Michael Kors Holdings Ltd: KORS Gets a Boost, But Don’t Overdo It!

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There may be no bigger (and pleasant) surprise in the markets so far this year than luxury retailer Michael Kors Holdings Ltd ( KORS ).

In a retail environment that drew concerns this past holiday season - strength in the U.S. Dollar and declining consumer sentiment among critical factors - the recent third quarter of fiscal year 2016 earnings report was a shock to the system.

The hard facts speak for themselves. Earnings per share for KORS stock reached $1.59, a solid lift of 9% above consensus estimates . Although not earth-shattering by itself, KORS was able to sell through a good chunk of its footwear and accessory products.

This occurred despite a shift in fashion trends that forced the company to focus on items with lower price tags. In addition, Michael Kors responded positively to suggestions regarding its online presence, and the effort paid off. Overall, Q3 sales hit $1.4 billion, exceeding Wall Street's expectations by 6.3%.

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On a purely fundamental basis, the argument for KORS stock is further bolstered. In terms of profitability margins, Michael Kors is an industry leader, besting most other retailers. This shouldn't catch anyone off-guard since KORS has always catered to an affluent consumer base .

Essentially, it's the brand name and the company's finger to the fashion pulse that has kept the money flowing and the customers hungry for more. There's a reason why Michael Kors doesn't have to sell itself like a telemarketer, but can still deliver impressive return on equity.

It's important to note, though, that it's not just about the bottom line - it's the quality of those earnings. Retailers have been under pressure to keep overhead costs in check, resulting in less expenditures and investments. While such activities can improve earnings, it can also hamper competitive efforts in the future. KORS, on the other hand, is a relatively young, fresh entity that has wide appeal to the fashion conscious. There's still room for additional market penetration, given its lofty annual top-line sales trend.

That's caused a lot of bears to get awfully nervous. Just a few months ago in December, the short interest on KORS stock averaged 8.2%. Back then, KORS could be bought for around 40 bucks a pop.

As of the close of March 1, shares are worth $57.28, or roughly a 43% spike. Consequently, the short interest dropped to 6.19%, or a decline of nearly -25%. As KORS continues its trek north, more bears will be forced to cover their risk.

In a way, it's a self-fulfilling prophecy. The fear of losing more money in a trade gone awry will necessitate the buying back of stock that was initially borrowed as part of the short transaction.

Logically, that would imply a higher price point for KORS stock … but how much longer can shares be sustained on the back of technical tailwinds?

Broad data suggests that the nearer-term prognosis is quite optimistic.

Retailers that have been out of sorts during several stretches of 2015 - like discount leaders Target ( TGT ) and JC Penney ( JCP ) - were pushed skyward on the back of better than expected sales and earnings performances. This lent further confirmation that the U.S. economy is improving, particularly in light of generally bullish manufacturing and construction figures .

Against a longer-term framework, the future is a bit more cloudy. Michael Kors did have problems in its Q3 earnings report - namely, unfavorable currency dynamics that negatively impacted sales across Europe and other regions. That's something that's not going to go away overnight.

True, KORS should find plenty of affluent buyers, with a specific eye on Russia's ever-expanding roster of millionaires. But in a country where roughly half its citizens can barely make ends meet (and where the ranks of the poor are also expanding) can such polarization sustain the retail markets?

It's not just a Russian question. Wealth disparity isn't exactly a non-issue back home, and there's evidence that even among America's affluent, spending is being curtailed . Unsurprisingly, the situation for the middle-class is much more bearish.

According to the latest Index of Consumer Sentiment report by the University of Michigan, the benchmark dropped nearly -4% year-over-year last month. The Index of Consumer Expectations was even worse, down nearly 7% YOY.

Certainly, there are favorable factors pushing KORS stock to higher ground, and the company's sound financial health will likely attract more buyers.

Short traders who have been forced to run for cover will further lend a contributing hand. But the Michael Kors business strategy faces a major uphill battle in maintaining its performance ahead of a retail market that is still wobbly.

Until that problem is definitively solved, investors can dance with KORS stock - but don't buy the ring just yet.

As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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