Stay Away From Coach For Now

| About: Coach, Inc. (COH)

Coach, the maker of handbags, jewelry, footwear, and accessories, with over $4 billion in annual sales, has been in a funk for a year now. After topping out at around $80 in early 2012, the stock is down over 40%. What is the weakness in Coach's (NYSE:COH) stock price telling us? It could be one of two things:

(1) Consumer spending is getting weaker.

(2) The Coach brand is losing popularity.

Is Consumer Spending Getting Weaker?

In assessing the stock charts of Tiffany's (NYSE:TIF), Michael Kors (NYSE:KORS), Nordstrom (NYSE:JWN) and the entire S&P Retail ETF (NYSEARCA:XRT), it's pretty clear that the consumer is doing just fine. While each has been weak over the past week or two, along with the overall market, none of these charts are near their 52-week lows like Coach. In fact, XRT is at all time highs and has significantly outperformed Coach for the past year. Technically, if Coach were to bounce now would be a logical place for it to bounce as it is around long-term prior support of $50 from 2007. Given its underperformance, it seems logical to me that there is something fundamentally wrong with the company that the market has spotted ahead of the results that the company is reporting.

Is the Coach Brand Losing Popularity?

Typically the first signs of a brand losing popularity would show up in the following areas of the financial statements:

(A) Weakening gross margins

(B) An increase in inventory relative to sales

(C) Or a big increase in marketing expenses relative to sales

Below I have put together a chart of the past 5 years of financial data as well as the most recent 5 quarters to assess if any of these trends exist for Coach.

While net margins, which account for advertising spend, have declined from 24.6% to 21.8%, they have risen each of the past 3 years and don't appear ominous. Gross margins have dropped from 75.7% in 2008 to 72.8% in 2012, but again they have risen from the 2009 lows. Perhaps the most recent trend in margins is beginning to tell something to investors? Gross margins in the most recent quarter were 72.1% and have fallen from the Q1 2012 highs of 73.8%. Coincidentally, shares peaked in Q1 2012 around $80.

However, I don't think this is enough of a sign to suggest that their brand is losing popularity. However, when comparing with Kors the difference in trends are pretty remarkable. Below are the same stats for KORS in the periods available (most recent 5 quarters weren't available so I excluded them).

Very impressive figures for sure. But that is to be expected given the relative size of each (COH's sales were four times larger than KORS).

So while the trends in COH aren't weak enough to support the argument for a weak stock, what is it that the market is seeing? For this the best thing I can do is read reviews online to get a sense for what consumers are saying and obtain feedback from industry sources.

Online polls:

In a poll of 176 people, reported a month ago that 59% of people would rather receive a designer Kors branded item than a Coach branded item. In reading the reviews, it's pretty clear that Coach is viewed as an older brand and Kors is the edgier, trendier, hipper brand. While this is only one online poll it does suggest to me that the market is sensing a shift going on.

Industry Sources:

Blueshift Research, an equity research firm, did a report on the two brands roughly a year ago and came away with feedback from industry executives and strategic consultants that suggest Kors is making inroads against Coach. Here are some interesting points from their report:

(1) Owner and designer of a leather goods manufacturing company in New Jersey:

"Michael Kors is more of a fashion designer who caters to a fashion-forward crowd, yet in a safe conservative way - whereas Coach is totally confused, commercial, boring, predictable and essentially the McDonald's of fashion. They are only taken seriously by Middle Americans who are out of touch, or folks in foreign countries who want whatever is American, but that is about it. Coach's biggest enemy is Coach."

"Kors can only go up in popularity, especially if they hit the right trend...Kors is Fashion. Coach is the Mall."

(2) Strategic consultant for a leather goods manufacturer

Kors is having an impact on Coach, attracting younger women with an eye towards fashion and trends. Kors' rise is at Coach's expense. Coach has something for everyone, appealing to a broader range of customer. Coach is nearing a plateau while Kors is climbing. Kors selling products at Marshalls is bad for the brand's image and could be damaging.

(3) Handbag sales associate, Nordstrom store at a San Francisco Bay Area mall

"Kors is more popular, fashionable and on-trend. They offer a lot of sizes and styles that change. Young and old customers buy their product."

"Coach sales have slowed down over the last three years. Coach doesn't change that much and stays more consistent with their product and with who buys it."

"Kors attracts more of an audience than Coach, but Coach has loyalty."

"Coach is better quality. I have seen the metal tarnish on Kors bags. A lot of bags do come back. Mostly for exchanges for another Kors bag."

While these comments don't imply that Coach is going away imminently, they do suggest that they have a brand-imaging problem with their customers. Their quality of craftsmanship stands out as being better than Kors. However, quality issues don't appear to be that drastic based on comments provided by these key contacts in Blueshift's report. For a designer of fashion brands, I believe having image issues with consumers far outweighs having quality issues. Quality issues can be much easier to overcome and based on the comments above and the poll (albeit a small sample size) online, it appears Coach is now seen as the stodgier, unhip brand.

This might not be that big of a problem as far as the fundamentals go because Coach is favored by the older female crowd, but in the eyes of investors it's clear that KORS is the it brand. And Kors appears ready to steal more customers away from Coach, which I believe is easier to do now that they are known as the hipper brand. Imaging problems are very difficult to battle in any industry. Just ask Nokia (NYSE:NOK) and Sony (NYSE:SNE), one time market leading brands in consumer electronics that were taken out by upstart Apple (NASDAQ:AAPL). This appears to be showing the beginnings of a similar trend as the Apple vs. the world battle that was waged over the past decade in consumer electronics. I believe the market is sniffing this out and it is the reason why Coach's stock has been in a funk for a while now.

My advice would be to steer clear of Coach for the time being. It looks cheap on paper but it is subject to rapidly changing consumer tastes and those tastes appear to be growing in favor of Michael Kors. While I don't ignore the possibility of a bounce here given what appears to be a rough long-term range of support around $50, I would recommend avoiding shares of Coach from the long side and if you are looking to short it I would wait for a potential spike higher to the $50 to $53 to initiate a short position.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

About this article:

Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500. Become a contributor »
Tagged: , , , Textile - Apparel Footwear & Accessories
Problem with this article? Please tell us. Disagree with this article? .