Coach: An Imminent Takeover Target?

| About: Tapestry, Inc. (TPR)


Rumors are starting to swirl that the company is an imminent takeover target.

Even if the rumors turn out not to be true, such rumors are a clear indication that there is more value to the company’s shares than the market is recognizing.

The shares pay an over 3 percent yield that the company is committed to continue paying as plans to transform the company brand go into effect.

We were preparing our third article on Coach, Inc. (COH) during the week for publication at the beginning of the market-trading week when we noticed a surge in COH's stock price on August 8, 2014 (Friday) without explanation. Our first response was "Someone knows something." Later in that trading day news came out that a French luxury-brand company named Kering was potentially about to bid $48 for COH's shares. The shares rose over 5 percent on the rumors. Both companies refused to comment on the rumors.

We do not know whether the rumors will come true, but we do know that such rumors are a strong indication that the market is not fully realizing the value of COH's shares despite the company's well-known recent struggles. Since the beginning of 2014, COH's share price is down over 30 percent and had been repeatedly hitting 52-week lows since early May 2014. While COH has been struggling, we discussed in a previous article the company's detailed and sophisticated plans that were targeted to transform the company from an "accessible luxury" accessories brand to a "modern luxury" lifestyles brand. We strongly believe that those plans, launching within weeks in the U.S. market (in advance of the company's new Fall/Winter 2014 collection), will rejuvenate the brand and the company's share price.

Fiscal fourth quarter 2014 earnings

Net sales on a reported basis totaled $1.14 billion versus $1.22 billion a year ago, a decrease of 7 percent. Earnings per share totaled $0.59 as compared to $0.89 in the prior year's fourth quarter, excluding transformation-related charges in both periods. International sales increased 7 percent to $414 million from $388 million last year. North American sales fell 16 percent to $691 million from $825 million last year. COH's sales in their international division represent about one-third of COH's business. Sales rose 7 percent on a reported basis, primarily impacted by a weaker yen on a year-over-year basis. China sales rose about 20 percent from prior year, taking the full year to $545 million, fuelled by double-digit same-store sales and distribution growth. In Europe, where COH's brand is small, but growing rapidly, the company generated significant sales growth.

During the earnings call, the CEO of COH set forth trends the company is facing and within the market as a whole:

There were some sustained themes in our North American women's business throughout the year, including our fourth quarter. Leather continues to outpace logo across all channels and we are designing into this trend. It's a long-term shift that favors Coach, given our heritage in leather goods. Small bags also continue to trend well. In addition, we saw a relative strength in our elevated product in our retail stores. More generally, the above $400 price bucket grew in penetration and represented 21 percent of handbag sales versus roughly 16 percent last year.

Turning to men's, which represents 18 percent of the global category spend or about $7 billion today, and is expected to grow faster than women's at about a 10 percent rate over the next five years. As we've discussed, we're also continuing to drive our men's business globally, through new standalone and dual gender stores. In the fourth quarter, Coach's sales of men's bags and accessories continued to rise, taking the year to about $700 million globally. Looking ahead, we remain bullish about the prospects of our men's global business. However, given the announced brand transformation initiatives, … we are now targeting $1 billion in sales in fiscal year 2017, one year later than our original target.

Importantly, our focus remains on the long-term growth initiatives we have previously shared. First and most broadly, growing our business in North America and worldwide by transforming into a lifestyle brand; second, leveraging the global opportunity by aggressively growing our international businesses; third, tapping into the large and growing men's accessory market and other lifestyle categories; and fourth, harnessing the growing power of the digital world.

We are particularly excited about the replatforming of our brand, with the launch of Stuart's first collection starting this fall. We will also be introducing our new modern luxury retail concept in several key locations during holiday. Our global brand message will reinforce our distinctive positioning of effortless New York style through the use of iconic brand elements and the city's dynamic landscape as backdrop.

The company's earnings were slightly above the already dramatically reduced earnings estimates for the company. (The negative earnings were anticipated since the company's June 2014 analyst meeting.) The company's shares rose on the earnings announcement but gave up most of their gains in the following days until the takeover rumors arose.

Branding reset plans are likely to reinvigorate the company's brand COH's branding reset plans, which we discussed in greater detail in an earlier article, are well thought out, have been in the planning stage for at least one year and are about to be more visible to the public in September 2014. In summary, COH's plans to repair their self-inflicted wounds and to compete in the market are as follows: 1) reduce discounting and over reliance on outlet sales; 2) emphasize COH's quality, craftsmanship and the lasting relationships they have established with consumers; 3) adapt to changes in the North American women's accessories business; 4) pursue opportunities in China and Japan which COH considers their two most significant growth opportunities outside of the U.S.; 5) emphasize leather in their products as opposed to the "C" logo; 6) retain some COH signature design details in their new bags including the metal turn lock closure, hang tags and the horse and carriage logo; 7) emphasize a mix of COH's heritage with New York style; 8) aim to balance craftsmanship with functionality, while appealing to a new, younger and altogether more fashionable customer; and 9) reduce their product line of hand bags and increase their share of higher-priced affordable luxury models to address a market above much of the average prices of the affordable luxury market but below the European luxury product maker prices.


COH competes with multiple companies in the hand bag space. Michael Kors (NYSE:KORS) and Kate Spade (NYSE:KATE), however, are thought of as COH's primary competitors. COH effectively created the affordable-luxury hand bag market years ago. As KORS and KATE became increasingly successful competitors, COH, by their own admission, failed to continue to innovate and increasingly relied on discounting to increase their sales. Discounting has damaged COH's brand in the North American market in particular.

Analysts' views and our views

Analysts' opinions on COH are almost uniformly negative with most price targets for the company in the range of the upper $20s and the mid $30s. More optimistic analysts were encouraged that the company's comparable store sales were down less than expected. They noted that the company remains "in an investment cycle" by spending heavily on new product lines and on "re-platforming" their brand with revamped stores. Analysts with more negative opinions believe that COH is "a fading brand" and see little success in the company's repositioning efforts for "three to five years."

We have previously stressed that COH is navigating through difficult times. That said, COH has been planning almost a year in advance for this moment. We believe the company's branding reset plans are well thought out and likely to put COH on the road to repairing their brand. With COH's earnings announcement now passed, we can clearly see that the company is profitable but has fallen behind in the market. COH's setback is not permanent and need not take as long to recover from as analysts estimate.

While the company's earnings were clearly negative, COH telegraphed their earnings for the coming year in their June 2014 analyst meeting. Analyst estimates average $2.09 for the 2015 fiscal year as the company heavily reinvests in transforming their brand. In our earlier article on COH, we stated our belief that 18 months from now COH will prove skeptics wrong and reward investors. In fact, we stated that an investment in COH today would outperform an investment in highly-priced KORS shares over such 18-month period. We continue to believe such statement is true whether the above-discussed rumored takeover takes place or not. If the takeover takes place, COH shareholders will be rewarded immediately. If the takeover does not take place, COH shareholders will be rewarded with an almost 4 percent dividend while the company's detailed plans to reinvigorate and transform their brand take hold. Either way COH shareholders are destined to win.

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.

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