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Kors shares jump as less bad is good enough

Shares of Michael Kors shot up more than 20 percent Tuesday, after the handbag maker reported sales and profits that easily topped Wall Street's expectations during the holiday quarter.

More importantly, despite aggressive promotions that permeated across the broader handbag sector, the affordable luxury maker also reported better-than-feared gross margins.

A Michael Kors retail store on Market Street in San Francisco.
Adam Jeffery | CNBC
A Michael Kors retail store on Market Street in San Francisco.

What's more, management indicated that the brand's inventory build decelerated from the first half of the year, as it dials back on the amount of product it places in the troubled department store space.

"Given the big bottom-line beat, we expect the stock to be up significantly today. And deservedly so," Citi analyst Paul Lejuez told investors. "They put up good numbers in a tough environment."

Analysts have been cautious on Kors for several quarters, mainly due to fears that the brand has become oversaturated in the U.S. Many have drawn a parallel between the trajectories of Michael Kors and Coach, which is still trying to recover from a steep sales decline from its over penetration. Coach's revenues have similarly shown recent signs of life, with the brand last week reporting its first sales increase in more than two years.

But investors were also cautious on Kors because of its disproportionate exposure to the department store channel, where sales fell 2 percent in 2015. While U.S. wholesale revenues account for just 5 percent of Coach's sales, they make up roughly 40 percent of Kors' total revenues, according to Citi estimates.

Indeed, wholesale revenues did underperform those from Kors' retail and licensing businesses, ticking just 0.3 percent higher during the quarter. As such, CEO John Idol reiterated the brand's plan to pull back on the number of products it stocks at North American department stores, as a means of insulating the risk of markdowns. That, in turn, should preserve the brand's integrity as a luxury label, Idol said.

In a note to investors, Stifel Nicolaus analyst David Schick said Kors' deceleration in inventory build "may be the most important part" of its statement.

On a conference call Tuesday morning, Idol said he hoped that the brand's latest results prove to the "naysayers" that the brand is still growing. He pointed to international expansion and a burgeoning men's business — which he said could eventually increase from 11 to 500 stores — as two levers for growth.

He also said there's opportunity to introduce more handbags at higher prices, saying consumers have shown they're willing to spend more money for unique merchandise.

And as shoppers continue to favor smaller, less expensive handbags — a trend Idol attributed to smartphones reducing the number of items that need to be toted around — the company's sales associates are pushing shoppers to add more items to their basket. He added that once again, unit sales increased by high double digits.

"We see our opportunity really being in upsell with the customer, or in trying to take advantage of [the small bag] trend," he said.

Despite their beat, Kors' comparable sales declined 0.9 percent. While that was better than Wall Street's projection for a 4.4 percent decline, and an improvement from an 8.5 percent decline in the second quarter, it also represented a significant slowdown from last year's 8.6 percent increase.

Kors shares were trading above $49 late Tuesday morning, up 23 percent.