I’ve posted this elsewhere but was wondering if anybody else had additional thoughts. If I recall, there were at least a few of us who posted on KORS early this past summer. Is anybody still invested in it?
Michael Kors Holdings is far, far, far removed from what I would call my wheelhouse. Usually my fashion sense extends little beyond not wanting to drip salsa on my shirt. Reading extensively about fashion lines, runways and handbags while a Miami Heat is on in the background has made me question many things, not the least of which is my sanity. And, yet, here we are.
I stumbled upon KORS because it is one of TMF1000’s “super stocks”. After its huge stock price drop earlier this year, it seemed like a good place to jump in, and I made an initial purchase at about $47. I do believe that at current prices the company represents a great value and will reward patient shareholders.
One more note before we begin: For entirely my purposes to distinguish the two, “Kors” will refer to the fashion designer and founder of the company, “KORS” will refer to the company. Michael Kors could refer to either depending on context, but I have done my best to try to make it clear.
Michael Kors Holdings (KORS)
Twitter Intro
Michael Kors Holdings currently produces a range of products including accessories, footwear, watches, jewelry, men’s and women’s ready-to-wear apparel, eyewear and a full line of fragrance products. The company is often described as a “global luxury lifestyle brand”.
History
At the young age of 22 and just four years after dropping out of the Fashion Institute of Technology in New York City, fashion designer Michael Kors launched the Michael Kors womenswear fashion line at several prominent department stores including Bloomingdale’s, Lord & Taylor, Neiman Marcus, and Saks Fifth Avenue in 1981. After suspending the line in the early 90s due to bankruptcy and financial woes, the line continued in 1997. In 2002, Kors launched a menswear fashion line.
In 2003, Kors left a French fashion house as a designer in order to focus on his own brand. KORS went public in late 2011 propelling Michael Kors to billionaire status. The stock more than tripled until 2014 when it began a long descent down to where it now stands at about half its all-time highs.
Michael Kors, the person, appeared on Project Runway as a judge for the shows’ first ten seasons becoming a pop culture darling and helped KORS reach new business heights.
Business Model
Michael Kors earns money through three different revenue channels: retail, wholesale, and licensing.
1) Retail: In the fiscal year 2015, the retail business segment accounted for 48.8% of the company’s total revenue ($2.135 billion) and 44.3% of income from operations ($557 million).
For this segment’s purposes, KORS sells their products, as well as licensed products bearing their name, directly to the end consumer through our retail stores and concessions primarily in North America, Europe, and Japan. As of this past quarter, KORS operated 377 retail locations in North America, 155 in Europe, and 57 in Japan. They continue to open at an aggressive pace. In their last quarterly report, KORS stated they currently operated 589 retail locations worldwide, up from 473 locations at the same time last year. This month (November 2015), they are due to open a 9,000 sq. ft. flagship store, their largest yet, in Beijing.
There are four retail store formats:
I. Collection Stores – located in high-end and “prestigious” shopping areas
II. Lifestyle Stores – located in well-populated commercial and regionally-leading shopping plazas
III. Outlet Stores – Located in outlet centers, this is the company’s attempt to make some of their luxury items more accessible and to, ahem, “reach additional consumer groups” (that’s a direct quote from their 10K filing).
IV. E-commerce – Last fiscal year, KORS launched a new e-commerce platform in the U.S. and Canada and, since that time, digital sales have exploded in these regions. Digital flagships are expected to come online for European markets in the fall of 2016 followed by Asia thereafter. Currently their e-commerce business carries a lower operating margin than their physical retail locations, but the company expects this to change as the e-commerce platform grows and reaches scale.
In last week’s conference call (2QFY16), CEO John Idol stated:
We are seeing accessories and footwear emerge as dominant e-commerce categories, demonstrating the brand strength of these core luxury product lines. We believe the transition to online and mobile purchasing will continue worldwide, and we are poised to capitalize on this shift with the development of our digital platform to provide a global, multi-language, multi-currency e-commerce experience for our customers. The roll out of our digital flagships across Europe is expected to begin in fall of 2016, followed by Asia thereafter.
2) Wholesale: In the fiscal year 2015, the wholesale business segment accounted for 47.2% of the company’s total revenue ($2.065 billion) and 48.6% of income from operations ($611 million).
KORS’ wholesale segment sells products through major department stores and some specialty stores, primarily in North America and Europe. One thing KORS has been focused on for a while in this segment is to create a shop-in-a-shop experience in these department stores. From their 10K, KORS states they want to continue to “focus our sales efforts and drive sales in existing locations by enhancing presentation, primarily through the creation of more shop-in-shops with our proprietary fixtures that effectively communicate our brand and create a more personalized shopping experience for consumers.”
3) Licensing: In the fiscal year 2015, the licensing business segment accounted for 3.9% of the company’s total revenue ($172 million) and 7.1% of income from operations ($89 million).
KORS’ product licensing agreements allows third party manufacturers of a variety of products, including watches, jewelry, and fragrances, to use the KORS’ brand name and trademarks. KORS emphasizes that they are heavily involved in the design process for all licensed products.
In their last conference call, for their Licensing business segment they were particularly excited about: 1) Their new Gold Fragrance collection featuring scents for women “ranging from feminine and seductive to sparkling and sensuous”; 2) Their new eyewear partnership with Luxottica featuring aviator-style sunglasses; and 3) Their new connected fashion accessories line which will launch in Fall 2016 (I believe this is mostly smartwatches as part of their licensing partnership with Fossil).
Brand Strategy – Two Distinct Fashion Lines
The company offers two primary collections: the Michael Kors luxury collection and the MICHAEL Michael Kors accessible luxury collection. (Yes, the hope is that the clothes are more imaginatively designed than they were named.)
Michael Kors Collection – From the company’s latest 10K report, the Michael Kors collection company’s “establishes the aesthetic authority of our entire brand”. This collection is carried in a number of their retail locations, including all Collection stores, and higher-end wholesale locations including Bergdorf Goodman, Saks Fifth Avenue, Neiman Marcus, Holt Renfrew, Harrods, Harvey Nichols and Printemps.
MICHAEL Michael Kors Collection – The buzzwords for this space are “accessible luxury”. In other words, as a middle class American, while I will never be able to afford to buy my wife a $2,000 purse of blouse from the Michael Kors collection, I might be able to buy her a similar purse or blouse for $300-400 from the MICHAEL collection.
While this category offers footwear and apparel products, there is an especially strong focus on accessories here. The MICHAEL collection is carried in all Lifestyle retail locations and wholesale locations in department stores like Bloomingdale’s, Nordstrom, Macy’s, Harrods, Harvey Nichols, Galeries Lafayette, Lotte, Hyundai, Isetan and Lane Crawford.
The idea is that, with the two brands combined, KORS can target a broad customer base while maintaining a “premium luxury image”. Critics say the danger of offering an accessible luxury brand is that it cheapens the entire brand and lose its appeal among higher-end consumers.
For those interested, Michael Kors discusses the purpose and launch of the MICHAEL collection, among many other topics, in this interview from September 2012:
https://www.youtube.com/watch?v=hKkklMJ_4I4
Corporate Culture and Management
On Glassdoor, KORS has 3.4 stars (out of 5), 87% approve of the CEO, and 64% would recommend to a friend.
Michael Kors is currently the Chief Creative Officer and honorary Chairman.
John Idol has been serving as the CEO since 2011 and has been a director with KORS since 2003. Prior to working for KORS, Idol had previous career stops at Ralph Lauren and Kasper ASL. He has been in the fashion industry since 1994.
Joseph Parsons is the CFO and COO. He has worked at KORS since 2004.
Their 10K report states senior management has an average of ten years with the company.
Competition
KORS faces intense competition from a number of competitors in all phases of their business segments. For instance, in the retail and wholesale segments, KORs recognized these other companies by name in their 10K as serious competitors: Coach, Burberry, Ralph Lauren, Hermès, Louis Vuitton, Gucci, Marc Jacobs, Chloé, Tori Burch and Prada. And that doesn’t even take into account other design names like Kate Spade. With these companies, KORS will, according to their 2015 Annual Report, “compete on the basis of style, price, customer service, quality, brand prestige and recognition, among other bases.” I think we all get and understand this. Consumers have only a finite amount of money to spend and can choose to buy only a certain amount of purses.
In Wholesale, they are not only competing for the consumer’s finite purchasing money, but also with other manufacturers’ products for a finite amount of display space.
In Licensing, they reported watch sales were “soft” this past quarter. Hmm, Apple Watch anyone? While they are looking to introduce connected accessory devices next fall, they will have to compete with technology companies, as well as their more traditional competitors, moving forward in this space.
Risks and Concerns
Declining Same Store Comps. We cannot begin discussing concerns with Michael Kors without starting with the falling same store sales and massive slowdown in EPS growth.
Part of KORS stock price contraction has been a completely normal high-growth company evolving into a more mature one. The U.S. market is now fairly well saturated with KORS’ products and retail locations, especially the glamorous areas KORS wants to be associated with, and Michael Kors became a household name and a celebrity during his stint as a fashion judge on Project Runway. The high growth phase of KORS’ life is probably over so it makes sense that it’s P/E and probably its stock price would contract a bit.
Yet it was KORS falling same store sales that sent the stock price into a death spiral earlier this year. So why have same store comps declined? There are many answers:
1) Growth rates had been so high, they were simply unsustainable and made for hard-to-beat comps;
2) Current fashion trends are favoring smaller handbags. As an acute observer of fashion I’ve noticed this trend for a while now. Or I just read it on their last conference call. So while the number of handbags being sold is largely staying constant, the prices for these smaller handbags are decreasing;
3) The strong dollar is affecting margins in merchandise sold overseas and creating less tourist traffic in stores stateside;
4) Many retail stores and wholesale locations are located in malls and malls are currently operating in difficult circumstances and experiencing less foot traffic than in years past;
5) Perhaps, foremost, the aggressive opening of more stores, has led to a cannibalization of same store sales. Yes, that leads one to immediately wonder, “Why not just slow down the aggressive opening of stores then?” Many analysts ask the same question. In the last conference call, CEO Idol responded:
And, again, as we’ve said to you many times, because you’ve all questioned us regularly, I might say, on why do you open more stores.
Well, we’re profitable when we open more stores. And people, while online shopping is absolutely a trend and it’s going to move the needle for the company, people will still go out and shop in a store. That won’t, at least while I’m alive, won’t have evaporated. So we’ll be in the right cities, in the right locations, and feel good about that.
Not sure how I feel about that response. Would welcome any comments or responses.
6) Finally, a robust online presence has led to less store traffic.
So, I would like to delve a little deeper into two of the above concerns.
Sale Cannibalization. First, they obviously recognize the trend towards e-commerce. They have invested heavily into this revenue channel and their North American online sales have taken off since last year. They plan on launching similar online platforms in Europe next year and Asia thereafter.
Yet they continue to aggressively open up new stores too. While this would be fine if same store comps were still growing, they’re not. They have a strong balance sheet with a $431 million in cash and only $7 million in debt. So that’s not the concern. I just wonder if this is the best way forward, opening so many new domestic stores while comps are still falling and while their online business is exploding.
Strong American Dollar. Another area I would like to address is the strong dollar and foreign exchange rates. This is absolutely killing their YOY comps right now. Reporting on its latest quarter, Motley Fool’s Dan Caplinger wrote:
Geographically, Kors continues to see strength in its overseas markets, even though currency impacts reduced their positive effect. In North America, revenue rose 4.5%, but Japanese sales rose 36% even after taking into account nearly 25 percentage points of currency-related downward revisions. European sales grew 21% in constant-currency terms, but that equated to growth of just 2.3% due to the weak euro.
From http://www.fool.com/investing/general/2015/11/04/kors-soars-…
But the strong dollar doesn’t just affect margins on products sold internationally. It also affects the money international tourists spend when visiting the U.S. Many foreign tourists like to buy high end products from the country they’re visiting. In the U.S. KORS has traditionally seen a sizeable amount of traffic and purchases from such tourists, especially in areas like NYC and South Florida. With the stronger dollar, less tourists come to the U.S. and the ones that do have less money to spend. In the last conference call, CEO Idol specifically addressed this concern:
…the moderation from our previous guidance also reflects the continuation of what we think is impacting us is the tourist traffic. Both in the department stores and in the retail channel, we have huge doors, whether it’s in New York, whether it’s in the Southern Florida area, all of us are now being impacted in parts of Texas because of oil prices there, that’s a little bit less tourist, but some of it’s related to the Mexicans shopping cross-border with the peso to the dollar.
Beyond these concerns, investors in any company dependent upon changing fashions will have to be concerned with…
Changing Tastes in Fashions. Beyond the falling same store comps, the one concern investors will always have with fashion is that tastes are fickle and apt to change. Of course, this is true! For instance, in my own life I can often be seen wearing blue jeans and Guy Harvey t-shirts. But fifteen-twenty years ago I would’ve been wearing something like blue jeans and an Aerosmith t-shirt. So big changes in taste, like mine, will always be there.
Oddly, I’m not too concerned with this though. Michael Kors has been designing clothes since his teens. He first introduced a ready-to-wear clothing line when he was in his early 20s in 1981! He has been wildly successful designing and selling clothes ever since. During this time we’ve seen many changes in fashion sense and tastes, but that hasn’t affected his ability to design successful lines of clothes. I do not see why, going forward, this would change. However, if Kors ever left the company, for personal, health or other reasons, I would seriously consider selling or at least lightening my position.
Revenues and Earnings
Revenue (millions) Q1 Q2 Q3 Q4
2012 243.1 305.5 373.6 379.9
2013 414.8 532.9 636.7 597.1
2014 640.8 740.3 1,012.2 917.4
2015 919.2 1,056.6 1,314 1,081
2016 985.9 1,130
Earnings (per share) Q1 Q2 Q3 Q4
2012 0.13 0.25 0.28 0.22
2013 0.34 0.49 0.64 0.50
2014 0.61 0.71 1.11 0.78
2015 0.91 1.00 1.48 0.90
2016 0.87 1.01
Current (11/4/15, 2016 Q2 Earnings)
Revenue Growth (millions)
2015 Q2 TTM Revenue = 3,905
2016 Q2 TTM Revenue = 4510.9
Year Over Year Revenue Growth = 15.5%, last quarter 23.6%
Earnings Growth (per share)
2015 Q2 TTM Earnings = 3.80
2016 Q2 TTM Earnings = 4.26
Year Over Year EPS Growth = 12.1%, last quarter 21.08%
P/E = (Check current price) 42.57/4.26 = 10
1YPEG = 10/12.1 = 0.83
Balance Sheet
KORS’ balance sheet is nearly pristine:
Cash/cash equivalents = $431.541 million
Short term debt = $5.416 million
Long term debt = $4.123 million
Total debt = $9.54 million
Cash Flow
This is a little different. I’ve never calculated cash flow for a company before but am trying something new. Please feel free to let me know if you think this is useful in any way.
After guidance from TMF1000, I am equating cash flow with net cash from operations minus capital expenditures. This is how he calculates the measure for his page posts, and for an explanation of why he does it this way you can see this thread (requires Hidden Gems subscription): http://boards.fool.com/1008/kors-page-7-31980119.aspx?sort=w…
Cash flow (millions) Q1 Q2 Q3 Q4
2013 41.2 29.6 103.5 124.1
2014 149.3 (41.4) 215.0 112.3
2015 149.2 (107.8) 350.4 501.7
2016 173.7 25.7
Cash flow growth (millions)
2015 Q2 TTM Cash Flow = $368.7
2016 Q2 TTM Cash Flow = $1,051.5
Year Over Year Cash Flow Growth = 185.2%
Share Repurchases and Dividends
The company does not currently pay a dividend.
This past quarter the Board approved another $500 million in share repurchases. This raises their initial repurchase authorization to $2 billion, of which $758 million is available for future repurchases through March 2018. To date, buybacks have totaled approximately 23.2 million shares and $1.2 billion.
Conclusion – My Bullish Thesis for KORS
As an investment, KORS has several attractive qualities despite its obvious flaws:
Extremely Attractive Valuation. Currently Coach (COH), another struggling and much more mature luxury retailer, sports a P/E of 23.92. Ralph Lauren’s P/E is 21.37. Burberry’s P/E is 18.38. Kate Spade’s P/E is over 30! Now, I’m not saying these P/Es are or are not deserved. I just see no reason why KORS should be trading at half their peers’ valuation. IMHO, while KORS undoubtedly deserved to come off of its highs from a couple of years ago, the market vastly overreacted creating a great buying opportunity for patient investors.
Founder and Creative Director Michael Kors. I believe almost all companies’ histories reveal something important about their business. In this case, I believe it shows Michael Kors’ burning passion in life is fashion or, more specifically, designing clothes. While researching this report, I’ve come across several anecdotes driving this point home. These anecdotes ranged from how Michael helped design his mother’s wedding dress when he was still five to how he designed and sold clothes out of his parents’ basement as a teen. Are these stories true? I couldn’t tell you. What I do know is that everything in his life seems to have revolved around designing his own clothes even at remarkably young ages. Indeed Kors found incredible success doing so while in his early 20s.
This helps me trust that Kors, as the Chief Creative Officer, will not miss out on trends or make clothes that are out of fashion or that won’t appeal to contemporary tastes. He has designed clothes through numerous fashion cycles and has always been successful doing so.
Brand Recognition and Marketing. KORS has nearly become synonymous with high-end fashion, especially in the fashion accessory market. The accessories product category has been the fastest growing product category in the global luxury goods industry and a segment which they have aggressively pursued from the company’s beginning.
For publicity, KORS has managed to find a number of low cost ways to market their brand and products. The company hosts semiannual runway shows to highlight new products. They have had several celebrities sport their clothes on red carpets, including Halle Berry, Angelina Jolie, Blake Lively, Penelope Cruz, Jennifer Lopez, Michelle Obama, Gwyneth Paltrow, the Duchess of Cambridge, and Cate Blanchett. And Michael Kors himself has found ways to remain in the public eye as a fashion icon, like judging ten seasons on the Bravo/Lifetime series Project Runway.
Macro Trend Tailwinds. While they face several shorter-term headwinds (smaller average purse size, foreign currency exchange, etc.) management believes larger macro tailwinds are at the company’s back. These include a growing global accessory market, emerging middle classes in foreign countries, and multi-format retail operations, including a robust online presence and strategically-placed retail locations.
More growth in mature European economies is still possible. There are huge avenues of growth available in China, Japan and the rest of Asia.
Management understands the importance of e-commerce and is currently making the necessary investments to be a leader in that space for years to come.
Conclusion
Despite its low 1YPEG, this is not what one would characteristically call a “Saul” stock. I get that. Though avenues of potential growth clearly exist, it is much more of a value play than a growth story. The basic thesis is that after hitting the ball out of the park for so much of its early public trading history, the company stumbled and Mr. Market vastly overreacted. I would love to hear feedback though on what others think.
- Matt
