It Is Still Not A Good Time To Buy Coach

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 |  About: Coach, Inc. (COH), Includes: KORS
by: Stan Ackman

Summary

Stuart Vevers may not be the right creative director for Coach.

Coach's China sales growth assumption may be too high.

There is a risk for the turnaround plan itself.

Buy only after solid positive signs.

People following Coach (NYSE:COH) for a while on Seeking Alpha know that I have repeatedly advised not to buy Coach. My initial article published on Seeking Alpha in October 2013 has called for a high double-digit comps decline. While many investors are shocked by the devastated financial projection made on the Coach Investor Day, I am hardly surprised. I am actually glad that Coach's management publicly accepted the big problem for the first time. It also takes a lot of courage to accept a North American comps decline of more than 20% by reducing the online factory store exposure.

So, is it a good time to buy Coach now? My answer is, however, still NO. The simple reasoning is that the company still has several potential bad news to announce. The potential turnaround also needs a lot of time to show positive signs.

First, Stuart Vevers may not be the right creative director for Coach.

I am a fashion guy. This strength enables me to look at Coach from a different perspective. In the fashion industry, a designer's past success often does not yield a future victory. It is no doubt that Stuart has quite a few fancy names on his resume, e.g. Bottega Veneta, Givenchy, Louis Vuitton and Mulberry. All these companies have amazing handbags. Naturally, Stuart looks like a wonderful fit for Coach. What has disappointed me is the Coach Fall 2014 collection. It is not the handbags themselves not beautiful. Rather, it is the lack of resonance with Coach's core consumers bothering me. They are too fashion forward and too vintage. The reason why both fashion forward and vintage can exist at the same time is that fashion can be vintage. However, it is not the trend now. The current core premium/lifestyle handbag consumers clearly prefer modern than vintage. Someday, they may prefer vintage, but I do not see it happening in the next two years. Fashion, at the end, is a trend that will last for a while before a new trend settles in. The trend has a momentum that will not stop quickly.

Arguably, Stuart still can learn from a potential Fall 2014 collection failure and design something that resonate with consumers better in the future. Many designers fail their first couple of collections badly when they move to new fashion houses. In this case, however, the failure will translate to further share decline. The current consensus in the financial community is that the Fall 2014 collection is great and it should help offset some level of Coach's market share decline. If the consensus changes later this year, a reset of assumption will result in a drop of the share price.

Second, Coach's China sales growth assumption may be too high.

In the presentation of the Investor Day, Coach still projected double-digit sales growth in China. It is also a consensus in the financial community that Coach's China performance is still intact, even though it suffers greatly in North America now. This consensus can change as well. I am a frequent traveler to China, and have good connections with China's fashion insiders. From what I know, Michael Kors (NYSE:KORS) has already invested highly in a few fashion infrastructure projects in China. These projects start to convince even the most critical eyes of China fashion experts. Michael Kors just started to build a few flagship stores in China in the recent years. It does not have near as wide footprint in China as Coach does. This is partly the reason that Coach's China sales have not been materially impacted by Michael Kors yet. Given the rising status of the MK brand in China, I suspect Michael Kors will start to grab market share from Coach in China, just as what it did in North America. As a result, if Coach no longer claims double-digit comps in China, the market will likely assume a much worse scenario for Coach's turnaround plan.

Third, there is a risk for the turnaround plan itself.

No doubt, Coach's management is trying to do the right thing for the company, but good intention does not necessarily mean a good result, especially in a turnaround scenario. If we examine Coach's past success closely, we shall see a company with great efficiency. Average return of equity of more than 50% is impressive, but it is another sign of underinvestment. Coach management did confirm their lack of investment in the last several years in the presentation and their short-term profit-driven strategy in the past. They want to change, but what are the odds of a success? I do not feel comfortable with even a 70% chance. Even though Victor is a new CEO, most members of his senior management team, including himself, have been with Coach for a while. They are used to the short-term profit-driven style. It will be quite different for them to change to an investment mode. So far, the turnaround plans laid out in the 4-hour presentation are just the very typical luxury retail revamp, i.e., closing underperforming stores, ramping up marketing campaigns, revamping full-price store format, etc. There is no guarantee that management will execute the plan precisely.

Counter-argument?

I can hear some counter-arguments to buy Coach now. The number one reason is that Coach is very cheap now, traded at a trailing P/E of less than 11. For a company generating ROE of near 50%, it is very cheap valuation. But it is not necessary the ROE for the new Coach. It is certainly not the case for Coach FY 2015 and FY 2016. For FY 2015, Coach projects a low double-digit revenue drop and an operating margin decline to the high teens from almost 30%. Combining these numbers, I see Coach may experience net income decline of 50% in FY2015, which translates to a future P/E of 22. By no means is it a cheap valuation for a company subject to high turnaround risks.

Furthermore, if Coach still does not see a positive turnaround sign by FY 2016, the company may announce management shakeup, which will likely produce an even lower share price and an even longer turnaround time. The financial market is good at forward-looking, but typically only in a six-month to 1-year horizon for troubled companies. So, any short-term rebounds caused by supply/demand imbalance will likely fade soon after.

My recommendation is staying on the sidelines for the turnaround process. Buy only after solid positive signs. Certainly, this approach will miss the absolute bottom, but it limits significant downside and generates returns much faster. For example, the people buying today have as little chance to buy at the bottom as my approach does. If they are lucky enough to see a successful Coach turnaround, their money may generate as much percentage return as my money does. But they will likely lose the time value of money in the next 1 or 2 years. Not to mention the risk of turnaround failure. As a result, the waiting is worth the upside risk here.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within 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.