Hold On Until Coach Recovers

| About: Coach, Inc. (COH)

Coach Inc. (NYSE:COH), a prominent New York designer and retailer of modern luxury accessories for men and women, recently reported its Q2 fiscal 2014 earnings. The company's revenue declined by around 6% during the reported quarter compared to the previous fiscal year's comparable quarter. Earnings were 15.9% lower in comparison to Q2 fiscal 2013. These results reflect the company's poor performance and were below analysts' estimates. Analysts, on average, expected the company to earn $1.11 earnings per share and the company was just able to make $1.06/share. The company's revenue also missed analysts' estimates by $60 million. As a consequence of this event Coach's share price plunged by 6.57%.

The company's deteriorating performance in North America has been identified as the reason behind the shortfall in figures. Earnings from North America fell 9% while the company's international sales grew by 2% in comparison to the previous fiscal year's results. The company's CEO also regarded the weakness in the company's North American women's bag and accessories business as the reason behind the decline in the holiday quarter's sales. This decline was partially offset by solid growth in men's footwear. The international segment grew as a result of vigorous sales in the emerging Asian markets and Europe. The company's sales in China also increased by 25%.

So, my article will focus on the company's future outlook with respect to the factors behind the company's underperformance. I will also consider the potential areas where there is room for the company to grow as well as the company's struggles to capture back its market position. So, let's begin with analyzing North American Market for the Company.

North America's Materiality and Market Outlook

The company generated 69% of its total revenue in fiscal year 2013 from North America while the remaining 31% was earned from international markets. The decline in women's bag and accessories market has been observed as a reason for the fall in the company's performance. The next heading will detail the materiality of these product categories.

Overall Product-wise Analysis

The following chart demonstrates the revenue contributed by each of the company's product categories. The company has been generating around 60% of its revenue from women's handbags over the last three years. You can also see that the proportion of revenue generated by the company from women's handbags and accessories has been declining from 2011 to 2013. Men's products have increased their proportion from 5% to 11% over the past three years.

Source: COH 10K Filing

So, considering this pattern I will analyze the current situation of the women's handbags and accessories market in North America and determine its outlook to determine the company's future in this market.

North American Women's Accessories Market and the Company's Position

Economic Recovery is A Growth Driver

Premium handbags and accessories are among the rapidly growing segments in the luxury market. The industry was hit by an economic slowdown but started to recover by 2012. Overall, the US handbag market is forecasted to be worth $9 billion by 2015. The increase in consumers' disposable income, the growing middle class, the rising sentiment for branded products and the increase in the number of wealthy people drives the growth for this industry. Recovery in these areas in the US has already provided benefits for the company as sales of the company's handbags priced $400 or more rose during the recently reported quarter. The company has plans to expand the range of products in this category to further support the company's revenue.

Decline in Traffic in Shopping Malls

The company's sales during the holiday quarter were hit by the declining number of shoppers in stores. This was due to the trend of online and mobile shopping. The company's online sales were hit by the non-recurring limited access to the company's e-factory flash sales site. The restoration of accessibility will support the company's sales in the next quarter.

Despite shops offering deep discounts, consumer traffic in malls was down this holiday season. As a result, the shopkeepers were left with massive inventories at stores that were reserved for the large flock of shoppers expected during the holiday season. The situation will turn into a need for clearance sales that are likely to put a strain on profit margins in the coming period. Coach's inventory levels were up 12% during the holiday quarter and deep discounting will further hurt the company's gross profit margin but the company is striving to improve its performance and position. I will now discuss some of solutions planned by the company in an effort to increase sales.

Internal Struggles

Another reason behind the company's shrinking business in North America during the crucial holiday quarter was the loss of its customers to rapidly growing rivals. According to Euromonitor International Coach's market share fell from 19% in 2012 to 17.5% in 2012 but it remains the market leader of the women's handbag market in the US. The loss market share was captured by Michael Kors (NYSE:KORS) whose share rose from 4.5% to 7% from 2011 to 2012.

New Collection by New creative Director Due Next Fall

In order to regain shoppers the company is determined to offer more footwear and fashion to transform itself into a lifestyle brand. Coach will also be displaying a selection of its products at the New York Fashion Week next month for the first time. It is also "rebalancing" its merchandise variety and adding more to its line of handbags valued at $400 or more. The company introduced low-price handbags during the recession but now since economic recovery is evident these things low-priced bags are becoming less attractive. The company aims to grow its foothold by around 9%.

During fiscal year 2013, about 69% of Coach's total net sales derived from its newly launched products. The company now plans to unveil its new collection by Executive Creative Director Stuart Vevers in September 2014. Mr. Vevers joined Coach from Loewe, a luxury handbag brand held by LVMH (LVMH) in September, taking the place of longtime creative director Reed Krakoff. LMVH is the largest global luxury group encompassing more than 50 luxury brands. A person with experience from a successful luxury group can definitely be expected to bring benefits for Coach in the near term.

New launches are likely to attract customer traffic and successful new collections will help the company to maintain its profit margins.

The company also has its international dealings to offset the decline in the US. Emerging markets like China and India with rising purchasing power among working ladies are expected to support the market growth in the coming years. The company has a great opportunity to earn growth from this area and so far it has been capitalizing on this opportunity.

Growth from Europe and Asia

Demand for this industry in Europe is projected to remain positive till 2017 as disposable incomes grow. In July 2013 (fiscal 2014) the company obtained 100% of its European joint venture by acquiring Hackett Limited's 50% interest in the joint venture. This provided Coach with complete control and allowed it to merge its domestic retail business. This will also support the company's growth in the near future as Europe is a growing market for the company's products.

With regards to the Asian market Chinese consumers were the greatest consumer group of luxury goods, in terms of spending, in 2012. The market is still expected to grow in the future as the economic conditions in the area improve with the government's support. The company can be seen expanding in these areas through the rise in its store count (see table below).

Source: COH 10K Filing

Closing Take

Although the company has disappointed the market with its recently reported quarterly results I would still suggest holding its shares. This is because the company is well aware of its weak areas and has started taking action to address those weaknesses. Global economic recovery will support the overall industry growth in the coming years and the company has started to capture stakes in the emerging markets. Hiring a new and competent creative director on and displaying its collection in Fashion Week shows that the company has been striving to improve its position. These actions along with the growth recorded in sales from international markets have made me to remain optimistic about the company.

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

Business relationship disclosure: The article has been written by a Blackstone Equity Research research analyst. Blackstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Blackstone Equity Research has no business relationship with any company whose stock is mentioned in this article

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Tagged: , , , Textile - Apparel Footwear & Accessories
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