Coach: Growth In China Cannot Offset Weakness In North America

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Fashion is a fickle business. A brand can become a household name overnight if the right celebrity is seen wearing it. But all it takes is a single bad season or a new fashion darling to catch the eye of the fashionistas to torpedo a decades-old premium brand.

Unfortunately for handbag and accessory maker Coach (COH) — as well as the embattled holders of Coach stock — the winds of fashion appear to have shifted.

Shoppers — and particularly American shoppers — have fallen out of love with Coach’s wares. And COH has been powerless to stop rival Michael Kors (NYSE:KORS) from cutting deeply into its market share.

A Quick Look at Coach Earnings

First-quarter Coach earnings just came out, and it wasn’t pretty:

  • Sales were down 21% in North American stores open more than a year.
  • Company-wide, sales were down 7% for the quarter, or 5% stripping out the effects of currency moves.
  • Not surprisingly given the sluggish sales, COH’s margins took a hit across the board; gross margin fell to 71.1% from 74.1% a year ago, and operating margins tumbled to 23.9% from 29.3%.
  • Earnings for the quarter declined from 84 cents per share in the first quarter of 2013 to 68 cents last quarter.

Investors didn’t take the news well; shares of Coach stock are down more than 8% on the news.

Yet as dismal as the COH results were, there was a fair bit of good news buried in the press release.

For instance, Chinese sales rose 25%, and Chinese same-store sales rose at a double-digit rate — and this despite the slowdown in the Chinese economy. International sales grew at 14% and 20% if you strip out the effects of currency moves. Sales of men’s products were also “strong,” though specifics were not provided in the press release. And management maintained the dividend of Coach stock at 33.75 cents, offering a yield of 2.9% at current prices.

So… what’s an investor to do? Has Coach stock now become an attractive value play after the slide?

COH: One Big Hang-Up

At first glance, there is a decent bit to like. Coach stock is relatively inexpensive, trading for less than 15 times consensus 2014 earnings estimates of $3.13 per share. And while margins have slipped, COH is still a wildly profitable company. Coach’s return on equity has consistently been above 30% since 2001. COH also has been a dividend-raising machine, more than tripling the quarterly payout to Coach stock since initiating a dividend in 2009.

And let’s not forget the success the company has had in China and in pushing new product lines, such as accessories for men.

There’s one big problem, however.

COH is still very dependent on American women, the key demographic that has abandoned the brand. 543 of Coach’s 1,011 stores are in North America, and the region accounts for 60% of sales. Another 199 stores are in Japan — a country with tepid domestic demand and a currency that I believe to be in terminal decline. COH has 147 stores in China and another 96 in other parts of Asia. Together, these make up nearly a quarter of Coach’s store count.

So, an investment in Coach stock is essentially a bet that either the Coach brand stages a major comeback among American women, or that its popularity abroad surges ahead fast enough to compensate for declines in North America.

Sure, a fashion comeback could happen. However, accomplishing a turnaround in fashion is trickier than accomplishing one in, say, industrial machinery. Once a brand loses its cachet, it’s hard to get it back.

What about international sales? Here, the outlook is better, and I expect Coach to benefit from a turnaround in emerging-market currencies. But if the brand has lost its appeal among American women, it might be just a matter of time before their sisters in China and other emerging markets follow suit.

Bottom line: It’s probably best to sit this one out for now. Avoid Coach stock.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. This article first appeared on Sizemore Insights as Coach: Growth in China Cannot Offset Weakness in North America.

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