Monday, 8 June 2015

Should you be buying Michael Kors post the plunge?

We all know the theory: 'buy low and sell high'. However, when a big plunge in a share happens often we as investors are reluctant to act as the psychological influences and questions of a sharp fall in a share price predominate. Take Michael Kors for example. Just under a couple of weeks ago shares in the designer, marketer, distributor and retailer of women's apparel and accessories and men's apparel fell by around a quarter in one day. For a share that around fifteen months ago touched the US$100/share mark to be trading below US$50/share is a huge move: 


So what to make of Michael Kors at the prevailing share price?

Well, let's first think about what went wrong.  There are some exogenous influences such as the role of exchange rates (and their impact on tourist flows) but these probably account for only a quarter or so of the decline and correctly structural factors are the ones that most commentators are placing the blame on: 

"Michael Kors, the brand, is becoming ubiquitous, and that’s the kiss of death for trendy fashion brands"

For a premium priced brand (I hesitate to use the phrase 'luxury') this is a serious charge particularly when over-expansion is combined with the costs of expansion (store openings plus in online for example).  The company still sees scope to open well over 100 new stores in America alone for example so such start-up costs are going to linger.  

'Trend appeal' is always hard to gauge so let's look at a few numbers. Over the last fiscal year reported same store sales look strong...but the sharp deterioration even in constant currency in all regions (and particularly the sharp fall into negative comparable store sales data terms in North America) was particularly striking.  That is not a good trend.  

Nevertheless, as one commentator put it: 'the company's management forecasted revenues in the range between $4.7B and $4.8B. This represents a 7.5% increase of the previous year's record of $4.37B. The estimate is rather conservative as it is four times lower than the growth rate in the previous fiscal year'. This seems prudent in terms of a sequential comment but when you have such a shift magnitude in comparable store sales data little can be taken for granted.  Certainly much of any improvement is going to be back end loaded.  

As for earnings they are expected to come in at $4.40 to $4.50 per share, a 3-5% increase compared to the $4.28 which the company has just reported for 2015. This guidance is based on the assumption of a 3% reduction in the share count which implies that earnings in real dollar terms are seen flattish.  Given the company has around US$1bn of net cash unsurprisingly they are buying back shares: Michael Kors initiated an additional US$500 million to its US$1 billion buyback.  At US$1.5bn in cumulative size this is equal to over 17% of the current market cap (although currently there is a general expectation that such a buyback will be undertaken over a number of years - based on the last fiscal year run rate it would be just over 3 years).  

A specific within the numbers that did disappoint amongst the range of Michael Kors products was in the watch category where the impact of the introduction of the Apple Watch was noted. The company is hopeful that with 30% of its watch range being evolved then it can improve performance here.  

All of this talk about Michael Kors reminds me of another stock I have written about in the past, Kors' great rival Coach who over much of the last three years have struggled with many akin issues including sharply falling sales and the resulting poor corporate progression as noted (usefully in comparison to Michael Kors) below: 


The above chart is a bit deceptive as we know that Michael Kors' numbers are primed to sharply deteriorate.  Far better to look at the respective share price movements of the last couple of years...


...and some recent operational performance metrics:

KORS recent Bad quarter, Debt = Zero, ROE = 33% Net Profit Margin = 17%
COH recent qurater , Debt= 35% of Equity, ROE= 14% and Net profit Margin= 9%

So thoughts, especially as Coach has employed many of the turnaround techniques (new design talent, expansion in men's sales, global geographic expansion) that Michael Kors talked about as positives/upcoming initiatives in their conference call?

Two come immediately to mind.  First is that Michael Kors is fortunate that it has no net debt and second such turnarounds take time.  Look how the Coach share price has waxed and waned over the last year - and this followed a sharp decline over the preceding couple of years.  Nevertheless in terms of absolute magnitude of decline Coach has fallen a little over half whilst - as noted above - Michael Kors has fallen around half from its recent (all-time) high.  In essence much of what has happened to Coach has been compressed into the sharp fall in the Michael Kors share price in a shorter period of time.  

But is Michael Kors cheap?  The answer today below US$50 a share is 'yes for a starter position'.  If you believe the EPS forecast then the forward EV/ebit of the company is around x7 whilst Coach is still on a low double digit 'recovery' multiple. I own Coach for its recovery prospects from here (c. US$35s share price which it has broadly triple bottomed at) but feel it is correct that this position should also be augmented with one in Michael Kors too at prevailing levels.  

Coach is more dividend yield-y but from a total shareholder remuneration perspective Kors has that large share buyback capability to put to work if it wishes to.  Coach also has a more Asia-centric sales base but this has been a mild double-edged sword recently.  

Net net in the broader retail/pseudo-luxury space at around US$35/US$50 you can make a case for both Coach and Michael Kors.  I think you wake up in a couple of years having handsomely beaten underlying broader indices with an investment in one, other or both of these companies. They will bounce along the bottom for a while with - no doubt - some excitable trading updates/quarterly statements (certainly true of Coach over the last year or so!) but are they attractive larger cap value investments today?  In my view yes.  

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