Wait Before You Buy Coach, Sell Michael Kors

| About: Coach, Inc. (COH)

Coach (NYSE:COH), an "affordable" luxury player in the accessories business, shed 18% of its price yesterday, following its earnings release for the last quarter for its fiscal year 2012. The drop in price is attributable to fears of losing market share for the company's North American operations to competitors like Michael Kors (NYSE:KORS). The North American comparable store sales were up 1.7%, far less than what analysts had expected (6.5%). This was due to the removal of the in-store coupons that attracted customers to factory outlets.

Coach's Performance:

For fiscal year 2012, revenues are up 14.5% (YoY) as compared to 15.5% in 2011. The last quarter saw an increase in sales of 12% over the last year.

EPS is up 20.9%, from $2.92/share in FY2011 to $3.53/share for FY2012. For the last quarter, the EPS came out to be $0.86, showing a 27% increase over the last year.

The company beat analyst estimates for EPS, but fell short of the revenue estimates.


Analyst estimates

Last QTR revenue

$1.16 billion

$1.2 billion




Operating margin for the last quarter was 32.1%, compared to 30.3% last year. For the full year, it was 32.6% compared to 32%.

Debt is not an issue, as the current portion of its long term debt is approximately $22 million. Cash flow from operations was $102 million for the quarter ending March 2012.

International direct sales were robust (China's Q4 sales growth was 60% with double digit comparable store sales and Japan's Q4 sales were up 18% in dollar terms), while North American sales slipped because of competition. The company had earlier removed its coupons at lower priced (factory) outlets, which turned away shoppers who are already price conscious given the prevailing economic conditions. The company responded by reinstating coupons in some factory outlets in June. The factory outlets constitute two-thirds of the revenues that Coach earns from its factory and premium priced outlets. Removing the coupons turned out to be a self-inflicted blow, which the company realized and remedied. JC Penny (NYSE:JCP) had earlier suffered as well after it removed its coupons. Mid-tier stores like Kohl's (NYSE:KSS) have also suffered earlier due to consumers being more discrete in spending.

According to the company, international indirect sales through department stores were up because of the growing luxury market abroad, while U.S. department store sales decreased. Overall, the indirect sales were flat.

Coach has a 35% share of the U.S. hand bags market, compared to KORS' 9.5%. This 9.5% can be expected to increase if KORS continues to expand at its current pace.

In North America, Coach presently operates 354 retail stores and 169 factory outlets. China now has 96 outlets, with an addition of 11 net locations. Japan's stores total stands at 187.

The company has reported double digit sales and earnings growth for the last 11 quarters, and is considered a pioneer of the "affordable luxury" segment. Coach is currently pursuing initiatives to grow internationally, especially in emerging markets for luxury, and is making inroads in men's accessories. It also introduced its domestic Coach distribution businesses in Taiwan and Singapore this year.

Future Outlook:

International growth will be the main driver of the company's sales growth and profitability, as COH plans to keep buying distribution businesses in countries like Korea and Malaysia. Coach termed FY2013 as "an investment year" in its earnings release.

The company recently launched its Legacy line of accessories, including bags and shoes, and is positive about its contribution to the bottom line.

The company reiterated its goals of continuing double digit sales and profits growth going forward.

Competition from KORS:

KORS, which drives 75% of its sales from accessories like handbags, is in the early stages of expansion and acquiring a greater market share. It started opening stores in 2006 and got listed late last year. Last quarter it opened 71 stores, which helped in fueling the sales growth of 80%. It is also opening shops within department stores. KORS has the potential to have 600 stores across the world, according to its CEO, who also says that the company plans to derive 70% of its revenue from its own stores in the future. It might be prone to fashion misses as it progresses, an area where Coach has consistently delivered in. Moreover, the high same store sales would decline once the company stops adding new stores.

KORS currently trails Coach in gross and net margins. Gross margin in the last quarter reported by KORS was 55% compared to Coach's latest quarter gross margin of 72%. Net margin for KORS was 11.5% in its last reported quarter, while it is 22% for COH.

The inventory turnover for KORS is 3.7 compared to COH's 2.6.

KORS is aiming to build outlets close to Coach's, according to a UBS analyst.

According to retail metrics, same store sales for KORS would come in at +34.6% for July. In its last quarter, this figure was 37%. This high number reflects shoppers' preference for the relatively new KORS, over pioneers like Coach.

Michael Kors expects full-year (FY2013) sales of $1.7 billion-$1.8 billion (while the Street expects $1.78 billion) with EPS of $1.08-1.12/share (Street estimate is $1.12/share). For the last fiscal year ended March 2012, it reported sales of $1.3 billion.


Yesterday, when Coach traded down by 18%, KORS was down 0.46% and Ralph Lauren (NYSE:RL) was down 1.88%. KORS is trading at almost twice its December 2011 IPO price of $20/share.

The forward P/E for COH is 14x compared to KORS's 34x and RL's 17x. Below is the valuation based on P/E of 14x.

The long term growth rate for COH's EPS is 16%, compared to KORS' 28% and RL's 13%.

In the fiscal year 2012, the company spent $700 million in repurchases. $260 million remains under the repurchase authorization.

We think that the company's stock price has been overly punished by investors for the sales drop, and will rebound in the short term. We give Coach a hold rating in view of the competition in North America, and the weak international economic outlook. Investment and expansions are likely to pull margins down in the coming year.

We will be bullish once we see some improvement in economic conditions, positive response to its Legacy line, achievement of the international sales targets, and some competitive edge over peers like Michael Kors and Fifth & Pacific's (FNP) Kate Spade, which are doing well in the present economic situation. The next quarter's results will show if Coach is able to get back the customers it has lost due to removing its coupons.

We also advise consumers to be cautious about KORS because of its high P/E. Earnings growth will slow down once the rapid expansion come to an end, and the company stops gaining a further market share in North America.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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