Run a Business Like Michael Kors

After coming back from my Christmas Vacation, I was doing a screening on Bloomberg when a company with excellent to perfect numbers simply jumped out of the monitor and caught my attention: Michael Kors.

Two days later, after a bit further research, I was fully convinced that this here might be one of the best investment opportunities that I could ask for this year. I bought the stock at $35. I usually have a rule of never having one position that is more than 25% of the total portfolio value. I broke the rule for KORS. I re-organized my securities and initiated a long position on the company that weighs “dangerously” at 45% of my total portfolio! I rode it to its earnings, and on which day, it soared by 25%! I sold it a few days later at $50. That was a 42% gain on my largest position! I sold it not because it was not good anymore, but because I wanted to break down the risky position to initiate a few well-diversified ones, one of which was a company that I believed was even more undervalued. I will discuss that in a separate article.

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KORS went on to trade as high as $58 before it dipped. The next thing I noticed, KORS was at $40.20 just a few days ago. I could not be happier since I received a sum of money from call-writings as well as new investments coming in to the fund. Thus, I was trying to find out what happened to KORS, and if there was any lasting reason for the price dip. I could not find anything convincing that I think would intrinsically harm the way in which the business is operated. Since I already have read its reports and done research about it, I bought it back right then and there. After only less than a week, it returned more than 5% and as I am writing, it has gone up another 4% in the after hour trading on heavy volume.

I will continually hold KORS for so long as I think it is undervalued. For now, I think it is tremendously undervalued.

Michael Kors is a fashion brand. It does not entirely rely on third-party retailers. It has its own wholesale stores that spread out across the world. A fashion company of such nature will continue to do well as long as it can sell. Michael Kors certainly knows how to sell. Its sales revenue was a measly 508 million in 2010. After 5 years, in the most recent annual report, it reported a 4.37 billion revenue. The annualized growth rate is 53%! I do not expect any company to be able to continue a growth rate this high. My point is, though, Michael Kors knows how to make and expand its sales.

Many companies are not profitable in their early years, due to investment, project expansions, or simply a lack of experience. KORS is a different story. It was profitable when it went public in 2010. Over the next five years, its EPS grew at a pace of 83% per year, soaring from $0.22 to $4.28. I do not expect the growth of earnings to continue, either; but again, I think the difference between a company which turns a profit and those that don’t is underrated. I think there is intrinsic good in a company’s management that turns a profit and it will carry forward for a long time. I understand the excuses of not being profitable, but i will gladly stay away and take my money to those who can in fact make an income. Michael Kors is one that can make money.

The next logical question is: “What is KORS going to do with its earnings? Does it have a lot of capital expenditures that drag down its earning power?” Michael Kors has seen its free cash flow growing faster than its earnings and its revenue. From zero annual FCF to more than 730 million (2015) in just five years, the company is more than impressive in its operations. It will be able to invest in more projects, open more stores, and design more lines of fashion with its FCF. For this reason, the company has also experienced a tremendous growth in its working capital. The company has been doubling its working capital every year for the past 4 years.

More than anything, I appreciate a company that operates without debt. KORS is in perfect financial health. It has no debt, and has done impressively all by equity.

The question that causes concern is, “Isn’t the brand dying?” I have read numerous analysts raising this concern. The bearish sentiment is mostly from the perspective that the company not only will see a slowed growth, but also may experience “death by irrelevance.” After all, Nordstrom recently stopped carrying Michael Kors handbags, complaining that the sales are too low and the quality is not high enough.

There is definitely something to be said about a general slow down in the luxury brand fashion. The world economy has not done particularly well in the recent years and the younger millennials tend to place less importance on luxury brands. However, I can see the industry alive and well for at least another two decades. Michael Kors will continue to make sales across the world, especially in the Asian market. In the most recent year of 2015, the company sold more than 3.2 billion dollars in North America and 800 million in Europe. However, comparing to that, the company has a dwarfed sales number in Asia. It saw a retail revenue of 66 million in Japan and that is all. The entire market of China has not been tapped into and it also happens to be the country with the most number of people, most number of billionaires, and the country that right now has the highest demand for luxury brands. With the prospect of a move into China, the company’s future will be off the chart!

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Secondly, I recently had the honour of meeting the CEO of Michael Kors Canada, Debra Margles. Margles is a terrific woman who has tremendous passion and love in what she does. She also expressed a way of thinking that focuses on the change the society is embracing. A large portion of the company’s recruits are younger people. It does so with the purpose of understanding the new generation of consumers and making strategic changes to the way the business is run. In fact, one thing I recall said by Margles, was “I have accepted that the society is changing and I don’t know enough, so now I just surround myself with people who do understand.”I appreciate when a company acknowledges the sociological shifts and accepts its vulnerability. I believe such companies can go a long way in adjusting and adapting, and ultimately making their businesses better. She also discussed some aspects about the potential future products and their plan to come up with products that combine the old sense of “luxury” and a younger, more vibrant sense of “efficiency.” I am impressed and put to rest by how much the company understands the obstacles facing them in today’s market, and the willingness to make the changes needed. Many companies do not have the sense to understand the issues, and those do are often stuck in the stage of denial that prevents them from making adjustments.

In conclusion, I think the company is close to being a “perfect” company. It knows how to expand and make a profit. The profit in turn can be used freely on more expansions and designs to propel for further growth. There is considerable brand loyalty in this industry. There is significant room for growth with China untouched. Finally, the management accepts vulnerability and seeks out for change. That is the way a business should be run, and I am proud to be able to invest in Michael Kors!

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