Friday, 6 November 2015

Time to buy (more) Michael Kors shares?

Back in June I wrote about Michael Kors (and Coach - link here) concluding that:

'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'.  

I touched on Coach a few days ago following their most recent quarterly update noting that:

Held Aug guidance & 'positive North American comps by the end of the year'. No wonder shares called up 3%+

I think the comment above and the chart below support this along with comments about progress in Asian sales and good reviews of recent fashion launches.

Note however that I was talking about a c. US$35 share price as a base for Coach back in June...and today it is just below US$33.  So progress operationally but not so much with the share price (albeit in a difficult market backdrop). 

And certainly the same immediate observation can be made with Michael Kors where the aforementioned US$50 level over the sloppy summer period became a floor around US$40.  

Still at least there has been a been a bounce back following the publication of their recent quarterly numbers where as with Coach there was an improvement in US trading...although there were inevitable FX translation issues too.  

'Michael Kors (NYSE:KORS) announces revenue rose 12% on a constant currency basis in FQ2. Retail net sales in The Americas segment increased 3.7% Y/Y to $384.86M. The company's gross profit rate fell 220 bps 58.8% due largely to foreign exchange swings during the quarter.Company-operated store count +116 Y/Y to 589 retail stores. 215 licensed stores are in operation'

The US improvement is shown below...'net' sales may be up but for the like-for-like sales the best we can say is that the pace of decline has sequentially improved:

Looking more broadly around the world non-US sales did improve but they only make up 25% of the company's total revenues:

Still 'revenue growth of...21% in Europe, and 61% in Japan, on a constant currency basis' should not be sniffed at and indicating the relative excitement the company has about building the brand in Asia they noted on the conference call that:

'We're excited to be hosting a star-studded event in November with Vogue called Young China to celebrate the opening of our largest flagship location in Huamao, Beijing, totaling 9,000 square feet'

(Of course this is happening at a time of some retail volatility in China...but I believe a brand with low penetration still retains considerable growth optionality in what is still the best exciting retail growth market in the world). Recall the potential the company sees for growth in the broader Asian region (as per a corporate presentation of a couple of months ago): 

More generally however - and despite good sounding ongoing digital...

...and male product retail initiatives - the still tough US environment for the company is apparent as the company noted: 

'For the full fiscal year, we now expect revenue of $4.6 billion to $4.65 billion. On a constant currency basis, total revenue is expected to increase in the low double-digit range, assuming a $164 million impact from the change in foreign currency rates. We expect a mid-single digit comp store decrease on a reported basis and a low-single digit decrease in constant currency...Our revised revenue expectation reflects our tempered outlook for the second half of the year. While we believe our product and marketing efforts will benefit our business longer-term, we are taking a more prudent stance in the second half'

Consistent with the negative like-for-like US sales chart above Michael Kors remains deep in a recovery zone.  

However as noted in the original note back in June the market has to look forward and two aspects strike me as interesting.  First - and inevitably - is the valuation which even factoring in the above is at around x8 EV/ebit (current year) which certainly is at the value end especially with a good balance sheet (small net cash).  Given the evolution of growth profile clearly this will necessitate a change of investor profile - but I would suggest much of the share price change over the last year or so reflects that. 

And on the balance sheet point, I was really pleased to see ongoing share buybacks and an expanded authorisation: 

'During the quarter, we repurchased approximately 9.4 million shares, totaling $400 million, under our share repurchase authorization. To date, our buybacks totaled approximately 23.2 million shares and $1.2 billion. We remain confident in our long-term growth outlook and free cash flow generation and are pleased to announce that the board of directors has authorized the repurchase of an additional $500 million of the company's ordinary shares. This increases our initial repurchase authorization to $2 billion, of which $758 million is available to us for future repurchases through March 2018'

The average buyback price of just above US$42/share is noteworthy and should help investors build confidence in the stock in the lower US$40s area.  

Absolute value and sensible use of the balance sheet highlights to me why investors should be looking to augment/initiate a position in Michael Kors.  Having looked at the stock again my instinct is to double up at/around prevailing.  A return to even a barely double digit EV/ebit valuation profile implies 25%+ upside but a fuller recovery would suggest re-attaining the US$60+ share price seen earlier in the year.  There are still risks - including a fashion disaster (some talk on Twitter about the longevity of the smaller handbags craze etc.) - but for me there is value in the shares.  I think investors are rewarded in 2016-17 in both this name and the aforementioned Coach. 

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