KORS delivered the print and outlook needed for a rebound after underperforming retail by over 20% in the past 3-months. Importantly, not only is strength coming from both retail and wholesale channels, but European sales came in among the strongest in retail with comps up +14% and sequential trends across channels accelerating quarter-to-date. Despite a more constructive outlook for FY13, KORS is still expensive. The reality is that great brands with robust earnings momentum and conservative expectations will always look expensive. We'd still rather buy FNP than KORS. If cap is a concern, then RL.
What We Liked:
- Nearly every metric came in better than expected with the sole exception of tax rate disrupting an otherwise solid earnings algorithm of +58% top-line translating into +80% EBIT and +65% EPS growth (would have been +80% at expected 40% rate).
- Owned retail stores continue to drive top-line growth with store productivity approaching $1,400/sq. ft. among the best in retail and comps coming in above the originally guided range as well as Q1 outlook of ~35% coming in 2x Street expectations and above our above consensus +32%E. In addition, store growth of ~70 in FY13 is modestly higher than the 68 we had modeled and the Street at 64. With the retail channel accounting for 2/3 of FY13 growth in our model (see table below), this is perhaps the most notable takeaway in the quarter.
- Margins were up sharply following a warehouse transition and 1x costs associated with the IPO last quarter driven primarily by significantly better gross margins in addition to SG&A leverage. While much of the improvement in gross margins can be attributed to greater retail and int’l mix accounting for over 100bps of the +180bps expansion, wholesale improved as well providing an added boost. With a 5pt sales mix shift to retail in F13, we expect channel mix to provide at least a 100bps tailwind. As such, we think the company’s outlook for margin contraction in FY13 is conservative.
- KORS’ initial FY13 outlook suggests significantly stronger sales and earnings growth than expectations with
full-year comp growth of at least 20%, revenues +30%-40%, and EPS growth of 40%+ compared to comps in the mid-teens and earnings expectations in the low 30s settling one of the biggest concerns headed into the quarter.
What We Didn’t Like:
- Perhaps the biggest negative in the quarter is the sales/inventory spread, which eroded 18pts to -2% with inventories up 60% outpacing sales growth of 58%. We’re willing to give them a pass as swings here can be expected to support aggressive store growth, but this is undeniably gross margin bearish near-term.
- Expenses were leveraged in the quarter; however, we expect slight deleverage in FY13 as the company adds headcount to support global growth and related infrastructure. Adjusting for IPO related 1x expenses in FY12, we’re modeling ~60bps of operating margin expansion driven by +70bps gross margin expansion offset by modest SG&A deleverage.
- In addition, CapEx is headed higher. CapEx has been running at 6.5%-7.5% of sales over the last three years and is expected to increase to 9%-10% in F13 to support store growth and various infrastructure investments. While this will subdue FCF generation over the intermediate-term, the reality is that the company is investing when it should to grow what is a nascent brand overseas and drive top-line growth even if at the expense of further upside to earnings growth. UA is a great example of a company that executed a similar strategy over the past year proving that top-line preservation is more critical than margin expansion in a brands’ early growth stage.
All in, KORS is expensive and likely to remain so over at least the intermediate-term. We’re shaking out at 40% revenue growth in F13 and 26% in F14 and $1.20 and $1.57 in EPS respectively.
Accountability and Outlook: Here’s a look at KORS’s variance between guidance and actual, as well as
initial outlook for F13 vs expectations:
Highlights from the Call:
- Marketing spen - are spending 'a lot of money in the social media space' - has been solid sales driver thus far
- Looking to hire a COO and add'l headcount to grow global business - expect expenses to reflect these efforts by 2H F13
- Will have more detail re e-commerce plans over next 6-months - re bringing in-house
- Most expenses related to warehouse transition already incurred, now a matter of increasing utilization
Europe & Comp Growth:
- The brand is resonated at retail at both free standing stores and at department store business
- Seeing sequential acceleration vs. last quarter
- Dealing with individual landlords, slower going re opportunistic growth - expect greater ability to flex growth at wholesale
- At wholesale, apparel will be larger than accessories due to stores that are focused there vs accessories
- Accessories will be the lead in KORS owned stores
- Will be stronger positioned this time next year as one of the leading players in UK, France, Germany, Italy and Spain, etc as a leading accessible lux player
- Europe strength a reflection of getting product to the region
- Expect NA to have higher comps over LT due to greater brand awareness
- Expect NA and Europe to comp ~20% in F13, Japan slightly lower
Demographic - Customer:
- Hasn't changed since IPO - still ~35 years-old women
- After Europeans, South Americans are the strongest global consumer - KORS doesn't currently have any stores there
- Monogram has already reached 25% as percent of sales - sooner than expected, very conscious to not let it grow too large
- Accessories at 75% achieved that threshold sooner than expected as well - likely to grow to 80%-85% of revs over time
- Small leather goods continues to be the strongest performing category
Margins - Store Performance:
- Very little differentiation in comp store performance b/w stores that are 1,3,5 yrs old
- Full price stores are highly productive, not seeing tremendous differentiation between full-price and outlets in terms of productivity
- Wholesale gross margins also improved in the quarter
- Marketing by region - spending at much higher levels in Europe and Japan relative to more mature brands
- View is they have to 'act bigger than they are' when marketing to a market