Is it Time to Sell Michael Kors and Buy Coach?

Investors in Michael Kors Holdings have seen impressive gains over the past year as shares have risen roughly 50%. The company has established itself as a high-end luxury brand that sells its products at reasonable prices. Unfortunately, with such tremendous growth in both the business and share prices, investors are likely to find compelling value elsewhere.

Success story
Michael Kors has impressively grown its total number of stores from 177 in 2012 to 328 in the recent quarter. The company has seen strong same store growth (40% in 2012) and has seen margin increases over the last four years as it continues to capitalize on the high margin accessories category. In fiscal 2013, the company had a gross margin of nearly 60% and an operating margin of around 29%. 

International growth potential plays a very attractive part in the company's longer term story. European operations are just beginning to reach profitability, and Japan is the next major focus.  The company hopes to double its global store base to 700 locations through international and domestic expansions.


So why should investors sell?
Despite the tremendous momentum over the years, Michael Kors has only captured a 10% share of the North American handbag market, losing to its largest competitor Coach , which controls a 30% market share. 

In the near term, Michael Kors' margins could be at peak levels. Margins could come under pressure as management continues to make SG&A investments in infrastructure to keep up with the company's high growth rate and ambitious international expansions. That said, there is limited upside for the time being.

All eyes on China
According to a McKinsey study, in 2015 China will account for about one third of global luxury sales, which is estimated at $175 billion. China represents an extremely important battleground for all luxury brands, and Coach is likely to emerge as more successful than Michael Kors.

According to Digital IQ Index: China - Fashion Supplement, a report that benchmarks 27 global fashion brands in the Chinese market, Coach has emerged in fourth place, and is the top ranked American company. Selling and marketing strategies helped Coach reach this status and win over the all-important Chinese consumer. The company operates a Chinese language e-commerce site that offers free shipping and free returns, customer reviews and ratings, and a very fast load time.

Another example of Coach's commitment to China is its focus on social media. The company has created popular marketing campaigns, including a "New York Style" video that was advertised on Weibo, the Chinese microblogging site with over 500 million registered users.

Coach already maintains a strong presence within China, which includes 126 locations across 47 cities. The company plans to open around 30 new stores in China and sees its sales rising from $430 million in fiscal 2013 to $530 million in 2014. By comparison, Michael Kors maintains only 77 locations across the entire Far East region, and hopes to open 100 stores in China over the next five years. This will not match the presence Coach will maintain in the country.

Buy the company that has more attractive valuations
Michael Kors appears less attractive on several metrics, including P/E and cash, which makes Coach a more compelling investment:

-Michael Kors has a P/E of 33.86, compared to Coach's P/E of 14.95.

-Michael Kors holds $639 million in cash and a market cap of $15.39 billion. Its cash to market cap ratio is 4.1%.  Meanwhile, Coach holds $1.13 billion in cash with an almost identical market cap of $15.19 billion, making its cash to market cap ratio more attractive for investors at 7.4%.

Here's an idea: buy a retailer!
Investors who want exposure to the general high end fashion market should consider a retailer. Nordstrom targets customers looking for high quality brand name merchandise, which includes the Coach brand.

Nordstrom is an innovative industry leader that plans to utilize mobile point of sale, or POS, systems based on iPods and iPads. Mobile POS devices improve the opportunities for Nordstrom sales associates to engage customers and recover floor space for increased merchandising opportunities.

Longer term investors can anticipate Nordstrom's expansion into Canada with the opening of eight to 10 full-line stores, accompanied by 15 to 20 Rack locations. An expansion up north can evolve into a $1 billion per year business over time. 

Conclusion
The markets for handbags and luxury goods are only going to increase in popularity and sales over the coming years. Handbags will remain one of the two most desirable accessories along with shoes. Investors can profit from this trend by investing in a retailer such as Nordstrom, which will continue to offer innovative ways to attract customers, or through a high quality brand name such as Coach.

While Michael Kors remains a great company with a popular product, from a valuation and international expansion point of view, Coach remains a better investment at this point in time.

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.

The article Is it Time to Sell Michael Kors and Buy Coach? originally appeared on Fool.com.

Jayson Derrick has no position in any stocks mentioned. The Motley Fool recommends Coach. The Motley Fool owns shares of Coach. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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