Michael Kors Is Down, But Is It Out?

By Matthew Cochrane Markets Fool.com

Image source: Michael Kors Holdings Ltd

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Michael Kors Holdings Ltd (NYSE: KORS), the luxury designer and retailer of apparel and accessories, suffered yet another disappointing quarter when it reported its 2017 third quarter results last month. Total revenue decreased to $1.35 billion, a 3.2% decrease year over year. That's not disastrous but the carnage doesn't come close to stopping there. Retail comparable sales decreased 6.9%, wholesale net sales were down 17.8%, and licensing revenue was down 22.9%. Ouch!

Predictably, the stock price has followed the falling fundamentals. Three years ago the stock traded just a shade below $100, today the stock bounces around in the mid- to high -$30s. The stock price will not recover until management convinces investors there is a clear path to return to growth.

KORS data by YCharts

Playing the blame game

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As with the entire suffering retail sector, there are several culprits for Michael Kors' struggles. The rise of e-commerce has led to steadily declining mall traffic for years. Michael Kors management has developed a robust online platform but it is unclear if this is doing anything more than cannibalizing sales from its physical retail locations. For instance, in the most recently reported quarterly conference call, CEO John Idol noted the company witnessed this very issue when they introduced a European e-commerce platform. Idol stated:

In Europe, overall retail net sales were essentially flat during the quarter. In our newly launched digital flagships, sales significantly exceeded expectations. In stores, comparable sales decreased in the mid-teens range ... If we were to include e-commerce sales, our European comparable sales results would have been down in the mid-single digits on a reported basis and essentially flat on a constant-currency basis. This is similar to the trend we saw in North America when we launched our e-commerce platform.

Of course, there are several other factors weighing the stock price down. There has been a broader fashion trend toward smaller handbags and accessories, translating into a lower average sale price. The strong dollar also hurts the company, not only with exports, but also with wealthy foreign tourists who visit the United States. This demographic, which has always contributed to luxury retail sales, effectively has less money to spend in the United States as a result of the strong dollar.

Finally, Michael Kors management has long blamed the highly promotional wholesale environment for not only dragging down the average sale price of merchandise but also for hurting the brand's exclusive image. As a result, Idol says the company will be selling fewer products through these channels. This strategy should lead to higher prices for merchandise, though it will likely lead to a reduction in net sales through fiscal year 2018.

Righting the ship

In the company's most recently reported quarter's conference call, management outlined several initiatives that it believes will help the company return to growth. For instance, to give its accessories a more "elevated" look, the company's design teams plan on introducing new design elements into its accessories like "artisanal craftsmanship, iconic hardware details and intricate mixed-media leathers."

Ready-to-wear dresses and footwear sales also remain strong and the company is looking to exploit the growth in both of these categories. Idol believes the company can capitalize on this momentum by increasing its footwear presence in its retail stores and launching a new online dress shop this fall.

Image source: Pixabay

While the company must remain nimble to stay on top of fickle fashion trends, perhaps the most encouraging sign is its dedication to digital and omni-channel sales. Last quarter Michael Kors rolled out a trial click-and-collect program for ten North American stores where customers can make online purchases and pick up their merchandise the same day at a retail location. The program was so successful it is being rolled out to all U.S. locations this quarter.

The company's digital North American platform delivered double-digit comparable sales growth while the recently launched Chinese and European digital flagships "exceeded expectations." In addition to this, the company is beginning to offer more customized products on its North American website. With the new Custom Kors option, customers can order free monogramming for their handbags or customize it with other select design options.

While fashion watch sales did continue to decline, this was partially offset by the incredible success of its new ACCESS line of wearable technology. During the holiday shopping season, the new ACCESS watches routinely sold out in stores without ever being placed on sale. While Idol declined to comment whether wearable technology would ever surpass traditional watches, he did state, "We're at the very beginning of something that could become sizable." Much more remarkable, however, were his comments that he believes the company could eventually become "the second-largest wearable watch business in the world."

Finding value on the clearance rack

Unfortunately for Michael Kors investors, there doesn't seem to be any relief coming in the next few quarters. The entire retail sector is struggling and Michael Kors does not seem to be immune. Furthermore, if less merchandise is going to be sold through department stores, net sales could easily continue to meander downward.

In other words, Kors is a flawed retailer with real problems and to pretend otherwise would be foolish. But these problems persist throughout the luxury lifestyle brand world. Coach Inc, Kate Spade and Ralph Lauren Corpall face similar problems. Yet Coach's current P/E ratio is 20.9. Kate Spade's is 19.8. Ralph Lauren's is 45.4. Meanwhile, Michael Kors is currently trading at a valuation of just 8.5 times earnings.

For a company that generates free cash flow and is investing heavily in digital commerce, this discrepancy in valuation doesn't seem to make sense. Of course, more volatility should be expected in the quarters ahead, but that doesn't mean this isn't the time for value-oriented investors with a long time horizon to scoop up shares while they're still on the clearance rack.

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Matthew Cochrane owns shares of Michael Kors Holdings. The Motley Fool owns shares of and recommends Coach. The Motley Fool owns shares of Michael Kors Holdings. The Motley Fool has a disclosure policy.