One retail stock which has been an especially big winner is Michael Kors Holdings Ltd (NYSE:KORS). KORS stock is up more than 30% since the start of November. It’s actually up more than 70% since a blowout second quarter report in August supported the thesis that the worst is in the rear-view mirror for Michael Kors.
It is part of one of the biggest narratives in the market recently: the resurgence of retail stocks. Consumers opened their wallets this holiday season and shopped everywhere, not just on Amazon.com, Inc. (NASDAQ:AMZN).
As a result, many retailers are coming off what was their best retail season in several years. And retail stocks are popping. The SPDR S&P Retail (ETF) (NYSEARCA:XRT) is up a whopping 16% since the start of November.
Can this strong rally in KORS continue?
I think so. Here’s why.
I’m not in love with KORS here. I don’t fully believe that the Michael Kors brand is back in fashion. After several quarters of sizable declines, sales are rebounding, especially in America. But I don’t think the Michael Kors brand will recover peak 2014 popularity any time soon.
A simple look at online search interest trends provides a bearish read. Search interest related to Michael Kors was essentially flat year-over-year in November/December despite the exceptionally bullish retail backdrop. That isn’t good, especially since KORS is closing stores and focusing on its digital sales channel.
Michael Kors was also pointed out as one of the brands most quickly losing mind-share among teens in Piper Jaffray’s Fall 2017 Taking Stock With Teens Survey. That was also the case in the Spring 2017 survey.
Consequently, I don’t think the Michael Kors brand is back in fashion.
But the Michael Kors brand doesn’t need to be the hottest trend in fashion in order for KORS stock to head higher. Through its acquisition of Jimmy Choo, Michael Kors is building a global luxury group that isn’t entirely reliant on the Michael Kors brand making a huge comeback (Jimmy Choo revenues are expected to be $1 billion soon; total KORS revenue last year was $4.5 billion).
Now that Michael Kors is a multi-faceted luxury brand with diversified revenue streams, the long-term growth picture has become much clearer. All the sudden, the company’s Runway 2020 targets (which call for low single digit revenue growth by fiscal 2020) seem very achievable.
Meanwhile, gross margins are expanding and should continue to expand because the company is dramatically reducing promotional activity in order to preserve brand integrity. Sales growth should also drive healthy expense leverage.
All together, this is a company which can very easily grow earnings at around 10% per year by fiscal 2020. The S&P 500 is trading at a 90% premium to its earnings growth prospects (20.4x this year’s earnings for 10.7% earnings growth prospects). KORS stock easily deserves a 100% premium given its strong balance sheet and healthy cash flows.
A 100% premium implies a fair price-to-earnings multiple of 20. A 20x multiple on fiscal 2020 earnings estimates of $4.30 implies a fiscal 2020 price target of $86. Discount that back by 10% per year, and you get to a fiscal 2018 end price target of $71.
I don’t love KORS, but I do think its a slightly undervalued name in a sector that currently has a lot of firepower.
So long as the narrative in retail stocks remains positive (and it should with consumer confidence soaring and tax cuts coming), KORS stock should rally alongside its retail peers.
Michael Kors stock looks fundamentally undervalued until the 70’s. At that point, KORS stock looks like more risk than reward. But until then, I think you stick with the rally in Michael Kors
As of this writing, Luke Lango was long AMZN and XRT.