Trade of the Day: Michael Kors Holdings Ltd.(KORS)

KORS looks like it will keep racing ahead

   

Stocks ended Q1 on a powerful note, but there is little doubt even among bulls that the market may be overextended. A 15%+ run in four months’ time is certainly reason for sentiment to reverse for a while.

So with the market currently overextended, but with a bullish bias solidly intact, what stock still presents a good entry point with considerable growth potential?

Expectation-Busting Growth

From same store sales surpassing analysts’ expectations to sales growth figures in recessionary regions of Europe that have surprised even company management, Michael Kors Holdings Limited (NYSE:KORS) has been a leader among retailers.

While a forward P/E of 23.2x is not exactly cheap, KORS’ long term earning potential is one of retail’s best. Analysts’ consensus estimates have KORS growing at an annual clip of 32.6% compared to an industry average of only 12% and a sector average of 14%. So while KORS’ P/E may seem a bit expensive, when factoring in their growth potential the price may look quite the opposite: KORS has a PEG of only 0.94. Compare this to the sector average of 1.45 and an S&P average of 1.83. In this light, even if KORS simply meets analyst expectations over the next couple quarters, the current stock price is still inexpensive relative to broad market growth rates.

Many retailers live and die by the same store sales number, also called comparables. While KORS has been guiding the Street to around 25% comp store sales (a remarkable growth rate), the company has been delivering closer to 40%-45% comps. They have been able to do this primarily because of their ability to work closely with vendors in keeping inventories replenished and to target products that are flying off the shelves in real-time.

Can KORS Continue at Breakneck Pace?

This appears to be the question on most investors’ and analysts’ minds. After putting up a same store sales number of 41% in the US and 58% in Europe, it is expected that this astounding growth rate will be tempered sooner or later.

However, there are a number of engines to propelling KORS’ growth. Replicating a 40%+ same store sales number is difficult, especially as the company becomes bigger in size. But according to analysts, KORS has the ability to more than double their present global store count to over 600 units. Even if comps begin to come down, the growth in outlets has the potential to keep total sales expanding.

Also, company management indicated that the European market for “accessible luxury” (KORS segment) is much more fragmented than the US with far fewer players. Given their explosive growth rates in the region – and in spite of the recessionary difficulties that pervade much of the EU –the European market has the potential to eventually rival the US in size.

Finally, the company expects to implement several drivers to increase margins over the medium to long term:

  1. shifting the mix of retail/wholesale from its current 50/50 distribution to a 75/25 mix,
  2. increasing  the category mix of accessories from 75% to 80% of total sales over the next six to 18 months, boosting both gross and operating margins, and
  3. bringing the ecommerce business in-house to become KORS’ highest-margin business.

So while it is natural to assume that their blistering pace of sales growth must decelerate, KORS believes it still has fuel to burn.

Red Hot Metrics, Lukewarm Stock?

4 3 13 kors 300x159 Trade of the Day: Michael Kors Holdings Ltd.(KORS)
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Since its IPO 16 months ago, KORS stock has followed a pattern of range-bound trading, occasionally jostled free by a surprise positive earnings announcement, after which it settles into a new higher range. There have been three notable instances as marked on the chart. Gap #1 was followed by a six-month trading range between $35 and $50. Gap #2 broke the stock out of that range and lifted it to the $48 to $56 level for another six months. Finally, Gap #3 on Feb. 12 of this year sent it higher yet again and the stock reached $65 twice in the wake of the earnings announcement, appearing to have set a resistance level.

However, since then the stock has retreated back down to $54 and now sits at the low end of its new range. Will KORS see another period of range bound trading in which the stock moves back to the $65 level?

4 3 13 kors 2 300x159 Trade of the Day: Michael Kors Holdings Ltd.(KORS)
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KORS has more than “filled the gap” since its latest jump on Feb. 12 (Gap #3) and any further downside momentum from here will be technically negative to maintain support for this new $54-65 range. For short term traders, this will be a key level to watch.

However, even if the stock falls back within its previous range, there’s substantial support at $48 with two instances of pronounced price rejection and bullish candlestick patterns in mid-November and late December 2012. For longer-term investors, this scenario provides a ratio of roughly $6-$7 of downside risk to $9-$10 of upside reward.

Recommendation: Buy KORS on a bounce off support at $55 per share. We are targeting $66 in the near term but stops should be set at $50 or just below.

Option Alternative: Buy to open the May 57.50 Calls for $2.50 or less on a bounce off support at $55 per share.

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John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news.  Get in on the next trade and get 1 free month today by clicking here.


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