One of the cheapest stocks in our Large Cap 1000 – Deep Value Stock Screener is, Michael Kors Holdings Ltd (NYSE:KORS).

Michael Kors (Kors) designs, markets, and distributes retail branded men’s and women’s apparel and accessories. The company operates in segments including retail, wholesale and licensing segments.

The retail operations segment consists of collection stores and lifestyle stores, including concessions and outlet stores, located in the United States, Canada, Europe and Japan, as well as e-commerce. The wholesale segment includes department and specialty stores located throughout the United States, Canada and Europe. The licenses segment includes trademarks on products such as fragrances, beauty, eyewear, leather goods, jewelry, watches, coats, men’s suits, swimwear, furs and ties, as well as through geographic licenses.

A quick look at the company’s share price history (below) over the past twelve months shows that the stock has been reasonably flat, up 7%, and trading at $42.98, 27% below its 52 week high of $59.49 back in March of this year.

(Source: Google Finance)

While investors haven’t been overly kind to the company over the past twelve months I believe there’s a lot of upside to come for Kors. What we’re witnessing with Kors is not a company specific issue but more of an industry related issue. This is highlighted by the performance of Kors competitors, Kate Spade & Co (NYSE:KATE), Coach Inc (NYSE:COH), and BURBERRY GROUP UNSP ADR EACH REP 2 ORD (OTCMKTS:BURBY). Here’s how all three have performed over the past twelve months:

(Source: Google Finance)

Reducing Promotional Activity

While Kors revenues have declined less that 4% from Q2 2016 to Q2 2017, one reason is that its American business has had a strong amount of promotional activities generated from competitors and from other channels of distribution.

To address this, Kors has announced that starting on February 1 it will focus on reducing the amount of promotional activity surrounding its brand. It’s a strategy that’s been working well for its best-selling handbag group (Mercer) this Fall season. The product is being sold as a non-promotional item and it’s working. It’s working well in every channel of distribution which would suggest that customers are willing to pay more when they understand that these products can’t be put on promotion on a regular basis.

Further reductions in promotional activity will include five product groups in its Spring season that will be sold on a non-promotional basis and excluded from any of its authorized sale periods in Kors. The focus will remain on delivering luxury products with fashion sensibility at the right price-point, such as its medium-sized handbags being sold at $295.

What has also been working well for Kors is its active footwear category and its smartwatch business, both of which appear to be gaining traction. Sales of its smartwatch business aren’t big enough yet to offset the declines its having in its fashion-watch business but that has more do do with the company’s current inability to fill the high demand.

Also notable is the strong performance of Kors men’s business, which delivered a solid performance in the second quarter, ended the quarter with 244 sportswear and leather goods shop-in-shops within its wholesale doors globally. This provides the company’s North American and European wholesalers with a major new designer menswear line to offer to its customers.

Growth Opportunities

The two areas where I see significant amounts of growth for Kors is its Asian business and its digital flagship platform.

In the Asian region, Kors has recorded sales increases of 96%. This was driven by the addition of its China business, as well as mid-single-digit comparable store sales increases in Japan. China represents significant potential for strong sales growth as the company’s store network expands and its brand awareness increases. The company stated in its Q2 2017 earnings results that it believes Asia will ultimately reach $1 billion in revenue.

In terms of its digital flagships, Kors North American digital flagships continued to perform well during the quarter with strong double-digit comp growth. I expect the momentum in its digital flagships to continue as the company further invests in this growing channel.

In Europe, while traffic continues to decline in certain major markets Kors is investing heavily in its international digital flagship strategy to ensure it’s positioned to capture future growth opportunities in the region. The company has launched its digital flagship businesses in the U.K., Germany, France, Switzerland, Spain and Italy. While it’s still too early to measure the impact of the strategy the company now has the platforms in place on which it can build. Kors is planning to have e-commerce capabilities in 16 additional European countries in Spring of 2017.

One area that hasn’t been performing well for Kor’s is the company’s wholesale segment with overall revenues declining 18%. The biggest decline was in Asia, down 43% and the Americas, down 22%, but the bright light was Europe, up 3%.

What seems to be overlooked is that the company has been strategically reducing its sell-in to department stores in order to protect its brand and margins. I expect we’ll continue to see further reductions in inventory flow and promotional activity in the wholesale segment. In Asia, the decline may be attributed to the shift of Kors China and South Korean businesses to its company-owned retail segment. In Europe, the 3% increase, which is lower than historical trends is likely being negatively impacted by a mix shift towards crossbodies and small leather goods, which carry a lower AUR.

Let’s Run The Numbers

A quick look at the company’s quarterly income statement (below) shows that while there was a 4% decline in revenue from $1.13 billion in Q2 2016 to $1.09 billion in Q2 2017, the company’s gross margins remain very strong at around 60%.

Operating margins have come down slightly but its important to remember that there’s been a lot of heavy lifting on both SG&A and capital expenditure this year with its projects, the company’s distribution facilities, corporate offices, and digital flagships. It’s expected that these expenses will level off now that Kors has its infrastructure in place. Kors also has a healthy net margin of 15%, with improvements to come now that the e-commerce platform is in place.

(Amounts in millions)
Quarterly Income StatementSep16Jun16Mar16Dec15Sep15
Revenue1,0889881,1991,3971,130
Cost of Goods Sold444397501566466
Gross Profit645591697832665
Gross Margin %59.2459.8558.1659.5358.81
Selling, General, & Admin. Expense380354392378345
Operating Income204187244409273
Operating Margin %18.7218.9220.3629.2924.17
Net Income161147177295193
Net Margin %14.7914.8914.7721.0817.09

(Source: Company Reports, sec.gov)

A quick look at Kors quarterly balance sheet (below) shows that the company has a strong balance sheet with $186 million in cash and cash equivalents at the end of Q2 2017 and $384 million in long term debt. Increased debt is not an issue when you consider the company’s free cash flow below. What’s not shown here is the 2.5% reduction in inventories due to decreases in inventory flow to department stores as mentioned above.

With its current market cap of $7.059 billion and debt in excess of cash of $198 million that means Kors has an Enterprise value of $7.260 billion.

(Amounts in millions)
Quarterly Balance SheetSep16Jun16Mar16Dec15Sep15
Cash, Cash Equivalents, Marketable Securities186337702697432
Long-Term Debt384248

(Source: Company Reports, sec.gov)

A quick look at the company quarterly cash flow statements (below) shows the company had $1.18 billion in operating cash flow (ttm) and capex of $275 million (ttm) which means Kors generated $907 million in free cash flow (ttm). With an enterprise value of $7.260 billion that means the company has

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