Michael Kors Holdings’s (NYSE: KORS) most recent return on equity was an outstanding 26.5% in comparison to the Consumer Discretionary sector which returned 8.8%. Though Michael Kors’s performance over the past twelve months is highly impressive, it’s useful to understand how the company achieved its strong ROE. Was it a result of profit margins, operating efficiency or maybe even leverage? Knowing these components may change your views on Michael Kors and its future prospects.
ROE Trends Of Michael Kors
Return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity. It is calculated as follows:
ROE = Net Income To Common / Average Total Common Equity
ROE is a helpful metric that illustrates how effective the company is at turning the cash put into the business into gains or returns for investors. But it is important to note that ROE can be impacted by management’s financing decisions such as the deployment of leverage.
The return on equity of Michael Kors is shown below.
source: finbox.io data explorer – ROE
Unfortunately for shareholders, Michael Kors’s return on equity has decreased each year since 2015. ROE decreased from 43.5% to 39.6% in fiscal year 2016, decreased to 30.7% in 2017 and decreased again to 26.5% as of LTM Dec’17. So what’s causing the steady decline?
Michael Kors’s Declining ROE Trends
In addition to the formula previously discussed, there’s actually another way to calculate ROE. It’s often called the DuPont formula and is as follows:
Return on Equity = Net Profit Margin * Asset Turnover * Equity Multiplier
Analyzing changes in these three items over time allows investors to figure out if operating efficiency, asset use efficiency or the use of leverage is what’s causing changes in ROE. Strong companies should have ROE that is increasing because its net profit margin and/or asset turnover is increasing. On the other hand, a company may not be as strong as investors would otherwise think if ROE is increasing from the use of leverage or debt.
So let’s take a closer look at the drivers behind Michael Kors’s returns.
Net Profit Margin
Unfortunately for shareholders, Michael Kors’s net profit margin has decreased each year since 2015. Margins decreased from 20.2% to 17.8% in fiscal year 2016, decreased to 12.3% in 2017 and decreased again to 11.3% as of LTM Dec’17.
As a result, the company’s worsening margins help explain, at least in part, why ROE continues to decline. However, let’s also take a look at Michael Kors’s efficiency.
It appears that asset turnover of Michael Kors has generally been increasing over the last few years. Turnover increased from 1.78x to 1.79x in fiscal year 2016, increased to 1.81x in 2017 and decreased to 1.32x as of LTM Dec’17.
source: data explorer – asset turnover
As a result, the company’s declining ROE is not due to its asset turnover performance which has generally been increasing.
Finally, the DuPont constituents that make up Michael Kors’s ROE are shown in the table below. Note that the table also compares Michael Kors to a peer group that includes Coach, Inc.(NYSE: TPR), Under Armour, Inc. (NYSE: UAA), Burberry Group Plc (NYSE: BURBY) and Hanesbrands Inc. (NYSE: HBI).
source: finbox.io’s DuPont model
In conclusion, the DuPont analysis has helped us better understand that Michael Kors’s continuous fall in return on equity is the result of a steadily deteriorating net profit margin, an improving asset turnover ratio and increasing leverage. Therefore when looking at the core operations of the business, Michael Kors shareholders have reason to be concerned due to the company’s deteriorating profitability along with increasing leverage.
The DuPont approach is a helpful tool when analyzing how well management is utilizing shareholder capital. However, it doesn’t necessarily tell the whole story. If you have not done so already, I highly recommend that you complete your research on Michael Kors by taking a look at the following:
Valuation Metrics: how much upside do shares of Michael Kors have based on Wall Street’s consensus price target? Take a look at our analyst upside data explorer that compares the company’s upside relative to its peers.
Risk Metrics: how is Michael Kors’ financial health? Find out by viewing our financial leverage data metric which plots the dollars in total assets for each dollar of common equity over time.
Efficiency Metrics: is management becoming more or less efficient over time? Find out by analyzing the company’s asset turnover ratio which measures the dollars in revenue a company generates per dollar of assets.
As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.