $4 billion to $4.1 billion, or $3.85 to $3.91 per share.

By the end of trading Monday, Kors' stock had recovered somewhat to close around $77 per share. The stock rebounded on Tuesday, hovering just under $80 per share at midday. Consensus estimates put the stock around $105 in the next 12 months, but I think that could be a little high.

Analyst Estimates

Analysts are divided. Last month, Maxim downgraded Kors to a Hold from Buy, Baird downgraded the stock to Neutral from Outperform, and Citigroup lowered its price target on the company to $98 from $107. And some analysts are even more bearish on the company.

BMO Capital Markets Senior Retail Analyst John Morris said after Kors' earnings announcement Monday that he considers the stock a Hold and lowered his price target on the company to $80 from $90. "Right now, the stock is probably dead money until we get clarity on where that margin floor is going to be," said Morris. "I'm pulling for Kors. I want them to come back and really show us that you know this isn't a pure product proliferation because this management team is doing a lot of really creative things." Stockpickr identified resistance at $85 and support at $70 after Kors' earnings release Monday.

At the same time, TheStreet is still rating Kors as a Buy, giving it a B+ rating. "The company's strengths can be seen in multiple areas, such as its robust revenue growth, largely solid financial position with reasonable debt levels by most measures, solid stock price performance, impressive record of earnings per share growth and compelling growth in net income," explains TheStreet. "Although the company may harbor some minor weaknesses, we feel they are unlikely to have a significant impact on results."

But, the big problem I see is the business management.

Understanding The Business

Kors is showing a revenue increase of 30% in North America, 128% in Europe, and almost double in other regions - and the global luxury lifestyle brand is jumping on the market while its hot. According to Kors' 2014 annual report, "total global sales of luxury goods were approximately $251.5 billion in 2011, $277.7 billion in 2012, and are estimated to be approximately $284.3 billion in 2013." And that growth is expected to continue. The worldwide luxury industry is estimated to gross between $295.6 billion and $301.3 billion in 2014.

Kors is doing this by opening a rash of new stores. "At June 28, 2014, the Company operated 443 retail stores, including concessions, compared to 328 retail stores, including concessions, at the end of the same prior-year period," reports Businesswire. "The Company had 162 additional retail stores, including concessions, operated through licensing partners. Including licensed locations, there were 605 Michael Kors stores worldwide at the end of the first quarter of fiscal 2015." And those figures do not include the number of wholesale retail outlets that offer Kors products. At the end of fiscal 2014, Kors had wholesale deals with 2,496 department store and specialty stores in North America and an additional 1,232 department stores and specialty stores internationally.

It sounds like a lot of stores but the retail figures support that growth. According to its 2014 annual report, Kors' retail segment account for 48.1% of its revenue while its wholesale segment accounted for 47.6% of its sales. Its remaining FY14 revenue came from distribution and licensing agreements, such as its licensing agreements with Fossil for watches and affordable accessories, Estee Lauder for fragrances, and Marchon for eyewear.


Going forward, there are opportunities for growth. For instance, Kors focuses a good portion of its product line towards handbags, shoes, watches, jewelry, eyewear, and other accessories like scarves, belts, wallets, and tech accessories and the largest area of growth in the luxury goods industry is accessories. From 2005 to 2013, this subset was the fastest growing category in luxury goods. In 2013, "the accessories product category is estimated to have generated sales of approximately $79.6 billion, representing 28% of total luxury goods sales." And, Kors is well-positioned to harness this subset, but competition is fierce.

Kors needs to boost brand awareness and reinforce the concept of the company as a global luxury brand. One way it is doing that is by installing products at retail outlets with appropriate branding and demographics for the price point. There are two tiers to Kors' business - its higher cost luxury "Michael Kors" brand and its more affordable "MICHAEL Michael Kors" concept offering. Its luxury brand can be found at stores like Bergdorf Goodman, Saks Fifth Avenue, Neiman Marcus, Holt Renfrew, Harrods, Harvey Nichols and Printemps while the MICHAEL brand is centered around Bloomingdale's, Nordstrom, Macy's, Harrods, Harvey Nichols, Galeries Lafayette, Lotte, Hyundai, Isetan and Lane Crawford.

"Our focus goes well beyond one year in order to support growth," said Michael Kors Chairman and CEO John Idol on the earnings call Monday, citing strategic investments in expanding its store base and increased spending on marketing and technology. One such investment is the development of a website.

Kors does not currently operate its own website but rather runs its online shopping portal michaelkors.com through Nieman Marcus. While it receive most of the profits from this venture, Kors is expected to launch its own self-managed website this fiscal year. So, this will also contribute to boosting the company's bottom line if it can keep the costs of managing such a portal to less than the cost of going through Nieman Marcus.

On The Downside

But there is a downside.

The company could go far but Kors is getting so big so fast that managing inventory levels, manufacturing, and distribution outlets is a real concern. In addition, the company has limited operating experience at its current size. Growing beyond its current state is going to be just as dependent on having the resources to implement growth initiatives in a timely fashion as it will having an experienced leader in place to guide the company as it grows.

This is good hold position but don't expect the company to really pop unless experienced management can take the lead.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within 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.