Wednesday, 8 February 2017

KORS 3Q result no kors for concern

The LT3000 Blog got off to a seemingly inauspicious start by posting a long thesis on KORS a day before the company’s 3Q result came in short expectations, sending the stock down as much as 15% intra-day (10% by the close). I increased my position by 50% at close to the daily lows of $35, reducing my average in to US$39, and increasing the position size to 25bp of the fund. The stock is trading up today early in the session at US$38, against a weak broader market, so my position is only marginally underwater at present.

The 3Q result itself was actually broadly in line with expectations. While headline sales and operating margins were down YoY, this was already baked into guidance/estimates. Comp sales declined slightly faster than expected (6-7%, vs. 5-6% expectations), but quarterly earnings actually beat street estimates by a penny. The real issue was weaker 4Q outlook commentary, where the company guided for an accelerated low-teen decline in comp sales in 4Q, and reduced its 2017 fiscal EPS guidance from about US$4.40 to about US$4.20.

I couldn’t care less. The result does not change my long thesis in the slightest, because it is not based on an extrapolation of short term earnings trends or any prediction about whether and when earnings turn. It’s based on the fact that the stock is cheap. Stocks are seldom cheap when the outlook is good. Stocks always bottom when the outlook is poor and uncertain. Most investors are not willing to buy stocks in the face of considerable uncertainty. I am - particularly in my basketed value strategies, where results are not dependent on any one individual stock, only statistical averages.

I learnt a long time ago that in order to lose a lot of money on a highly-rated stock, the company need only have one bad year, whereas to make a lot of money in a lowly-rated company, they need only have one good year. My sense is that expectations for KORS are now so low that merely one or two quarters of marginally positive comp sales will be enough to send the stock up 30-50%. I like those odds. At present, it feels obvious sales will keep comping down for an extended period - even to me - but the future has a habit of surprising us.

Important is the fact there is comparatively little evidence that KORS’s sales and earnings pressure are primarily due to company specific problems. The entire luxury sector is going through tough times. Indeed, according to Morgan Stanley, KORS net promoter score remains the highest in its brand peer group, and KORS’s fiscal 2017 revenue guidance is also within a whisker of all time highs, despite headwinds from a strong USD. Maybe the fairer sex will decide they don’t want to own fashionable handbags in future years, but I seriously doubt it. If KORS were suffering sales declines while its peers were performing strongly, that would be a much greater cause for concern. There is a strong case to be made that KORS' problems are primarily cyclical, not structural, and yet the stock is being priced as if the issues are definitely structural.

Also being ignored is the company’s continuing strong FCF generation. By 3Q17’s end, KORS has moved into US$150m net cash position, despite having spent almost US$1bn on stock buybacks in the past 12 months (1/6th of KORS’s current market cap). With an EV of US$5.8bn, the stock is currently trading at 6.3x 2017 guided EBIT. That is cheap, even if earnings fall another 20% and never recover.

Happy to stay long at these levels & to have had the opportunity to add more at $35.