I first wrote a Coach Inc. (NYSE:COH) overall review here. At the time, I classified the company as a long-term buy, especially because of the pronounced stock price decline. However, seeing the volatility on the stock, I think we need to put proper emphasis on the short-term turbulence that the company is going to face in the following quarters. I believe this exercise is needed in order to prepare the long-term holder to face the short-term with confidence.
During the most recent earnings conference call, CEO Victor Luis gave several indications about what we can expect during the following quarters.
New brand concept
We have also discussed our holistic strategy to position Coach, as a global modern luxury brand, further differentiating ourselves from the accessible luxury positioning that we defined. -- Victor Luis, CEO
Basically, the company wants to go from an affordable luxury accessories company to a modern luxury lifestyle brand. This move will open the current portfolio of bags and accessories to other clothing and footwear. At the same time, the passage from affordable to modern is a clear indication that the company is no longer open to sacrifice its margins for sales growth.
The main problem kicks in the short term. The company is focused in redefining the brand and experimenting with new collections. Most likely, this trial and error exercise will bring inventory costs up, constituting a major drag on the company's sales and margins in the short term. Obviously, in the long run, if the new positioning is successful, Coach will benefit from the higher price points to achieve better margins. The incursion into other clothing categories, should offset (at least partially) the lost sales due to higher price points.
In addition, we will broaden our presentation in U.S. department stores, including moving to more open, accessible and fully-branded displays, changing our product offering, driving relevance and making Coach more shoppable. We will be further developing our outlet strategy to maximize our modern luxury merchandising strategies, product flow and leverage our new store concept. -- Victor Luis
In order to achieve the transition from affordable luxury to modern luxury, the company has to redefine its retail policy. Therefore, Coach intends to spend around $500 million in redesigning its stores, while it predicts to close around 70 underperforming stores. Again, the costs associated with closing underperforming stores and refurbishing the surviving stores, will be a major hit on sales and margins.
The bright side
Not everything is going against the company fortunes. The international sales (i.e. excluding US and Japan) are growing, which has helped to smooth the sales figures. On the same note, the Men segment is also growing considerably.
Unfortunately, the growth trends in these segments are slowing down. In my opinion, this means that the company has limited time to sort its problems in the home market before things start getting worse.
I fear that things might get very confusing in the short term. On one side we have decreasing sales in the US and Japan, on the other side we have growing sales in the international markets. I see 3 main possible scenarios:
- The home market recovers sooner than anticipated, in which case the turnaround will be mostly unnoticed going forward, and the stock price should recover rapidly;
- The home market keeps underperforming and the international markets start declining. In this case, things will be ugly for a couple of quarters, the stock price should fall a lot;
- The home market keeps underperforming while the international markets keep growing. The stock price should stabilize or even improve a little.
In any of the scenarios, I believe that the company has what it takes to execute the turnaround successfully (you can consult my previous article on this company). This way the long-term investor should be focused on the long-term earnings power. Obviously, the 3 mentioned scenarios could have a big impact on the timing of the buying decision. I fear that my crystal ball can't offer much help on which scenario will materialize (at the same time this should offer a good debate in the comment section).
Putting the pieces of the strategy together, we should expect to have lower sales than presently. On the other hand, we should expect to have better margins than currently. I am using 2011 revenues as reference while I think the company should target 25% profit margin, therefore:
Table 1 - Projected normalized earnings for 2016
As we can see on table 1, there is a lot of potential after the turnaround is completed. I have used a 14 multiple for earnings, which I believe to be conservative. The price around $51.25 offers significant return given the present price around $37.
My view is that the investor should avoid the short-term noise (or even use it to create buying points) and focus on the long-term picture.
Final Remarks: I deconstructed what I believe to be the main variables in this case and created a basic model and a simple set of scenarios that any reader can use. I populated it with my own assumptions, obviously, many readers will not agree with them. I will just ask you to:
- If you don't agree with my assumptions: provide your own assumptions in your comment;
- If you think the scenario/model is flawed or incomplete, please give a good argument;
I believe this will enrich the debate. Thank you very much.
Disclosure: The author is long COH.
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.