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The Best Stock For The Luxury Boom


Among people with money to spend, there's been a significant shift away from ultra-high-end purchases since the financial crisis, say analysts at global banking giant Barclays.

It isn't that top-tier consumers have stopped spending, but nowadays even they're more likely to scale it back a notch, devoting more dollars to what could be called the "affordable" luxury space.

Simply put, wealthier shoppers are still looking for high-quality, fashionable items. But maybe they're no longer quite so dead-set on the priciest versions like a $2,000 Gucci tote bag, a $1,500 Lanvin T-shirt, or a $4,000 Chanel purse.

While this may not be welcome news for high-end retailers, it bodes well for those specializing in affordable luxury -- currently a $285 billion industry worldwide. With its increasing popularity, affordable luxury is projected to grow 8% to 10% a year domestically and 3% to 5% a year worldwide during the next few years.

The big question for investors is how best to capture this growth. It might be tempting simply to default to Ralph Lauren (NYSE: RL) since it's probably the best-known industry player, what with its iconic brands of apparel, accessories, and fragrances. But that would be a mistake.

No doubt RL's stock has been awesome, nearly quadrupling during the past five years. However, the massive run-up means a lot of its future growth potential is already priced in, especially since analysts see earnings per share (EPS) decelerating significantly. So I don't see shares gaining much more than another 30% to 40% during the next five years.

Instead, investors should consider one of RL's main rivals, a global apparel, accessories and footwear retailer/wholesaler with much better growth prospects -- Michael Kors (NYSE: KORS).

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Michael Kors has been blowing away the competition recently in terms of growth and profits -- and it could be the top stock in the affordable luxury space right now.

While several catalysts have fueled this exceptional performance, perhaps the most important is highly intangible -- the vision and sense of style of the company's namesake and chief creative officer, Michael Kors. Since these intangibles are at the heart of what makes KORS a success -- just as Steve Jobs' spirit of innovation was so crucial to Apple (Nasdaq: AAPL) -- shareholders will want to keep tabs on Kors himself. At this point, he's relatively young (age 54) and has no serious health issues or personal scandals I'm aware of that could adversely affect the stock price.

  Michael Kors plans to double the number of domestic retail outlets and rely more on licensing to drive revenue.  

As I've already hinted, another key growth driver at the company is product pricing that targets a wider market within the luxury space. For example, Michael Kors wristwatches for women are in the $150 to $350 range, whereas similar offerings by Gucci start at $400 to $500 and can then go much higher. While a Prada double-zip handbag might retail for around $1,500, the Michael Kors equivalent is more around $400.

Notably, KORS has already begun a major push to expand its men's fashion and accessories business, and management expects sales in that area to rise 20% in 2014.

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Even with better pricing and the talent of its namesake, the company wouldn't get far without being as well-run and or strategically well-positioned as it is. Indeed, it has thriving retail and wholesale segments, each accounting for nearly half of total revenue ($3 billion during the past 12 months). A relatively small licensing segment kicks in around 4% of revenue.

Right now, operations are focused mainly in North America. Of the company's 304 retail outlets, 231 are in North America, with the rest in Europe and Japan. Wholesales occur through 2,215 department and specialty stores in North America, compared with 1,034 such outlets internationally.

The company has ambitious plans to augment its vast distribution network, such as nearly doubling the number of domestic retail outlets to 400 -- a goal it could reach within a few years based on a fast rate of overall global growth. During the first three quarters of fiscal 2014, for example, the company added 133 locations worldwide.

Of the new locations, 42 are licensed stores (owned by third parties, not the company), confirming earlier statements by management that it would begin to rely more on licensing for revenue. Increasing the proportion of such revenue is wise, in my opinion, because it helps contain costs by placing the expense of operating a store mainly on the licensee.

Importantly, expansion plans include building up in faster-growing emerging markets. For instance, the company recently opened two stores in Brazil and plans to have 40 locations in Latin America within a few years. The opening of the company's 6,000-square-foot flagship location in Shanghai earlier this month was well-received as expected, since the market for the types of products Michael Kors sells has become a $19 billion industry in China. Management estimates it could build a couple hundred stores in the region over time.

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Risks to Consider: The continued success of KORS depends heavily on Michael Kors. If something happened to him, the company could lose its innovative edge.

Action to Take --> KORS has emerged as a premier growth stock in the affordable luxury space, with the potential to outperform RL, the rest of the industry and the broader market in coming years. With EPS projected to rise more than 25% a year for the next five years, shares have 125% upside by 2019, assuming a price-to-earnings (P/E) multiple in line with the current industry average of 23.

With a trailing (P/E) multiple of 32, KORS may seem too pricey right now -- but I don't think it is. With earnings likely to climb at a well above average rate, the stock's current premium is justified.

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