Earlier this week, Michael Kors Holdings Ltd (NYSE:KORS) announced market-stunning earnings for its third quarter. Earnings per share beat Wall Street estimates by 40%, coming in at $0.64 against an estimated $0.40. The shocker came from Kors’ continued pressure on comparable-sales growth, which jumped up 41% in the quarter. Not only did that make forecasters look silly — include me in that list — but it also handily beat out the company’s own expectations for mid-20% growth.
With its foot firmly planted on the accelerator, it appears that any guess is as good as another for how high Kors can fly. Of course, the other side of that growth coin is the fear that Kors’ wings are thick with wax, which is going to melt as it floats ever closer to the sun. Once again, any stumble from the company is going to have a dramatic impact on the stock, but that doesn’t mean that a stumble is coming anytime soon. Here’s a rundown of the most recent earnings release, and what investors should look for over the next few months.
Third-quarter knockout
Right now, Kors is making everyone else look bad. At the end of 2012, holiday sales were up about 1%, with many companies falling flat on their faces. Analysts have said that the slow growth was the worst performance that the U.S. has seen since 2008. That sound bite quickly found its way into earnings calls, with management hemming and hawing about growing 3% even in a tough marketplace (if one more CEO brings up the fiscal cliff I might give up on investing altogether). Then along comes Kors with its 70% increase in revenue and suddenly people start to look silly.
Sales didn’t come at the expense of the bottom line, either, with Kors refusing to play the markdown game just to get feet in the door. Gross margins increased year over year, up about a percentage point to 60.4%. While that increase was largely driven by the company holding fast on pricing, it also saw a favorable shift in product mix to higher-margin items.
Looking way down the road to 2014, Kors announced that it was going to help boost sales even more by bring its e-commerce business in-house. Right now, Neiman Marcus runs the online business, and while the company is happy enough with the relationship, it’s been talking for a while about bringing it all back under one roof. That’s great news for the long run, and should really help the company address its omnichannel goal of having one Kors experience wherever customers shop.
In addition, Kors management has said that 40% of the customers who visit its site are from international locations that don’t have a store and can’t be shipped to. That’s a great indicator of the brand’s international strength and potential. But that’s all the long game — what should investors be watching this year?
What the future holds
One of the follow-on successes of having a luxury brand is that people want to buy everything they can with your name on it. Coach, Inc. (NYSE:COH) and Tiffany & Co. (NYSE:TIF) have made all sorts of lower-price-point items because the demand is so great. In this last quarter, Kors saw a surprise upswing in women’s ready-to-wear clothing that came from the demand for the brand. Look for the company to expand the ready-to-wear line in its retail stores to draw in additional foot traffic.
While ready-to-wear is a surprise growth point for the company, it’s also focusing on European expansion. The company has had a good response in Europe among vacationers from all over the world, and the locals seem interested, too. European stores managed a 58% comparable-sales increase last quarter, and between retail and wholesale, European revenue increased 112%. That market is going to continue to be a hot one for Kors, and the vacationer traffic should provide the company with an inroad to some of those markets that it doesn’t have stores in yet. Watch for that comp rate to increase over this year.
This past year European revenue accounted for 9% of total revenue, which is a 2-percentage-point increase from the same quarter last year. While the company doesn’t have a public target, I’d be surprised if Europe didn’t account for close to 15% of total revenue by this time next year. It’s the company’s fastest-growing region.
If it can manage to pull in additional traffic from ready-to-wear and the new stores, then it should have no problem beating its internal comp sales target again. For the second quarter in a row, management predicted mid-20% comp sales growth in the coming quarter. While that would still be leagues ahead of Coach and Tiffany — which were flat and down slightly, respectively, in the U.S. last quarter — it would be a dramatic drop from 40% growth. Right now one of my biggest fears is that management’s estimates are so pessimistic that they’re becoming meaningless. At some point this year I’d like to see them be in the right ballpark for estimated growth.
Finally, look for Kors to start pushing on its celebrity status to gain customers from Coach and other handbag makers. In Wednesday’s New York Fashion Week presentation, Kors presented to a star-studded crowd. As those celebrities start to pick up more and more Kors pieces — Michelle Obama wore Kors to the inauguration this year — it’s only going to increase its status as an aspirational brand.
The bottom line
Kors continues to be a difficult stock to read, as evidenced by its recent surprise. In part, it’s flying higher than anyone expected and in part it’s having a hard time making internal predictions work. That means that forecasting success is getting more difficult. I like what the company is doing with its branding and I like the rapid expansion it’s undertaking while the brand is hot. Having said that, a P/E of 36 is well above the retail average and companies like Coach can be had for less than 15 right now. It’s difficult to bite the bullet and just buy. I’ll certainly keep watching, though. This is a fun company if nothing else.
The article Urgent: Michael Kors Earnings Update and What to Watch originally appeared on Fool.com and is written by Andrew Marder.
Fool contributor Andrew Marder has no position in any stocks mentioned. The Motley Fool recommends Coach. The Motley Fool owns shares of Coach.
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