Michael Kors disappointed investors last week (February 7) with its sixth consecutive quarterly comp store sales decline along with a glum outlook, which calls for further productivity deterioration through fiscal 2018 (another five quarters). Weak store traffic trends, sales of lower priced items and a continued slump in the fashion watch market, exacerbated by a mid-teen comp decline in European stores, drove a 6.6 percent comp decline and 400 basis points of margin contraction (650 basis point margin contraction in its retail segment). Not surprisingly the Kors shares were off 10.6 percent at the close.
Well, duh! Mall traffic has declined for the past eight years, so why does Kors continue to open more stores? Isn’t this a strategy of diminishing returns? And given the recent reports from many luxury leather goods firms, the competition is faring quite nicely, though the terrain is full of potential landmines of the exogenous type. Coach’s turnaround is firming with three consecutive quarters of comp gains and compelling product at higher price points, and European luxury brands spoke to positive trends as 2016 ended. Innovation and rationalized distribution are key today, even in growth markets of China.
It appears that the luxury personal goods sector turned at the end of 2016, with Hermes (+7.6 percent Q4 sales gain), Kering (Gucci and Saint Laurent reported 20-plus percent sales gains and Bottega Veneta, still negative but improving) and LVMH (+9 percent in its fashion & leather goods segment) reporting sales lifts and accelerating comps in the final quarter. LVMH’s CEO Bernard Arnault quipped on the company’s Q4 call with investors, “The stores are full. We don’t know how we can meet demand.” You didn’t hear that on the Kors call.
Too Big Too Fast and With Too Much Derivative Product
Kors reliance on me-too merchandise, inspired by Valentino to Louis Vuitton to Gucci, is a popular product strategy but not a brand building strategy for luxury or accessible luxury. These labels that need to create and sustain an emotional connection and a brand promise of belonging to an exclusive community. The Kors product lacks a point of view. Today’s transparency reveals the inauthenticity of the Michael Kors brand, at a time when authenticity is king. That, with overly distributed product, results in promotional pricing pressure. Kors’ management has trivialized the Michael Kors brand.
Well they have a fix, five initiatives to improve comp performance, of which four are product focused and one, digital marketing, with nary a nod to slowing expansion. Moreover, they continue to open new stores, with 193 net new stores in the last 12 months (143 related to the Greater China and South Korea acquisitions) and 29 net new stores in the most recent quarter alone. More are planned. Ugh, this could get ugly.
Groundhog Day or Haven’t We Seen This Before?
More than a decade ago some of these same managers executed a similar strategy of over-distribution to optimize short-term gains with the Tommy Hilfiger brand in the U.S. More recently, Coach acknowledged its overexpansion and embarked on a brand transformation at its June 2014 analyst day, which has taken nearly two years to accomplish. A luxury brand strategy is inextricably entwined with its business strategy. The Kors plan is overly simplistic and doesn’t address over-expansion and the rapid pace of redundancy. And while we have seen this before, there is a change, this is 2017, a more complicated retail environment than even three years ago. 2017 will be pivotal in the rapid adoption of the ecommerce channel and omnichannel selling, making retail real estate a questionable asset. Achieving a turn won’t be easy in an environment where stores are fast becoming tombstones for previously vibrant meccas.
Luxury brands require a temple to worship. And Coach gets it. Just look at the new Fifth Avenue flagship, Coach House. The four floors of the world of Coach are replete with art installations, an in-house customization workshop, monogram station, a made-to-order desk, and for the whimsy in today’s luxury shopper, Rexy, a 12-foot Tyrannosaurus rex sculpture crafted entirely out of Coach leather goods, that greets one upon entering Coach House.
With the work of the past two and a half years, Coach is recovering brand allure and pricing power. While the brand is still heavily dependent on the factory outlet channel (about 60 percent of North American brand sales), the product strategy is focused on innovation that spans across all Coach points of distribution and has allowed the company to navigate the highly promotional environment of holiday 2016 at outlet locations. Today most Coach Factory outlet product is designed by Stuart Vevers. While we are confident in the innovation at Coach, Kors is in the very early innings and has much work to do.
Transparency, Redundancy and Just Too Much Stuff.
The second initiative articulated on the Kors’ investor call is to expand its new Jet Set signature accessories in brand stores for the fall season. While Jet Set positioning is an iconic element of the Michael Kors brand, this is not enough. They really need another Project Runway, something to get excited about, drive store traffic and make the merchandise covetable.
Are there any bright spots? While Kors handbags may be under pressure, its athletic footwear remains strong and its line of Access watches is capturing early success. In concert with Coach, Kors is reducing shipments to the U.S. department store channel, a plus in terms of price stabilization, reduced channel conflict and brand erosion. CEO John Idol spoke to rebalancing the business with a heightened retail focus, led by digital and Asian opportunities. They are walking away from the promotional business to restore brand value. This is a good thing but sales and margins will be penalized for another year or more. The stock is extremely cheap at 9.6X forward earnings estimates and it’s not likely to budge near term absent news of a game-changing acquisition.
Handbags are still identification and status badges. Innovation and strong design elements are winning at every price point. The market is healthy, and although a dominant leader is under siege, it didn’t have to be this way if they had managed their brand and business better.