Concern Over Coach

Coach (COH) reported earnings Tuesday morning and while analysts lauded the numbers as beating consensus and commented on 22 straight quarters of earnings growth, an interesting thing happened… The stock didn’t go up. In fact, it dropped over 5% on the third highest volume day this year. Personally, I put much more credence in what the market says over any analyst, no matter how talented or what credentials he has.

The last time I mentioned Coach, I mentioned that there was a good chance the brand mystique could be wearing off as the company opened new stores rapidly and had a line of bags selling for less than $400 [what a deal - ehm]. The final quarter [fiscal year ends in June] did little to convince me otherwise as the company reported factory store sales [read discount outlet stores] rose 31.2% while normal full price retail sales were only up 11.6%. The company is making headway in its indirect sales which are basically sales from department stores, but if Coach is available in all department stores doesn’t that do a little to cheapen the brand too?

An analyst asked about the possibility of cannibalization from factory stores and got an emphatic “NO” from management. The company claims to have done rigorous tests to determine that factory sales are not harming full price sales in any way, but later in the call management noted that many customers prefer to wait until a brand becomes available in the factory stores rather than pay up for it right away when it is first offered in normal stores. I take this to mean Mrs. Smith may love the handbag when she sees it in the retail store, but knows she can get a better deal if she waits. Mrs. Smith’s gain becomes Coach’s loss as 1) it likely pushes the sale to a later quarter or reporting period, and 2) causes the sale to be at a discounted price.

Analysts also commented they were disappointed to see the company had not repurchased shares. Coach has a great balance sheet with plenty of cash and investments. Capital expenditures for the next year look to be well within the company’s ability, but my main concern still revolves around selling luxury products at a split price. A difficult market environment could spell trouble for the consumer and in turn, Coach. I would avoid the shares and am excited to see if I can make a decent return on my short position.

COH 1-year chart

Full Disclosure: Author has a short position in COH.