- Buying Coach solves one of the major strategic conundrums for European players.
- Strategically, Coach can act as a bridge between high-end luxury brands and upmarket affordable luxury segment.
- Coach remains undervalued at current price levels, with a fair value estimate of $46 per share.
Owing to the ignorance of risks associated with moving a chunk of its products down-market, sales in North American market sunk like a stone for Coach (NYSE:COH). Emergence of affordable luxury entrants like Michael Kors (NYSE:KORS) and Kate Spade (NYSE:KATE) in Coach's territory exacerbated market share losses for the company, pushing its stock to unseen levels in the last few years. Given the stock's attractive valuation, rumors of the company buyout by France's "Kering" at $48 per share surfaced late last week. I have written extensively about Coach on Seeking Alpha (Article I, Article II, and Article III) and firmly believe in Coach's turnaround story and think the stock remains a potential buyout target at these price levels.
Unfortunately, management's bold attempt to steer the company into the down-market segment was doomed to fail, since affordable luxury had become the norm by then, rather than the exception. Facing this strategic riddle, the company ceded to price parallelism - aggravating the price wars, brand dilution, and sending its core customers drifting away. After several years of global success, Coach became a victim of its own success.
A potential answer to this strategic disaster requires careful rebalancing between absolute luxury and affordable luxury. Redefining a marketing campaign to share its cultural inheritance, and develop an emotional relationship with the consumer will help in gaining its customers back. In addition, the company should incorporate what its learned from the mistakes made by its European rivals who abandoned affordable luxury customers over wealthy customers. Designing the product mix targeted for outlet channels is a step in the right direction and enables the company to charge attractively by underlining newness.
Management has identified men's category as the next upcoming category for generating growth. Duplicating its success from the women's category into men's should remain a key focus. As mentioned during the recent earnings conference call, sales of men's bags and accessories continued to rise, taking the year to about $700 million globally. Men's category is expected to grow faster than women's at a 10% rate over the next five years.
Even though Coach remains exceptionally strong and continues to grow in the Chinese market, building stronger positions in the Chinese market at a cost of taking their eyes off European markets could cost the company significant opportunity. European markets offer pent up middle-class demand for luxury goods that fuse exclusivity with affordability. Penetrating European markets with a differentiated product and a sense of newness can encourage growth with a better price point. The company generated significant sales growth at POS and double-digit comps in the quarter in the European markets. Nonetheless, Coach needs to ratchet up its investments to spur brand promotion in European market or risk losing this opportunity to Michael Kors, which has already exploited the gap left by European players.
Last and the most-critical step in this direction is to limit outlet growth and close underperforming stores. The company plans to close approximately 70 of its least productive stores, creating uplift for the comp sales in the future.
Why Coach remains a target for European rival
Affordable luxury goods category has reached an inflection point, as an industry in its own right. Contrary to widely held beliefs, the affordable luxury segment has started to harm the luxury segment. Seeing no signs of growth slackening off in affordable luxury goods, and declining sales in upmarket segments, European players face a strategic conundrum for the future. As I mentioned earlier, Michael Kors exploited the gap left by European players in their markets as they concentrated heavily on development in Asian markets.
Increasing sales by shifting price points presents a major brand dilution risk for these names - something Coach has still not recovered from yet. Purchasing a stake in Coach puts up a credible deterrent for Michael Kors, inhibiting its expansion plans. Such a move could corner Michael Kors and limit the price wars in affordable luxury segment. Last but not least, buying a stake in Coach enables these players to do what they do best, "Appealing to the wealthy consumer."
I strongly continue to believe in the turnaround story for Coach, and hold the conviction that after the completion of this transition, its share price will converge to fair value estimate of $46 per share.
Additional disclosure: Initiated long Jan 2015 35 calls after analyst day.