- Investors anxiously wait to see positive gains from the upmarket switch company made two years ago.
- Growth in China will not be able to offset any North American declines if management's missteps inflict long-term damage to the brand.
- Investors should demarcate affordable luxury segment from affluent market segment to better understand Coach's core consumer.
After a dismal stock performance, market share loss to competitors like Michael Kors (NYSE:KORS), Kate Spade (NYSE:KATE), the question remains - Can Coach's (NYSE:COH) turnaround story help in winning over investor concerns? Has the revenue deceleration and market share losses for Coach encouraged too much investor optimism towards it competitors, mirrored by triple-digit gains during the last two years.
After several years of global expansion, the company aims to shift upmarket, culling entry-level products, narrowing distribution, transforming itself into a global lifestyle brand. Strategic shift to move products into upmarket segment is pushing gross margins lower in the near term, but the brand's repositioning should wield pricing power to make up for higher costs in the future. In addition, expanding the portfolio to men's products and accessories opens channels to penetrate a profitable category. Strong Chinese growth helped in offsetting the sharp decline in North American retail sales. Contrary to market share losses in North American market, Coach still upholds it brand position in the Chinese market.
At this juncture in the company's turnaround, integral to investor's analysis is seeing the shift underway from affluent segment to the affordable luxury segment. Invigorated appetite for affordable luxury goods globally is the true growth driver for brands such as Michael Kors and Kate Spade. Newer entrants leading to seize the market share in affordable luxury category warrants investor's jitteriness. Overwhelmed by brand dilution, Coach failed in identifying the rising global trend in affordable luxury, alienating itself from the global middle class consumer. Redefining strategy to avoid leaving a void with the resurgent middle class consumer, while meeting the expectations of its core consumer is long overdue for Coach. Targeting the middle class consumer with accessible pricing and refocusing on what it does best to nurture higher exclusivity with wealthy consumers will drive future growth. Coach cannot afford to abandon one over another - a mistake its European rivals have made and suffered from.
At the current juncture, it is hard to be complimenting Coach - which cannot afford any misstep in its turnaround strategy to resolve its revenue slowdown riddle. Pick any financial metric, and the stock appears attractively valued at these price levels. How business fundamentals shape out will decide the fate of an attractive value or a value trap, but understanding the risk reward warrants an estimate of intrinsic value.
- Discount Rate: Weighting revenues by operating regions to capture risk associated with each operating region (North America, Asia excluding Japan), provides a cost of capital of 9.80 percent.
- Revenue Growth: Impact on the revenue from Stuart Vevers' new collection will not be seen until next year for Coach. Negative North American comp sales will continue to impede revenue growth until an acceptance of Stuart Vevers' collection reverses this trend. For FY 2015 , I am expecting overall sales decline of 5 percent, followed by 1.75 percent decline in FY 2016 before returning to positive levels in FY17 and then after.
- Gross and Operating Margins: Upmarket shift will help the company in clawing back its previous gross margin levels, but an increase in wage costs will restrain the operating margins. Currently company enjoys pretax operating margin of 31.55 percent against global industry average of 18 percent.
Based on the aforementioned assumptions, my fair value estimate for Coach's share price is $46/share. At current market price of $39.37, the market is implying 1.37 percent growth in operating income over the next 5 years, contrary to the 26 percent compounded operating income growth expected for Michael Kors.
Under zero-growth assumptions, both Coach and Michael Kors remain fairly valued around $34 per share. Current market price for Coach includes $4.80 in future growth premium, whereas investors are paying $60 per share for future growth in Michael Kors' stock. Counting on margin expansions in the future for Michael Kors uncovers a logical flaw, especially when large global brands are entering to tap the affordable luxury goods market.
Investors eagerly await Stuart Vevers' first collection this September, to gauge a true sense of his impact on the company's turnaround. One major risk to my estimate is the failure of strategy in winning over consumers inflicting long-term damage to the brand.
Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in COH over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.