Michael Kors Stock Looks Undervalued: Time to Buy?

By Markets Fool.com

Source: Michael Kors.

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Michael Kors stock has fallen by nearly 33% over the last year, trading at 52-week lows because of fears about slowing growth. The company operates in a challenging industry, and it's only natural to expect decelerating growth as it gains size over time. However, Michael Kors is still a remarkably profitable growth company, and short-term uncertainty seems to be creating a buying opportunity for investors.

Michael Kors is doing great, but not as great as before
Michael Kors has achieved spectacular success over the last several years. The business is still doing remarkably well, but comparable sales growth in North America is clearly slowing down, generating considerable fear among investors.

Total sales during the quarter ending in December grew 30%, reaching $1.3 billion. On a constant currency basis, sales grew 33% year over year. The Michael Kors brand commands premium prices, so the business produces big profit margins, in the area of 61% of revenues at the gross level and 34% of sales at the operating level during the last quarter.

International markets are still firing on all cylinders: European revenue grew 72% to $241 million, with comparable store sales increasing 21%. Sales in Japan jumped 72% year over year to $16 million in the December quarter.

But North America is Michael Kors' biggest market by a wide margin, and while the business is still delivering solid performance, there is a clear slowdown trend in comparable sales. Sales in North America increased 22.6% to $1.1 billion, while comparable store sales grew 6%. On a constant currency basis, revenue in North America grew 23.1%, with a 6.8% increase in comparable store sales.

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Most companies in the business can only envy this kind of performance, but the slowdown is undeniable. By comparison, comparable sales in North America grew 10.8% in the September quarter and 24% in the December quarter during the prior year.

It's important to remember that Michael Kors increased its store count in North America by 19% during the last year, from 284 to 337 units. Also, square footage in the region grew by almost 30% year over year. It's only reasonable to expect slowing growth in same store sales when the company is expanding its presence that rapidly.

Besides, the company's new U.S. e-commerce site delivered a big increase in sales of 73%, and this took traffic away from the stores. Including e-commerce, comparable sales in North America would have grown by an additional 380 basis points, for a total increase in same store sales of 9.8%.

The Coach factor
Growth tends to naturally slow down as a business becomes bigger over time, which is no reason to panic. However, fashion is a particularly fickle business, and when a company loses its touch with consumers, things can get very complicated for investors.

What happened with Coach is probably exacerbating fears regarding Michael Kors. Coach used to be one of the most successful players in the industry, but the company went too far in its expansion efforts. Brand power got diluted due to excessive promotions to sustain growth, and Coach is now going through a transformation process to reverse the decline in sales.

There is no reason to believe that Michael Kors will make the same mistakes as Coach, but investors tend to associate different companies in the same industry. Besides, the fact remains that leading a high end fashion company can be remarkably difficult, as management needs to make careful and smart decisions on complex areas such as design, pricing, and geographical presence.

In the bargain bin
Michael Kors trades at a P/E ratio around 15.4 times earnings, a significant discount versus the average company in the S&P 500 index, which is in the neighborhood of 19.1. The stock looks even cheaper on a forward basis: Micheal Kors trades at a forward P/E around 13.4, versus 18.2 for the S&P 500.

Even assuming that growth will slow in the medium term, chances are that Michael Kors will outgrow most companies in the market by a considerable margin. Besides, Michael Kors is a remarkably profitable business with a pristine balance sheet, so the company could easily justify a much higher valuation.

There is plenty of uncertainty surrounding Michael Kors, but uncertainty sometimes creates big opportunities for investors. At current prices, Michael Kors offers substantial upside potential for long term investors who can tolerate the short term uncertainty.

The article Michael Kors Stock Looks Undervalued: Time to Buy? originally appeared on Fool.com.

Andrs Cardenal owns shares of Coach and Michael Kors Holdings. The Motley Fool recommends Coach and Michael Kors Holdings. The Motley Fool owns shares of Coach and Michael Kors Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.