The lowdown on luxury-goods stocks

These companies' fundamentals don't sparkle as much as their products do.

Catherine Multon 24 March, 2014 | 6:00PM
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Luxury brands may be the stuff of dreams for status-seeking and style-conscious consumers, but for the companies that provide them, the investment fundamentals may not be so alluring. Globally, the luxury-goods industry is a modestly growing market. In a report released Oct. 17, the consulting firm Bain & Co. forecasts compound annual growth of 5% to 6% between 2013 and 2015, which if accurate would increase the market to US$290 billion in sales by 2015.

Most of the world's leading luxury-goods companies -- providers of high-end brands such as Chanel, Louis Vuitton and Versace -- are based in Europe. Here in North America, the leading players include Tiffany & Co. TIF and Movado Group, Inc. MOV, both of which lack positive catalysts in their fundamental attributes that would be necessary to attract investors.

The industry group also includes the likes of Michael Kors Holdings Ltd. KORS and Coach, Inc. COH. Of the two, Michael Kors caters to a broader customer base and has the stronger fundamentals.

Jeweller and specialty retailer Tiffany has seen significant deterioration in its investment profile since Dec. 31, when it ranked as a Buy for momentum and growth-oriented investors, based on the quantitative criteria used by Morningstar's CPMS division.

Tiffany's fall from grace is attributable primarily to deteriorating expectations for earnings. This can be seen in the major change in the number of fiscal earnings-per-share estimates revised up versus down over 90 days. At Dec. 31, the 14 analysts following TIF had revised their fiscal earnings estimates upwards, but by mid-March, four of these 14 analysts had reversed course and revised these estimates downwards (the rest were unchanged).

Meanwhile, Tiffany now has a market-like reinvestment rate of 13% using the median of forward EPS estimates, which makes it difficult to label TIF as a "growth stock". Momentum-oriented investors will be unimpressed that any previous price momentum has now dissipated. The Dec. 23 announcement that Tiffany is obligated to pay the equivalent of US$449.5 million to Swatch Group AG in damages related to a failed partnership between the two companies -- a penalty that exceeds Tiffany's fiscal earnings last year -- has likely contributed to this middling price change.

Tiffany stock also appears expensive. Its lofty price-to-book value (P/B) of 4.2 is verging on its highest valuation in the past 10 years. As well, Tiffany's price-earnings ratio based on trailing EPS is a rich 25.1 times. It is clear that anyone tempted by Tiffany should window-shop only and avoid owning the stock itself.

Movado -- a maker of luxury watches -- looks equally gloomy from an investment viewpoint. While its quarterly earnings momentum was 12.2% for the quarter ended in October, its estimated earnings momentum for the quarter ending in January is -5.2%. Investors are unimpressed; Movado's stock price is down more than 3% since the beginning of January.

Michael Kors, which offers a much more affordable brand of clothes, shoes, luggage and accessories than Coach, should be attracting the eye of discerning shoppers of growth and momentum stocks. This is due primarily to its illustrious values for three very important investment criteria: the company's book value is projected to grow by 48% this year, it impressed analysts on Feb. 4 with a positive 9% earnings surprise, and 13 of those 14 analysts subsequently made upward revisions to their estimates for 2014 earnings. Clearly, KORS should be on the radar for all U.S. equity investors except for those following income or value-oriented mandates.

Coach has impressed in the past as a growth-oriented stock. It continues to rate well on three measures: its 41% forward return on equity (ROE), its 27% forward return on total assets (ROTA) and its 2.75% expected dividend yield. And at US$13.6 billion, Coach's market capitalization ensures plentiful liquidity. Holding Coach back significantly, however, is its current 5% drop in reported earnings versus a year earlier. Furthermore, the analysts have revised their fiscal earnings estimate down by more than 10% in the past three months, which rarely bodes well for a stock's prospects.

Growth-oriented stocks with falling earnings and reduced expectations are not ready for the catwalk. Coach is a company whose business has matured and that will need some creative approaches to attract new business.

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Catherine Multon

Catherine Multon  Catherine Multon is a contributing writer for Morningstar Canada.

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