If there's anything I don't trust it's a high-end retail name with a high price to earnings multiple in a recessionary environment. It was this healthy skepticism of overpriced apparel makers that led me to recommend buying put options on shares of trendy yoga wear manufacturer Lululemon (LULU) on May 8--those shares are down 21% since that call. A month ago (around the time I was researching Lululemon) I considered shorting shares of designer apparel manufacturer/distributor Michael Kors (KORS). Ultimately, I chose to hold off on making the bearish bet, as the company's earnings report was due on June 12, and, given the fact that it is a newly public company with an enormous buzz surrounding it, I concluded that investors would be apt to put a positive spin on the numbers regardless of how they came out.
My restraint proved prudent as investors cheered the company's earnings report, sending the shares up more than 10% the day they were released. Make no mistake, the numbers were impressive: the company tripled its profit ($43.6 million in the fourth quarter compared to $13.6 million in the same period a year ago) while providing guidance for the current quarter above Wall Street's estimates, a welcome sign given the disappointing guidance issued by other high-end retailers (Lululemon and Tiffany & Co. (TIF) for example). The 21 cent per share profit beat analysts' expectations of 16 cents. Revenue climbed 58% to $380 million and revenue at stores open more than a year jumped 36.1%.
Now for the bad news: the shares (up nearly 100% since the December IPO) have become overvalued. At $39.25, KORS trades at 51 times 2012 earnings and 37 times projected 2013 earnings. The bear argument for Michael Kors is similar to that for any company where investors are depending heavily on explosive growth to rationalize an inflated price to earnings multiple: the shares will fall to reflect a more realistic and sustainable multiple as soon as there is any sign that growth is faltering.
Consider the following: same store sales grew at 36% during the fourth quarter, that's down from 38% in the third quarter. Total revenue increased 58% in the fourth quarter, down from nearly 68% in the third quarter, and the company's profit margin fell to 57% in the fourth quarter from 59% in the third. While the company did offer upbeat guidance, KORS expects same store sales to grow by 35% during the current quarter and by only 20% during the fiscal year 2013. In other words, same store sales are expected to fall, and keep falling. Perhaps most disturbing of all, 11% of the company's revenue came from Europe during the three months ended March 31, 2012, that's up from 7% during same period a year ago. This could prove to be a problem should Europe fall deeper into recession.
While I believe all of this makes for a compelling case against the company, perhaps the best and most practical argument in favor of a bearish short-term view is the fact that the lock-up on the shares expires this Wednesday. While some analysts have encouraged investors to ignore the impending lock-up expiration, I believe that the company's 100% run-up since December and high price to earnings multiple will make it tempting for those who have previously been prevented from selling to dump their shares on the market and lock-in their profits. If you don't like the short-term speculative bet on the lock-up expiration, betting on the company to decline from current levels over the course of the next six months is a good bet as well. Short KORS or long KORS put options.