Why You Should Stay Away From This Fashion Retailer

Jul.27.12 | About: Michael Kors (KORS)

Shares of Michael Kors Holdings (KORS) have a solid YTD performance by returning investors 52.07%. I believe the current valuations at 36.9x the NTM EPS are not sustainable over the long term, and the stock is likely poised for a significant correction ahead. In this article, I will illustrate the rationales supporting my bearish view.

My value analysis includes Coach (COH), Vera Bradley (VRA), Fifth & Pacific Co. (FNP), and Guess (GES) as KORS' comparable peers. The estimated stock value is determined by equally weighting the valuations calculated by five different multiples - EV/Sales, EV/EBITDA, P/S, P/E, and EV/FCF.

Compared to the peer group, KORS has a stronger growth potential as market predicts the revenues, EBITDA, and EPS to rise robustly by a 2-year CAGR of 31.1%, 39.0%, and 33.5% over the current and next fiscal years. Accounting for the earnings estimates, the stock trades at a PEG of 1.4x, substantially higher than the peer average of just 0.9x (see comparable analysis table below).

KORS also outperforms the group averages in all of profitability measures I listed. But for margin metrics, KORS' outperformance is just marginal. The gross margin, EBITDA margin, EBIT margin, and net margin are fairly in line with the peer averages, and only ROE and ROIC are substantially higher (see comparable analysis table below).

One concern for the company is the weak FCF margin, which is the lowest among the group. Other liquidity measures such as debt/total capitalization, interest coverage rate, and current and quick ratios are generally in line (see comparable analysis table below).

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As such, I believe the KORS' valuation should warrant a premium over the peers at no more than 30% to 40% to account for its superior growth prospects. Nevertheless, the current stock price of $41.45 implies a whopping 261% premium over the five peer average valuation multiples, suggesting that the stock price is very much exaggerated by market's over-optimism (see relative valuation table below).

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Applying a more reasonable but still substantial premium of 50%, the estimated stock value will drop to $17.38, indicating a solid 58% downside (see relative valuation table below).

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Bottom line, KORS' lofty valuations offer investors very little margin of safety. The high growth will eventually revert to mean and a slight miss on market's overreacted expectations could easily trigger a major price correction. As such, I strongly recommend long-term investors to avoid this stock.

Comparable analysis tables are created by author and all financial data is sourced from Capital IQ and Morningstar.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in KORS over the next 72 hours.