December 29, 2014 Michael Kors Holdings Limited (KORS-NYSE) Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Outperform Date of Last Change 12/29/2014 Current Price (12/26/14) $75.21 Target Price $79.00 52-Week High $99.84 52-Week Low $68.89 One-Year Return (%) -6.66 Beta 2.00 Average Daily Volume (sh) 3,078,209 Shares Outstanding (mil) 206 Market Capitalization ($mil) $15,487 Short Interest Ratio (days) 2.34 Institutional Ownership (%) 89 Insider Ownership (%) 10 Annual Cash Dividend $0.00 Dividend Yield (%) 0.00 5-Yr. Historical Growth Rates Sales (%) 58.4 Earnings Per Share (%) 94.7 Dividend (%) N/A using TTM EPS 19.8 using 2015 Estimate 18.0 using 2016 Estimate 15.6 Zacks Rank *: Short Term 1 3 months outlook 2 - Buy * Definition / Disclosure on last page SUMMARY Michael Kors continues to impress with its performance. The company s second-quarter fiscal 2015 earnings of $1.00 per share and revenue of $1,056.6 million topped the Zacks Consensus Estimate and rose 40.8% and 42.7%, year over year, respectively. Driven by stellar results, the company raised its earnings projection for the fiscal 2015. The company continues with its international expansion unabated while focusing on product diversification to expand market share. The company is venturing into avenues like jewelry, fragrances, eyewear and Men s apparel apart from handbags. However, management s cautious commentary regarding margins on account of intense promotional backdrop and lowering of comparable-store sales guidance took some sheen away from the stock. This compels us to downgrade our recommendation to Neutral. Risk Level * Average, Type of Stock Large-Growth Industry Textile-Apparel Zacks Industry Rank * 105 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Jun) (Sep) (Dec) (Mar) (Mar) 2013 415 A 533 A 637 A 597 A 2,182 A 2014 641 A 740 A 1,012 A 917 A 3,311 A 2015 919 A 1,057 A 1,301 E 1,152 E 4,429 E 2016 1,134 E 1,270 E 5,298 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Jun) (Sep) (Dec) (Mar) (Mar) 2013 $0.34 A $0.49 A $0.64 A $0.50 A $1.97 A 2014 $0.61 A $0.71 A $1.11 A $0.78 A $3.22 A 2015 $0.91 A $1.00 A $1.34 E $0.93 E $4.18 E 2016 $1.05 E $1.12 E $4.81 E The quarterly figures may not add up to annual due to rounding off Projected EPS Growth - Next 5 Years % 26 2014 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
OVERVIEW Headquartered in Tsim Sha Tsui, Hong Kong, Michael Kors Holdings Ltd. (KORS) is a global luxury lifestyle company, founded by renowned designer Michael Kors. The company produces a diverse assortment of products including handbags, watches, accessories, jewelry and fragrance products and footwear under Michael Kors, MICHAEL Michael Kors labels. Michael Kors operates in over 85 countries, with significant presence in some of the world s most popular cities like New York City, London, Paris, Dubai, Milan Munich, Tokyo and Hong Kong. The company operates its own stores and showcases its merchandise with finest luxury retailers as well as leading department retailers including Bloomingdales, Bergdorf Goodman, Saks Fifth Avenue, Neiman Marcus, Holt Renfrew, Harrods, Harvey Nichols and Printemps. Michael Kors launched its e-commerce site for North America in September this year and plans to launch e-commerce sites for Canada in 2015 followed by Europe and Japan in 2016. Michael Kors online business was earlier managed by third party, Neiman Marcus through a partnership deal inked in 2007. The company conducts its operations through three segments: Wholesale, Retail and Licensing. Retail Segment (contributed 48.1% to net sales in fiscal 2014) comprises the company s retail stores. Store count as of Sep 27, 2014 is 473 outlets (excluding licensed locations). Wholesale segment (contributed 47.6% to net sales in fiscal 2014) sells the products to leading department stores/ specialty stores across the globe through shop in shop to give customers who prefer to shop from these stores a more personal treatment. As of Sep 27, 2014, total number of wholesale doors was 3,960 comprising 2,548 doors across North America and 1,412 doors internationally. Licensing segment (contributed 4.2% to net sales in fiscal 2014): License agreements allow third parties to use the company s brand name and trademarks in association with the manufacture and sale of an assortment of products, including watches, fragrances, eyewear and jewelry. Michael Kors actively participates in the design process, marketing and distribution of these products. As of Sep 27, 2014, the company had 176 locations operated through licensing partners. As per regions, North America continues to dominate with 84% contribution to total revenue followed by Europe (15%) and Other Regions (1%). Equity Research KORS Page 2
REASONS TO BUY Growth Catalysts: Michael Kors is fast emerging as a giant in the luxury retail space. The company is best known for its handbags and small leather goods collection, which is rapidly gaining market share in North America and outpacing its peers. Moreover, the company s collection of watches is a key contributor to revenues. In order to diversify its portfolio, the company recently started venturing in avenues like jewelry, fragrances and Men s apparel. Management believes that it will be able to grow the Men s business to a whopping $1 billion and around 500 stores, driven primarily by sportswear, leather goods and watches. Further, it aims to open around 500 jewelry shop-in-shops over the long term. Recently, Michael Kors signed a 10-year deal with Luxottica, a prominent leader in eyewear business, to enhance its place in optical and sunglass market. We believe that with diversification of the brand, the company will garner increased revenues and profits, which will consolidate its position in the fashion arena. Launch of e-commerce Site: In September, Michael Kors finally unveiled its domestic online portal. Until now, the company s online business has been managed by third party, Neiman Marcus, through a partnership deal inked in 2007. As more and more shoppers moved online, it was getting extremely important for Michael Kors to lay emphasis on its e-commerce. With a full-fledged functional site, management has already seen a 70% year-over-year spurt in net sales in the last two months. The company will be launching its site for Canada in 2015 followed by Europe and Japan in 2016. Rapid Footprint Expansion: To capitalize on opportunities presented by its ever increasing popularity, especially in the overseas locations, Michael Kors is on a store expansion drive across the globe. As of Sep 27, 2014, Michael Kors had 649 retail stores, of which 473 were company owned and the remaining were operated by licensees. It is to be noted that the company is laying more emphasis on opening retail stores as exhibited by opening of over 78 owned stores in the past year given the high profitability. Going forward, Michael Kors intends to open 50 stores in North America and continues to expect the count to reach 400 over the long term. Internationally, the company is eyeing the markets of Europe, Japan and China. The recovering European market has provided a boost to the company, as reflected in a 108% rise in sales in the second quarter of fiscal 2015. Fashion-conscious Europe presents considerable opportunities and hence management has rightly been seeking opportunities to open 50 stores in Europe in fiscal 2015 and more over the long term, taking the count to an impressive 200 from 111 stores at present. Moreover, it expects revenues from Europe to cross $1.5 billion over the long-term. In Japan the company is targeting 10 store openings in fiscal 2015 and 100 in the long-term. In rest of the Far East region (Greater China, Korea, Southeast Asia and Australia), the company has 116 stores and it expects to take the count to 200 over the long run. Shop-in-Shops: To ensure that its brand gets high visibility, management at Michael Kors has been growing its Wholesale business to bring the department store customers under its wing by collaborating with the leading department/specialty retail stores. The company has successfully implemented its strategy of converting department store doors to shop-in-shops as reflected in a 46.1% rise in Wholesale net sales in the second quarter of fiscal 2015. With over 299 shop-in-shop conversions globally, the company had about 1,969 shop-in-shops worldwide and is looking to increase the number by 750 in fiscal 2015. Ample Liquidity: Michael Kors boasts of a debt-free balance sheet with cash and cash equivalents of $1,012 million at the end of the second quarter of fiscal 2015. Boosted by robust liquidity, Michael Kors announced a $1 billion share repurchase program over a two-year time frame. The company has been constantly deploying resources to open new stores, building new shop-in-shops and has invested heavily to upgrade its information system and distribution infrastructure. In the past year, management invested nearly $185 million in capital expenditure. Further, the company anticipates capital expenditure of about $400 million for fiscal 2015. Equity Research KORS Page 3
REASONS TO SELL Stiff Competition: Luxury retail space is a highly competitive arena where Michael Kors has to compete with giants (both domestic and International) such as Ralph Lauren, Estee lauder, Coach, V.F. Corp., Phillips-Van Heusen, Jones Apparel, Liz Claiborne and Kenneth Cole Productions. A failure to offer highquality distinguished products at a competitive price may hamper the company s market share, consequently resulting in reduced top and bottom lines. Discretionary Spending Dependent on Health of Economy: Michael Kors sells products that are discretionary in nature, and in turn, depend upon consumers disposable income. On the other hand, the company s customer base remain sensitive to macroeconomic factors including interest rate hikes, increase in fuel and energy costs, credit availability, unemployment levels and high household debt levels, which may negatively impact their discretionary spending, and in turn the company s growth and profitability. Margin Compression Ahead: Management maintains a cautious stance regarding its margins. For fiscal 2015, management expects gross margins of the retail segment to decrease 50 bps and operating margins to come down to 29%, a 150 bps drop from last year. Increasing investments across board along with markdowns leading to normalizations will run down the benefits from favorable product mix and overseas expansion. Although no striking slowdowns will occur, we believe that the company also could suffer from an intense promotional backdrop, which might prevail on a long-term basis in the retail sector. Decelerating Comps Growth: Although the company reported comps growth in 34 straight quarters, there was very little to cheer as the growth rate drastically deteriorated in the quarter under review. Second-quarter comps growth was 16.4%, as against 22.9% reported a year ago period. As domestic retail trends weakened, comps growth decelerated. Moreover, the company lowered its comps guidance for fiscal 2015. Anticipating, foreign exchange headwinds in the second half, the company anticipates comps to grow in mid-teens as against earlier expectations of high teens. Moreover, the company expects comps to grow in the low-double digits in the upcoming quarter, which includes the crucial holiday season, in contrast to 27.8% comps growth reported in the third quarter of fiscal 2014. RECENT NEWS Michael Kors and Fossil Group Renew Licensing Agreement Nov 11, 2014 The global licensing agreement between Michael Kors and Fossil Group, Inc. has been renewed through 2024. Michael Kors in 2004 entered into a deal with Fossil Group to design, develop and distribute watches under the former s banner. Gradually in 2010 jewelry came under the ambit of this agreement and the two companies are now working together to enhance the men's watch business. Michael Kors Q2 Earnings Top Estimates on Sustained Growth Nov 4, 2014 Michael Kors has effectively maintained its streak of strong quarterly performance. The company s second-quarter fiscal 2015 earnings per share of $1.00 came miles ahead of the Zacks Consensus Estimate of $0.88 per share while rising 40.8% year over year. The company s quarterly revenues of $1,056.6 million handily surpassed the Zacks Consensus Estimate of $978 million and grew nearly 42.7% year over year. Consistent robust performance across all segments and geographies facilitated this growth. Equity Research KORS Page 4
Comparable-store sales (comps) increased 16.4% in the quarter, making this the 34th straight quarter of comps growth. Gross profit surged 43.4% year over year to $645 million, while gross margin grew 20 basis points (bps) to 61%. Operating profit increased 38% year over year to $305.6 million, but operating margin shrunk 100 bps to 28.9%. Segment Performance Net sales generated in the Retail segment increased 39.4% year over year to $495.6 million due to 121 new stores openings over the past year and comps growth of 16.4%. Operating profit increased 23.5% to $127.3 million. For the Wholesale segment, revenue increased 46.1% to $514.1 million while operating profit grew 59% to $156.7 million. Licensing segment revenues rose 42.8% to $46.9 million while operating profit grew 8.9% to $21.6 million. Regional Performance Revenues across North America grew 29.8% to $802.2 million while comps jumped 10.8%. In Europe, constantly increasing brand recognition and demand led to a whopping 108.6% rise in revenues, which came in at $237.9 million. Comps in the region stood out registering a 41.1% growth over the past year. Lastly, revenue grew 106.3% year over year to $16.5 million in Japan with a 52.9% rise in comps. Other Financial Data As of Sep 27, 2014, Michael Kors had cash and cash equivalents of $1,012.4 million and shareholders equity of nearly $2,245.1 million. At the end of second quarter, Michael Kors operated 649 stores across the globe, inclusive of licensed locations. Guidance Driven by stellar quarterly results, management raised the fiscal 2015 guidance. For the full year, revenues are likely to be in the range of $4.3 $4.4 billion as against earlier projection of $4.25 $4.35 billion. Comps are projected to increase in the mid-teens. Earnings are expected to be in the range of $4.13 $4.18 against the earlier projection of $4.00 $4.05 per share. Further, management expects third-quarter fiscal 2015 revenues to be in the $1.27 $1.3 million range, comps to increase in the low-double digits and earnings per share to be in the band of $1.31 $1.34. The tax rate is likely to be around 32.5%. Equity Research KORS Page 5
Share Repurchase Update On Oct 30, 2014, the company announced a $1 billion worth of share repurchase authorization over a two-year time frame. VALUATION Michael Kors current trailing 12-month earnings multiple is 19.8X, compared with 25.3X for industry average and 19.1X for the S&P 500. Over the last five years, Michael Kors shares have traded in a range of 18.8X to 67.6X trailing 12-month earnings. The stock is trading at a discount to the industry average based FY15 and FY16 earnings estimates. Our target price of $79.00, 18.9X 2015 EPS, reflects this view. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Michael Kors Holdings Limited (KORS) 18.0 15.6 22.2 20.5 19.8 67.6 18.8 Industry Average 23.1 20.4 15.7 16.0 25.3 134.3 14.1 S&P 500 17.7 16.6 10.7 16.0 19.1 19.6 12.0 Coach, Inc. (COH) 19.7 18.3 8.1 9.6 12.9 23.3 11.0 Grasim Industries Limited (GRSXY) 12.1 9.1 7.4 13.4 16.8 9.5 Under Armour, Inc. (UA) 71.8 56.7 24.4 67.5 80.4 88.2 27.3 Guess' Inc. (GES) 19.2 15.5 9.6 6.9 15.7 18.0 8.8 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Michael Kors Holdings Limited (KORS) 7.0 22.0 6.5 40.8 0.0 0.0 13.2 Industry Average 3.9 3.9 3.9 8.6 0.2 0.6-0.1 S&P 500 7.2 9.8 3.2 23.3 1.9 Equity Research KORS Page 6
Earnings Surprise and Estimate Revision History Equity Research KORS Page 7
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of KORS. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1139 companies covered: Outperform - 15.8%, Neutral - 78.0%, Underperform 5.9%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research KORS Page 8