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Summary

  • Coach’s share value hasn’t changed much over a year. Its recent performance revealed declining sales and poor cost management bringing a bigger blow to earnings that fell approximately 14%.
  • The market is not promising as many have found difficult to reach targets while few such as Michael Kors are managing to grow their business.
  • Shaky prospects and the macroeconomic environment support the suggestion to invest money in stocks that are non-cyclical and to stay away from luxury goods manufacturers.

Coach Inc.'s (NYSE:COH) share price has been stale for a year. It has stayed close to the $50 range it started in March of 2013. The marketer of fine accessories and gifts has seen some unfortunate performance during its latest period despite annual margins staying on top of the industry. Rating sites such as Zacks have already given the firm a sell rating. They blame the downward trend seen in estimates for Coach after it reported its second-quarter results this year.

In this article we will be looking briefly at the company's performance. We will then see what is really going on with Coach and the industry to determine what is making it such a poor investment.

The Quarter

Source: 10Q

During the second quarter the company's total sales decreased 6% to $1.4 billion compared to the second quarter of 2012. The decline in the US came from lessened demand and this shortened comparable store sales by $135.9 million or 13.6%. The company opened 21 new stores which included 5 for segmenting the men's market. The company also closed 10 stores.

International operations remained strong with net of currency impact sales showing an improvement of 11% that was driven by double digit growth in China and Asia, excluding Japan, of $37 million as new stores opened and a $7.5 million increase in Europe. Since Coach generates most of its revenue domestically this increase didn't bring a material impact to the overall top line.

With regard to profits the gross margin decreased domestically by 250 bps to 63.8% and 180 bps of that decline was brought by increased promotional activity in Coach's factory channel to improve sales. Also, 130 bps of that decline was the result of selling products with a higher average unit cost. While international operations showed no cost problems that would've caused a decline in the margin, the currency impact took a negative turn and brought international gross ratio down to 78%.

Selling, general and administrative expenses make up nearly 40% of the company's total revenue. Last quarter the acquisition of a 50% interest in a European joint venture and new store openings lessened the decrease due to lower performance-related compensation. The net result was SGA rising 120 bps quarter over quarter. One point worth noting was the marketing expense that remained relatively stable. I expect it to rise in the coming period because last quarter the increased expense as part of Coach's new marketing campaign was hidden under the marketing expenditures released through the divestiture of the Reed Krakoff business and this brought total expense to a net neutral.

Higher costs brought the diluted EPS down by 13.8% to $1.06. Summing it up, the international segment showed some improvement with growth coming from emerging markets but higher costs brought a greater blow to the already declining revenue the company faced in its domestic economy.

Present

When the industry is not performing well the companies operating within it are negatively impacted. While the three-year period of 2010-2012 was good for Coach's industry with competitors such as Louis Vuitton (OTCPK:LVMUY) enjoying double digit growth the present is not in the favor of luxury goods manufacturers. The blame is to be put on the challenging European economic climate, shifting consumer behavior in emerging markets, and the new anti-corruption campaigns that ban lavish gifts.

Even though China experienced good results last quarter Coach's main dependency right now is on its domestic arena. The company sells products that are largely discretionary in nature and thus depends upon consumers' disposable incomes. Consumers in turn are highly sensitive to the macroeconomic factors. Given the tough consumer spending environment in the past couple of quarters Coach and a majority of the luxury goods companies have found it difficult to maintain their stated targets.

Moreover, the aging fashion trends adapted by the company are a threat to Coach's operating model and it should consider involving a non-stop focus on product and design innovation. The company's pioneer position is being affected by delays in product launches. Coach is forgetting that it operates in a highly competitive luxury handbag and accessories market.

This is already proving damaging since few companies such as Michael Kors are snatching away shares as their comparable sales recently rose to 27.8%. Another rival, Kate Spade, managed to generate revenue growth of 48% during the Christmas period with a 61% increase in revenue for 2013. This may put a counter intuitive argument to my discussed industry trends but one must note that very few saw their sales jump.

Bottom Line

The luxury business may still be successful if you're able to bring in attractive products but for Coach this doesn't seem to be happening. While the company does keep shareholders in mind and has spent $350 million so far in 2014 to repurchase 6.6 million shares at an average cost of $53 per share its failing earnings guidance is a poor sign. With stale share prices and earnings falling the hiring of designer Stuart Vevers won't appear to be promising until results appear. This may make it difficult to sustain the current dividend of $1.35 in the future. I don't think investors should choose to invest in Coach for now. Therefore, I recommend selling the stock.

Source: Coach's Recent Quarter And The Falling Industry