A Rebound for Michael Kors
Investors in Michael Kors Holdings Limited (NYSE: KORS) are familiar with the concepts of winning and losing. After the stock began trading in 2011, it became a favorite of momentum investors and gained more than 300% in a little more than two years.
But, then earnings growth disappointed and the stock began a steep downtrend that pushed the price down as much as 68%. The price remains more than 45% below its all time highs even after a 66% rally over the past six months.
A rally that followed the company’s latest earnings announcement could signal that the recent gains mark a turnaround in the long term trend of the stock’s price.
A Solid Quarterly Report
Michael Kors (NYSE: KORS) shares jumped early Monday after the affordable luxury brand reported strong quarterly results and raised its full-year outlook, even though holiday-quarter guidance was weak.
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Kors’ fiscal second-quarter earnings per share (EPS) were up 40% compared to the same three months a year ago. EPS of $1.33 easily beat analysts’ expectations of $0.83. Revenue for the quarter came in at $1.15 billion, up 5.4% compared to a year ago. Analysts expected revenue of $1.05 billion.
The growth came from outside the United States. Revenue from the Americas unit rose 0.9% to $751.9 million, European unit revenue climbed 9.2% to $270.7 million, and Asian revenue soared 30.4% to $124 million. But overall same-store sales fell 1.8%.
The results demonstrate that the company has successfully completed its acquisition of luxury shoe maker Jimmy Choo and integrated operations to boost profits.
“Our second quarter results were better than expected, and we are pleased with our continued progress executing on our strategic plan, Runway 2020,” Chief Executive John Idol said in prepared remarks.
“The positive signs that we are seeing in our business illustrate that our efforts across product innovation, brand engagement and our customer experience are beginning to take hold,” Idol added.
At least one analyst agreed with the CEO’s assessment.
“Michael Kors has been on a long journey of reinvention, but these latest numbers suggest the brand is starting to reach its destination of reestablishing itself as a well-regarded premium player,” GlobalData Retail Managing Director Neil Saunders wrote in a note to clients.
“Strategically, the decision to buy Jimmy Choo along with the latest collections, suggests that Michael Kors is looking to move into a more exclusive and distinct part of the luxury market,” Saunders added.
However, even after the string quarter, Michael Kors management remains cautious about the upcoming holiday quarter.
Management told analysts to expect EPS of $1.22-$1.27 for the quarter on revenue of $1.355 billion-$1.385 billion. Both numbers are below expectations. Analysts are expecting EPS of $1.50 and revenue of $1.42 billion.
However, management does believe the full year numbers will be better than analysts expected. The company raised its EPS guidance for the full year to $3.85 to $3.95. up from an earlier outlook of $3.62-$3.72. Analysts had been expecting EPS of $3.74 for the fiscal year that ends at the beginning of April.
Management expects revenue for the fiscal year to be near $4.59 billion, helped by Jimmy Choo, up from a prior outlook of $4.28 billion. Analysts, on average, had been looking for revenue of $4.563 billion.
A Trading Strategy for the Stock
After the strong rally, KORS could be expected to retrace at least part of its gains. But the chart shows that after a gap driven by an earnings announcement, any pullback is likely to be minor.
Last quarter the stock rallied strongly after announcing earnings and after a relatively shallow pullback, continued moving higher into the current quarterly announcement.
The previous quarter, bad news in the announcement prompted a sell off in the stock and in the next three months, prices continued moving lower.
Based on past performance, it seems reasonable to expect the stock price to move in the direction of the gap, upward in this case, until the next major announcement from the company. That indicates traders should consider strategies that provide bullish exposure to the stock.
Benefit from potential gains in KORS
To benefit from potential gains in KORS that are expected over the next few weeks to months, an investor could buy shares of the company. This requires a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
A Specific Trade for KORS
For KORS, the December 15 options allow a trader to gain exposure to the stock through the earnings report and the next week.
A December 15 $55 call option can be bought for about $2.00 and the December 15 $57.50 call could be sold for about $1.00. This trade would cost $100 to open since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $100.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in KORS the maximum gain is $1.50 ($57.50 – $55 = $2.50; $2.50 – $1.00 = $1.50). This represents $150 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $150 to open this trade.
That is a potential gain of equal to 67% of the amount risked in the trade. The trade could be closed early, immediately after the earnings announcement, if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your goals, click here for details on Options Insider.