Analysis: The Michael Kors Turnaround Is Really Happening

At time of writing, shares of the company were up 3.23 percent to $48.55.

Analyst Camilo Lyon believes the strategic steps management has recently begun implementing are showing early signs of traction. This, the analyst said, has occurred after a multi-year stretch of excessive promotions, stale innovation in handbags and a watch category that disproportionately depressed comps and collapsed EBIT margins.

The analyst expects management's initiatives to result in a multi-step P&L march upward, which will manifest through comps and gross margins over the next few years.

Watch Worries Stalling

Canaccord Genuity noted that Michael Kors launched the Access smartwatch line last September to combat weakness in its fashion watch category. The firm said the Access smartwatches fully offset the weakness in fashion watches last quarter for the first time.

Furthermore, management expects Access watches to make up 20 percent of the mix by year end, the firm said. The firm estimates this to add 100 basis points to comps by year end.

Accelerating Pace Of Innovation

Acknowledging the lack of innovation in its past collections, the firm noted that Michael Kors has ramped up the pace of new designs. The firm's store checks revealed that the Mercer bag continues to be the top seller, and the recently introduced Sadie has also been performing well.

Overall, the firm sees positive momentum in the assortment at higher price points and full margins. This, according to the firm, should help improve both comps and gross margin.

Cutting Down On Promotion

The firm also noted that Michael Kors has embarked on this tough task of cutting down on promotions since February. Therefore, the firm believes average unit retail has seen a steady improvement. As such, the firm expects the weakness in traffic, a corollary of weak AUR, to continue until the company anniversaries the pricing change in the fiscal year fourth quarter.

Subsequently, the firm feels traffic would not be a significant drag on comps, with even handbags beginning to comp positively from next spring.

Earnings Momentum

Citing the positives and having a very conservative outlook on the Jimmy Choo acquisition, the firm expects earnings to touch $4.50 per share. As a result, the firm expects the P/E multiple to also expand back to the mid-teens, which is more in line with the company's historical average.

On valuation, the firm noted that the company's 12 times P/E valuation is below its direct peer Coach Inc COH and 10 times below its fashion/luxury index.

"We acknowledge it is still early days in this turnaround and KORS has much work to do to improve the full breadth of its fashion assortment," the firm said.

"However, Q1's sharply better results are a solid first step."