MorningWord 9/29/14: $KORS – Fashion Weak

by Dan September 29, 2014 9:50 am • Commentary

I know a lot of people that get emotionally attached to consumer stocks they own. They love the product, they buy the stock and for a while they are a happy customer and investor. Many of you may recognize this sort of strategy from legendary stock investor Peter Lynch, who ran Fidelity’s Magellan fund for decades.  It’s also a Warren Buffet theme.  I suspect where they differ is that Lynch was more in the Growth at a Reasonable Price (GARP) camp, while Buffet is a bit more focused on the reasonable price part of the equation.  As someone who writes hundreds of words a day, and goes on financial TV a few days a week offering my own opinions on public companies, their products, managements etc, I am often surprised at some of the responses I get from investors when I am less than complimentary of someone’s “baby”. Come on people, they are just stocks. Love the products, be irrational about them for all I care, but be prepared for a nasty breakup on the investment front. Just as consumer fashions and trends are cyclical, so are investment cycles.

I firmly believe that owning a basket of the best consumer brands in a somewhat equally weighted fashion is likely the way to go (AAPL, NKE, UA, M, WFM, SBUX etc), but knowing when to pull the plug on one, when the jig is up, could save you from sitting through a long hard fought restructuring and resurrection.

One such consumer name that could do no wrong from its late 2011 IPO to the recent all time highs in February, was Michael Kors (KORS) gaining 400% in that time period.

KORS since Dec 2011 IPO from Bloomberg
KORS since Dec 2011 IPO from Bloomberg

It seemed that investors and consumers alike thought that the market share gains of competitors like Coach (COH) were deeply rooted with fashion trends where KORS was leading the charge.  The company’s 68% and 52% year over year sales growth in 2013 and 2014 was rewarded with a very healthy valuation with a P/E of about 30 for most of 2013.  Growth at a reasonable price?

KORS PE since 2011 IPO from Bloomberg
KORS PE since 2011 IPO from Bloomberg

Earnings growth is decelerating a bit, despite sales that are expected to grow 20% a year this year and next.  Margins have been pressured by competition, and the earnings multiple has thus compressed, with the stock now trading at 15x next fiscal year’s earnings expected to grow 18%.  Stock seems pretty cheap.  But here is the thing, the fever for KORS products, and stock appears to be broken, and the chart most definitively is.

KORS 2yr chart from Bloomberg
KORS 2yr chart from Bloomberg

In hindsight it would have been easy to suggest that selling the stock on the first earnings report showing margin pressure would have been the way to play, but many invest-umers were in love with the story and likely thought it was a 1 qtr blip.  At this point, I think it makes sense to use stocks like LULU and WFM as a guide to once loved consumer darlings that overshot on the upside, but also did so on the downside.

I would make one last point – for those who would consider stock replacement, or hedges, options prices are as cheap as they have ever been:

KORS 30 day at the money IV  since IPO from Bloomberg
KORS 30 day at the money IV since IPO from Bloomberg

Volatility has started to pick up across the market in the past 2 weeks, leading to higher implied volatility levels across the market.  In a controversial stock like KORS, which has also exhibited significant volatility in the past 6 months. If this trend continues trough the Fall, long premium structures are likely a better alternative to simply long or short stock positions, whatever your directional view.