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3 Reasons for Michael Kors Holdings Investors to Be Cautiously Optimistic

Matthew Cochrane, The Motley Fool

Perhaps no iconic fashion company has endured the fickle nature of the industry more than Michael Kors Holdings Ltd (NYSE: KORS). After a huge drop in recent years, the luxury retailer bounced back after reporting its latest quarterly earnings results. That made the stock one of the top performers in the S&P 500 during the third quarter!

My own investing history with the company is well-documented. While my decision to sell wasn't based on the stock's movements, I sold my shares near Kors' lowest levels of the year this past summer. Ouch!

Model walking on a fashion runway.

Michael Kors investors have reason to be optimistic. Image source: Getty Images.

Caution: Challenges ahead!

Retailers have faced enormous competitive pressures and rapidly changing consumer spending habits. Yet Michael Kors' management defied logic by rapidly expanding its store count by more than 20% between early 2016 and this past spring before abruptly reversing course and announcing it would close 100 to 125 stores. This whipsaw came at great cost to the company, first in incurring costs to establish new locations and then having to pay about $100 million to $125 million in closing costs before realizing about $60 million in annual savings going forward.

A Michael Kors storefront in Hong Kong.

Michael Kors sales in Asia are showing strong growth. Image source: Michael Kors Holdings Ltd.

Kors also appeared inconsistent in its strategy. The retailer said it needed to sell its products without relying on promotions in order to preserve the brand's high-end image, but it chose to close full-priced retail stores rather than discount stores in outlet malls.

Yet despite all the things I think management has gotten wrong, I won't dismiss all of the company's efforts as misguided. In fact, after going through Michael Kors' latest quarterly conference call transcript (provided by S&P Global Market Intelligence), there are at least three reasons investors have to be cautiously optimistic about the company's future. 

1. Strong sales from millennial consumers in Asia

CEO John Idol categorized business in Asia as "very, very strong" during the conference call, and when looking at the numbers, it's easy to see why. Net sales in Asia increased by a third to $124 million, driven both by new store openings and same-store sales growth. The company's store count in Asia this quarter was 244, up from 207 in last year's second quarter. Asian same-store sales grew in the high single digits on a constant currency basis. Best of all, Idol maintained that the demographic showing the "strong reception" to aspirational luxury in the region was the "younger millennials and slightly older" category.

2. A big boost from Jimmy Choo

When Kors gave its revenue guidance for the fiscal third quarter, it said that it expects about $105 million to $110 million from the company's acquisition of Jimmy Choo this summer. When asked about the opportunities the company saw for Michael Kors ahead, Idol outlined three areas he thought that could be exploited for Jimmy Choo to get to $1 billion in sales (more than double its sales today):

Number one, there is an opportunity to open additional stores, and those will be predominantly in Europe and in Asia. Along with that, the e-commerce platform in the business is growing very rapidly, and we see a great opportunity to further enhance that with the team ... The second opportunity is to take advantage of the accessories momentum that they already have and really build that out to a much greater degree. Jimmy Choo has a very, very engaged customer who finds a place in her wardrobe for that product and for the vision of the brand, so you can look to us really over the next 24 months to make a major commitment to the accessories business with Jimmy Choo as we expand that category with them. And third, the men's business is also growing very rapidly inside the Jimmy Choo company, and we see that as a great opportunity to accelerate.

3. Fashion for the selfie generation

One of the things Michael Kors has long understood is the importance of social media marketing when it comes to reaching the next generation of shoppers. As Idol stated in the conference call's opening statement, "Social media is a cornerstone of our communications efforts and remains a principal focus in deepening our connection with consumers." Michael Kors now has 38 million followers across its social channels.

Michael Kors uses social media smartly in other ways, too. For instance, the company chose Chinese actress Yang Mi as its brand ambassador. Mi has 70 million followers on the Chinese social media site Weibo. It's little wonder that the company is doing so well with millennial consumers in China!

Overcoming headwinds

Investor interest in fashion companies is about as fickle as consumer fashion tastes. This can make investing in these companies an extremely frustrating experience for shareholders with a long-term mindset, as they try to ride out the inevitable highs and lows as these companies drift in and out of favor. An apparel or accessory brand riding the coattails of fashion trends can rise even as management makes a host of mistakes; likewise, even the best leadership teams will struggle as tastes turn against their products.

Michael Kors has added to its troubles by making costly mistakes in an environment where even the best brick-and-mortar merchants are struggling. Yet if the company can continue to gain real traction with young consumers in Asia, grow its Jimmy Choo business, and exploit digital marketing, then a real turnaround might take place. While these reasons are not enough for me to jump back into my former position, I understand why Kors investors might be more optimistic now than they have been in quite a while.

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Matthew Cochrane has no position in any of the stocks mentioned. The Motley Fool owns shares of Michael Kors Holdings. The Motley Fool has a disclosure policy.