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3 Leaders In The Luxury Segment

Tuesday - 5/7/2013, 5:35pm  ET

After the slowdown in the U.S. economy, luxury goods and apparels sales were largely hit as discretionary spending diminished. Now entering times of recovery, the leading trademarks in the segment seem poised to grow again and expand to new markets. On this occasion, we will look into Michael Kors Holdings , Urban Outfitters , and Coach  in order to understand the main reasons behind the expectations of recuperation.

A stock with margin growth

First in our list is luxury brand Coach, a pretty interesting case. Although the stock had been down for a few months, it has been showing considerable signs of recovery in the past days. After the announcement of stronger-than-expected third quarter results on April 22, the stock was up by almost 10% within a day and continued to escalate. However, the stock still offers a relatively low P/E ratio, since it trades at 15.27 times P/E, less than half the ratio offered by its main competitor, Michael Kors, which trades at 31.35 times P/E. This stock looks even cheaper compared to its peers, when its forward P/E of 13.8 times and PEG ratio of 1.4 are taken into account.

Several reasons lead me to believe that Coach is a good long-term investment. Coach is an established fashion (mainly handbag and accessories) brand, ranked by Forbes as the 51st most powerful brand in 2012. Its fame for high-quality products that compete with Louis Vuitton or Chanel attracts an oncoming public, willing to pay a premium for the company´s creations. Expansion of its worldwide distribution model, while penetrating under-exploited markets, combined with innovative products and persuasive prices, should drive comps and margins growth in the long-run. The recently-announced Q3 results arrived better than expected, portraying an optimistic outlook for Coach. Sales increased by 17% to $1.11 billion and EPS by 24%, year-over-year, reaching $0.84 per share. In addition, the board passed a 13% increase in dividends, now paying $1.35 per share annually. The company now yields 2.3% in earnings, almost doubling the 1.2% industry average.

Focus on overseas markets, like China, relieves considerable pressure exerted by the situation in the U.S. Comps grew nearly 60% in China during Q3, while expected sales for the full year amounts to $300 million, at least. Substantial double-digit upsurges were also registered in Taiwan, Singapore, and Japan. Current gross margin of 73.8% widely surpasses other companies’ like Ralph Lauren and Michael Kors, both offering margins under 60%. Operating margin is also considerably high, reported at 30.4% last quarter, close to the 10-year high of 38%, and way above most of its competitors that average an 8.3% margin.

As other analysts, I believe that the upside on Coach beats the risk it carries. Trading at bargain prices, this is definitely a stock to consider adding to your portfolio.

A leading brand

Coach´s number one competitor, Michael Kors, also deserves a look. Last quarter's results were also considerably strong, driving the stock to a 52-week high of $64.84 after the earnings were announced in February. The price is now down by about 12%, trading at $56.26 (Apr. 29). Exchanging at 31.58 times its earnings, doubling the industry 16.6 times P/E average, Kors seems a little overvalued. However, there are several reasons why I like this business and would recommend buying now, despite its valuation.

For starters, Kors is an established, actually leading, brand worldwide, currently stronger than ever. People know the name and are willing to pay a premium for its goods. This advantage is certainly reflected in its financials, as gross margin reached 60.2% during the last reported quarter. This leads us to a second reason to believe that this company will grow further: its balance sheet. Last quarter, maintaining a five-year growth trend, the firm reported a 41.1% increase in comparable-store sales (YoY) and an expected 20%-25% extra growth in the fourth quarter, to be announced early June. Revenue grew 70% (YoY) to $637 million, principally in account of Kors’ luxury business. Earnings reached $0.64 per share, rising 220% from last year’s same quarter and surpassing consensus estimates of $0.41 by 56%. Full year expected results also look quite encouraging, as the firm’s management expects EPS of $1.80-$1.82, up about 130% from last fiscal year’s. Revenue is also projected to rise by 61%, up to $2.1 billion.

Kors' financials are strong. This is most likely a reflection, asides from the brand name, of effective management. CEO, John Idol, has an impressive track record in the segment, having previously worked for Ralph Lauren and Donna Karan. His five-year expansion plan for the company includes the opening of 100 stores in China, the fastest growing luxury market, which is expected to provide 20% of this segment's customer base by 2015. Already in motion, the enlargement plan signified a 28% increase in the number of shops over the past 52-weeks (now attaining a total of 297 stores).

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