Coach Inc.'s (NYSE:COH) second-quarter earnings fell short of analysts' estimates. The company's stock price is at a 52-week low. In this article I will determine whether or not Coach is a good candidate for long-term investment or if should be ousted from an investment portfolio.
Recent Earnings Performance
The top line of the company is heavily reliant on North America which is accountable for generating approximately 69% of the company's total net sales. The remaining percentage is attributed to various countries around the globe with recent expansion into the Asian markets. During the most recently ended quarter the total net revenues of the company declined by 5.6%. The 8.6% plunge in North American sales is largely responsible for this decline. The decelerating sales margin in the region is a cause for concern since it is the third consecutive quarter of plummeting performance. However, this drop in sales was partially offset by the increase in sales in Asian and European regions wherein China indicated double digit growth. Where comparable store sales declined in North America new store sales in China boosted the company's sales performance.
Segregating the company's revenues among its operating segments reveals that women's handbags are responsible for generating 58% of the total net revenues. However, the segment's contribution to the top line has declined by five percentage points over the past three years owing to increasing competition and declining sales in North America.
Declining Market Share
It turns out that Coach is being challenged in North America from its rapidly growing rivals such as Michael Kors Holdings Ltd. (NYSE:KORS). Between 2011 and 2012, Michael Kors' market share has risen from 4.5% to 7% in the US handbag market while Coach's share dropped from 19% to 17.5% during this period.
Coach justified its drop in sales as a function of the cold wave that hit the American region leading to reduced customer visits to its stores. However, where Coach's top line declined during the previous quarter Michael Kors and other competitors reported sales gains. More likely than not the competitors' deep discount offers are largely responsible for the decline in Coach's top line.
Coach has been struggling to be viewed as a luxury fashion brand. Therefore Coach has been adding a few high priced products to its product line some of which exceed the $400 price mark. Some analysts fear that the higher prices will drive away customers to the lower-priced rival brands. My take differs, however. I believe that Coach's premium pricing strategy will not only improve the brand image of the company as a fashion brand among the customers but it will also cushion the margins of the company.
In Japan, total dollar sales plunged by a staggering 7% owing to the weakened yen compared to the dollar. The yen is expected to continue to fall compared to the dollar which is expected to further reduce the demand for Coach's products in the country.
Where sales are declining in North America and Japan China experienced double digit growth of 25%. It is projected that sales in China will continue to rise into the foreseeable future. The USA recently softened visa restrictions for Chinese visitors which leads me to believe that as the Chinese increase their traveling to the US Coach's sales are expected to increase. Moreover, the strengthening of the yuan over the dollar will further bolster the demand for the so-called luxury brand. Comparable store sales have risen by 10% in China following these recent events.
The Chinese are big on investing in luxury brands; more than 20% of the total luxury purchases around the globe are attributable to the Chinese. However, the availability of an increasing number of accessibility brands like Coach have driven more and more Chinese to become price sensitive. The economy, as a whole, is rapidly falling into the middle income group and this is expected to bolster the demand for Coach's products. About 68% of urban Chinese households fell in the income group of $9,800 to $37,000 as of 2012. Only 4% of Chinese urban households had that income level back in 2000. Furthermore, McKinsey & Co. estimates indicate that around 80% of Chinese consumers are estimated to fall into said range by the end of 2022.
Men's Segment Potential
Realizing that the competition is increasing in the women's segment as lower-priced competitors enter the market Coach has shifted its focus towards the men's segment. The segment has recently shown an increasing level of sales and is expected to continue to rise if targeted properly.
The Coach men's segment contributes about 11% to the total revenue base of the company. The contribution of this segment to the top line has increased over the past three years. Coach is enhancing its number of stores in this segment, besides dual gender stores, to further enhance the segment's profit margins. As of the recently ended quarter, the company opened five new stores catering to men's product demand.
I believe that Coach is correctly altering its strategy to target a relatively ignored market segment such as the men's segment and by entering high growth markets like China. The company's performance in China has been positive so far and I believe that its stance will strengthen the economy in the coming years. The company is in a growth phase as of now as indicated by its PEG ratio of 2.03 and yet its dividend yield has risen over the years (2.81%). Considering that Coach's sales are expected to rise as a function of its expansion into high growth regions and the men's segment I believe its stock price will appreciate as a result.
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.