Michael Kors (NYSE:KORS) is a well-known designer brand that makes accessories, handbags, footwear, watches and men's and women's ready to wear products. Since the company went through its IPO in December 2011, almost all of its quarterly earnings exceeded analysts' consensus estimates. Earlier this week, the company announced its first quarterly earnings, and without exception, it exceeded most analysts' estimates. However, the stock dropped as much as 6% in one day even through the company had an excellent quarter and announced that it is increasing its full-year earnings guidance.
Here are some of the outstanding results released by the company on Aug. 4 (see here for the full press release):
- Total revenue increased 43.4% compared with the same quarter of the previous year.
- Retail net sales increased 47.5%; comparable store sales increased 24.2%; wholesale net sales increased 40%.
- Net income increased 50% and diluted earnings per share (EPS) increased 49%.
I believe that the market mispriced Michael Kors and that the stock is largely undervalued by around 25% based on my intrinsic value estimate. I used two methods - Enterprise Multiple and Intrinsic Value Estimate - to find out whether Kors is undervalued or fairly valued.
Kors' Enterprise Value and Multiple
At the time of writing, Michael Kors has a P/E of 24.75 and an enterprise multiple of 13.76 (see image above). The enterprise multiple is a better valuation tool than the P/E ratio because the enterprise multiple also considers the company's debt and cash in addition to its stock value.
For a growth stock such as Michael Kors, an enterprise multiple of 13.76 is fairly low, considering that the company's revenue and net income have been growing 40% to 50% year-over-year almost every quarter since its IPO. Kors' revenue growth will eventually slow down to the mid-teens once it has opened enough stores in North America, Europe and Asia Pacific, but at this moment, its current enterprise multiple seems to suggest that the stock is undervalued.
Intrinsic Value Estimate
To estimate Kors' fair intrinsic value (business value), I used three net income growth scenarios with a discount rate of 11% (see image below). Net income is used as a proxy for the company's free cash flow because the company's latest Q1 report is not released yet at the time of writing:
- A high-end valuation with a compound annual growth rate (CAGR) of 20% over the next decade.
- A fair valuation with a CAGR of 18% over the next decade.
- A low-end valuation with a CAGR of 15% over the next decade.
Note that these net income growth rates are assumptions based on a normal trend that designer brand retailers - such as Michael Kors and Coach (NYSE:COH) - tend to have high growth rates in the beginning, but their revenue and net income growth tend to slow down over time due to increasing competition, maturing markets and/or change of fashion trends.
Based on my estimate, I believe that Michael Kors' current fair intrinsic value is around $22 billion in market cap or $105 per share, assuming that its net income will grow at a CAGR of 18% over the next decade. This means that Kors is undervalued by around 25% at the time of writing (Aug 6). If Kors' net income grows at a CAGR of 15% over the next decade, the stock should be worth around $18 billion in market cap or $88 per share.
Kors' high revenue and net income growth should eventually decelerate to mid-teens as the company opens enough stores in North America. This is why I made the assumption that its net income will grow at 15% to 20% CAGR over the next decade. As a reference, the five-year earnings growth forecast for Kors is 25%, according to MorningStar.
North America and Europe's Revenue Growth
Europe is the second largest market for Kors as it contributed 20% to the company's total revenue for the latest quarter ended on June 28 (see image below). Kors is becoming increasingly popular in Europe. Its revenue in this region grew 128% with a comparable store sales growth of 54.2% for the latest quarter. According to the latest Conference Call, management believed that the company can open up to 200 locations in Europe (compared with its current 101 retail locations) and that the European market can generate approximately $1.5 billion for Michael Kors, compared with $500 million revenue generated in the region in fiscal 2014 (Kors' fiscal 2014 ended on Mar 29 2014).
Source: Company Q1 Financial Release
North America is the largest market for Kors as it contributed about 78% to the company's total revenue for the latest quarter ended on June 28. Kors' revenue in North America grew 30% with a comparable store sales growth of 18.7% during the quarter. Management stated that the North American market can support 400 stores (not including potential men's locations), compared with its current 301 North American retail stores.
While Kors' North American market will eventually mature, I believe that the company has a lot of growth opportunities in Europe as well as in Asia Pacific (especially in China and Japan) that are largely under penetrated. This is evident in Europe's 128% revenue growth as stated earlier.
Similar to Coach and other luxury goods apparel companies, Michael Kors' biggest risk factors are changing consumer or fashion trends and increasing competition.
First, Kors is one of the most popular designer brands in North America and is an emerging brand in Europe as well as in Asia Pacific. Michael Kors, the designer, has done an outstanding job building his namesake brand and his company over the past 30 years. He is the Chief Creative Officer of the company and leads his designer team to produce great products that can meet the latest consumer and fashion trends. If Michael Kors is no longer the Chief Creative Officer and/or if his company fails to meet the latest fashion trends, the company's sales will be impacted.
Second, Kors operates in a highly competitive luxury goods apparel industry that has thousands of competitors in North America and international markets. Kors' largest competitors include Coach (its largest competitor in North America) and the most well-known European brands, including Louis Vuitton (OTCPK:LVMUY), Burberry Group (OTCPK:BURBY), Gucci, Prada, Chanel, Gucci and Hermes. All of them compete for mid-to-high income consumers who spend thousands of dollars on luxury goods each year. To remain competitive, Kors will need to release new products every season (e.g. Michael Kors Collection) to keep up with the latest fashion trends.
There are two things that I always do to find out whether a designer brand is still popular. For Michael Kors, the first thing is to visit its stores every quarter to observe the store traffic. I invested in the company several months after its IPO because I discovered that its stores were getting more traffic than the nearby Coach stores. The second thing is to observe what women are buying and to find out what luxury handbags and accessories that they like the most. If a designer brand such as Michael Kors is becoming more popular, you should see more women carrying their handbags and accessories. This is a good indication of the company's increasing sales.
The Bottom Line
I believe that Michael Kors is undervalued by around 25% based on my intrinsic value estimate and that its 13.76 enterprise multiple is fairly low for a growth stock. Its revenue growth will eventually decelerate from its current 40% to 50% level to mid-teens. However, Kors still has a lot of revenue growth opportunities in the international markets - especially in Europe and China - that are under-penetrated. Hence, Kors' revenue and net earnings should continue to grow rapidly over the next five years as the company continues to expand further in North America and in international markets.
Sources: Michael Kors' Q1 Fiscal 2015 Earnings Release, Conference Call, Fiscal 2014 Annual Report, Yahoo Finance, Morningstar, SA Transcripts and Intelligent Stocks.
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.