One of the best pieces of advice I’ve ever gotten is the simple motto, “If it ain’t broke, don’t fix it.” It helps me resist meddling in things that may just get worse with my intervention. But sometimes, it is broke. And when it is broke, you better get in there and do everything you can to fix it. Fix it once, and fix it right.
In case you missed it, Michael Kors (KORS - Free Report) “is broke.” I don’t mean they are out of money or are going out of business, but they are broken. They have an identity crisis and are in need of direction. A true change in direction that cannot be fixed with corporate buzz words from MBAs like “innovation” or “optimization.” I’m talking a true change in focus and realignment of their goals.
I understand that’s heavy talk from a guy hiding behind a keyboard. How dare I?! Who do I think I am?! Look buddy, this isn’t my opinion. You know how I know KORS is broken? The market told me, that’s how. Here’s a chart of how the market feels about your company…
The time for being defensive and sensitive about what’s going on is over. Don’t be a flat-Earther on this one, it’s Judgment Day. The identity crisis at KORS is simple. KORS tells the world it wants to be a luxury brand then turns around and makes business decisions like a Kohl’s (KSS - Free Report) . Luxury brands are exclusive and rarely discounted. Somewhere along the line, someone at KORS thought it was a good idea to put a Michael Kors in every mall in America and have sales all the time. That’s fine if you admit what you are, not fine if you’re pretending to be a luxury brand.
Not Luxury Brand Behavior
Luxury brands don’t have “25% the whole store” signs in front for every holiday. They also don’t find their goods on the sale rack at TJ Maxx (TJX - Free Report) . Have you ever bought a Gucci belt at Marshalls? I don’t think so.
You can put the slogan “The Champagne of Beers” on Miller High Life but you’re not fooling anybody. It’s not Champagne, it’s cheap beer. What’s happened at KORS is they are either the nicest brand in a cheap mall or they are the cheapest brand in a nice mall. That’s not luxury and it’s not a smart niche.
Including licensed locations, there are 960 Michael Kors stores worldwide. Rather than putting KORS into the luxury space, they channeled their energy into stealing sales from department stores which were carrying their brand. A temporary shell game which ultimately caused immeasurable harm to the brand image. Trading wholesale sales for retail sales in malls KORS stores had no business being in the first place.
KORS opened 159 net new stores in Q12017 and only increased retail sales by 50 bps. Comp sales were off 13.6%. Wholesale net sales were off 22.8%. So essentially what’s been happening is KORS is increasing retail sales by stealing wholesale sales from department stores in dying malls. That was a myopic strategy with no hope of long-term sustainability.
The painful part of the story for KORS is that the aforementioned strategy of cutting in on wholesale sales with retail locations was a trap laid by Coach (COH - Free Report) during its turnaround. When Victor Luis took the reins in January 2014 at Coach his plan was to close stores in smaller markets, focusing on getting better spots in department stores and high-touch flagship stores in 12 major US markets where it got half its sales. KORS seized the opportunity to cut in on Coach’s market share in the markets Coach left. By doing so, KORS brand image was watered down and they inherited the problems Coach skillfully disposed of. Coach 1, KORS zero.
Three years ago COH tricked KORS into entering these losing markets. Now KORS announced they are closing 100-125 stores. They are likely to make the business decisions to close the worst performing stores. On paper that makes sense, cut off the bleeding from the stores doing bad. However, the problem here is their worst performing stores are the ones in the luxury locations. Again, cheapest stores in the nicest malls. If they make this move, they are chopping off the highest end of their brand, and pushing themselves further away from the luxury brand they say they want to be. By doing this, KORS would thrust the brand deeper into the retail death spiral rather than differentiating itself as a luxury brand. Again, in the short-term this may work to calm shareholder angst but it is detrimental to brand.
Meanwhile, at Coach…
Earnings troughed in late 2015, about a year after Luis implemented their turnaround strategy. Here we are about 18 months after earnings bottomed out. Since then, the stock has gone from $28 to $46. Current year EPS growth is on track for 8.55% while next year growth looks to be 11.7%. In case you were wondering, KORS is pacing a 16.39% contraction in earnings while next year the hopes are for 3% growth.
Admit What You Are
What should KORS do? First, choose an identity. Stop saying you are a luxury brand unless you are going to act like one. It’s fine to not be mentioned in the same breath as Louis Vuitton and Gucci, just stop pretending like you want to be. The only thing about KORS that says luxury right now is the corporate profile. Align your strategy with your profile or change your profile.
When you realize that KORS is essentially watering down their brand image in order to gain market share in a shrinking market their main competitor left three-and-a-half years ago for greener pastures, it doesn’t make you want to invest in the company. At a trailing P/E 7.55 this is the value trap of the decade right here. What’s the key to this turnaround story right now? “Detailing and customization of merchandise.” Didn’t Lids do that in the late 90s?
We’re going to find out more about KORS new turnaround initiative during its June 9th analyst day. Management is already viewing FY2018 as a transition period. They are going to formalize their game plan for production, distribution and marketing using the “Runway 2020” moniker. Let’s hope “Runway 2020” doesn’t really mean “Runaway Now!”
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