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Michael Kors’ aggressive expansion comes at a cost

<<enter caption here>> on May 8, 2014 in Shanghai, China.<<enter caption here>> on May 8, 2014 in Shanghai, China.
Michael Kors attends the opening of his flagship store in Shanghai.Photo: Hong Wu/Getty Images

Michael Kors’ North American comparable sales soared last quarter and its profit blew past Wall Street expectations with numbers that would be the envy of any retailer. But behind those figures were signs the aspirational luxury fashion house’s growth is coming at the expense of its profit rate.

In its relentless drive to squeeze its more established rival Coach (COH), Kors (KORS) has been aggressively expanding, opening 101 of its own stores in the last year and bringing its total fleet to 405. By many measures, the strategy has worked: Coach’s North American comparable sales last quarter shrank by the exact same percentage as Kors’ grew. Yet despite its stellar fourth-quarter results and an upbeat sales forecast for this year, shares were up only 0.4 percent Wednesday, erasing a pre-market stock surge when the company told investors its profit rate would shrink a bit this year.

Opening new stores, a key engine of Kors’ growth, isn’t cheap— Kors’ operating profit in its retail business rose only 14.5%, compared to growth of 87.5% in its wholesale business last quarter. And Kors told investors on a conference call Wednesday that its operating costs as a percentage of sales would rise this year. A few weeks ago, competitor Ralph Lauren (RL) also warned investors that its retail expansion, which it is speeding up to become less reliant on department stores like Macy’s (M) and Nordstrom (JWN), would dent its profit this year.

Kors also warned Wall Street that its gross profit margin would be “slightly lower” this year, adding to the sense that Michael Kors’ torrid growth story could be finally cooling off. Last quarter, despite the big sales gains, the profitability of Kors’ merchandise profit only rose 0.2 percentage points to 59.7% of sales. Sterne Agee said it in a research note that Kors’ gross margin may have peaked. That suggests that like other affordable luxury brands, it is having to sell more at lower prices and more product through its outlet stores. And for all of the market share Kors is stealing, its gross margin rate lagged Coach’s by 11.2 percentage points last quarter.

WSL Strategic Retail’s CEO Wendy Liebmann doesn’t think Kors’ U.S. retail expansion has quite reached a tipping point yet, but warned that Kors’ overall “continued growth will depend very heavily” on international expansion. Kors only gets about 20% of its sales outside North America, meaning a big retail push overseas could further compromise profit growth.