Michael Kors Holdings Ltd (NYSE:KORS) is a leading accessible luxury brand. The company sells handbags, watches, wallet, shoes, and apparel among its offerings. Though most focused on the U.S., the company has also found significant success abroad, particularly in Europe and Asia.
KORS stock came public at the end of 2011 and found immediate success. Shares surged almost fivefold, at one point reaching $100 per share. However, the company’s rapid post-IPO growth phase faded. Enthusiasm peaked in 2014. Sales growth flatlined in 2015, and Michael Kors shares hit the clearance rack.
Michael Kors now trades around $50, down by half over the past two years. Premarket trading Wednesday shows another discount following disappointing Micheal Kors’ earnings results. The question now: Is it finally time to buy KORS stock, or will the discounts continue?
KORS Stock Pros
Fantastic Balance Sheet: Michael Kors maintains a pristine balance sheet that includes $700 million in cash and no debt. This gives Michael Kors a tremendous amount of flexibility to ride out weak periods and come back stronger. Right now, the company is buying back KORS stock at a solid clip, and some have even suggested that it might go private.
With no debt on the balance sheet, Michael Kors is potentially a very attractive takeover play with its highly profitable business, strong profit margins and total absence of debt or other overhangs.
Really Cheap: The upside of massive losses — at least for new money — is a cheap price on KORS stock. Michael Kors trades at 11 times earnings, or just 10 if you back out cash. That’s as cheap as it gets in this industry. Despite weak results and brand issues, KORS remains extremely profitable. Gross margins surged from 52% to 61% during the rapid growth years after the firm went public. Despite the weakness over the past years, those margins have only fallen back to 59%. That’s a solid show of resiliency.
Strong profitability also makes KORS a cash flow monster. In its most recent full year, Michael Kors generated $1.2 billion in cash flow from its operations. That’s an impressive figure for a $9 billion market cap firm. Given the company’s favorable margins and business model, it was able to turn that into $848 million in free cash flow. With that much cash generated from the business, the company could buy back 10% of its outstanding shares each year. Or it could make large new investments. Or offer a sizable dividend. With that much cash coming in, good things are bound to happen.
Prominent Investor Support: Michael Kors has strong institutional support. Many famous investors own KORS stock, including David Einhorn, Joel Greenblatt and Steven Cohen. That’s a pretty solid list, particularly for a firm that isn’t that large. Einhorn in particular owns about 6.7 million shares of the firm. That’s a stake worth around $330 million at today’s prices. In his most recent quarterly letter, Einhorn reaffirmed his belief in the company. He noted the company’s cheapness, favorability against peers, and said that: “Our thesis that Michael Kors is not a fad but a fundamentally healthy brand is playing out.” There’s been much discussion of whether Michael Kors in fact a fad or a lasting brand. Einhorn weighs in on the bullish side.
While famous investors aren’t infallible, they are a good sign. Particularly when a company is having issues, it is reassuring to see that notable investors still believe in the firm.
KORS Stock Cons
Another Soft Quarter: Michael Kors’ quarterly results were OK, but just that. Earnings and revenues came in ahead of expectations, but the profit beat was driven by higher wholesale sales. This goes against the company’s plan to reduce channel inventories. Retail sales failed to impress, and Michael Kors also cut guidance for the rest of the year. U.S. sales were down 5%, and Europe was only up marginally.
Much of the bull case for KORS stock revolves around China and emerging market growth. That said, fashion tends to be set in western markets, with the emerging world following suit. If the company can’t maintain its place in its domestic market, it is unlikely emerging market growth would be enough to sustain a rally in KORS stock. These earnings confirm that there is a serious issue with Michael Kors that goes beyond transitory economic weakness.
Mixed Marketing Messages: Much of Michael Kors’ advertising aims at a very high-end class of consumer. That is, the people flying in private jets and riding in limos rather than taking Ubers and flying commercial.
However, the actual strategy of Michael Kors is much more a second-tier luxury brand: accessible luxury. With its loud and sometimes tacky designs, the company’s products don’t quite match the opulence that its ads suggest. The more likely buyer for the company’s products, in the U.S. anyway, are upper-middle-class folks rather than elites. However, the company’s marketing acts as if they are a true top-tier brand. The mismatch in branding confuses consumers and arguably limits the brand’s success.
No Scarcity: Going with the above point, Michael Kors faces the issue of offering too much product. As you can see on eBay, for example, various Kors products sell at steep discounts online. You can buy one of the company’s main products, a black tote bag, at a 34% discount to MSRP. And that’s for totally new product.
True luxury brands don’t cheapen their products like that. If Michael Kors wants to be a top-tier global luxury brand, it simply can’t allow its products to start selling at steep discounts. Or, if it is going to allow discounting to that degree, it needs to embrace more middle-class consumers and stop trying to hit the ultra-high end of the market. One problem might be that KORS offers too many types of products. The shoes and clothing in particular feel lost in the shuffle; perhaps a smaller more-focused company on handbags and accessories would be sounder strategy.
Verdict
Michael Kors faces real strategic issues. It is a tarnished brand; the company needs to rethink its advertising and inventory management strategies. However, the company is still generating tons of cash and maintains strong margins. With a great balance sheet, they have time to fix the current problems. And if current management can’t turn things around, there’s a decent chance the company will be acquired.
I’d consider using the post-earnings selloff, if it continues, to take a position in KORS stock.
As of this writing, Ian Bezek did not hold a position in any of the aforementioned securities. You can reach him on Twitter at @irbezek.
