Coach -- Japan's Love of High-End Luxury Items (COH)

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What do you think about the following statistics?

Japanese consumers purchase 40 percent of the world's luxury goods every year. A 2002 survey found that 94 percent of Tokyo women in their 20's own a Louis Vuitton (Euronext PAR: LVHM) product; 92 percent own Gucci (ADR:, 58 percent own Prada, 52 percent own Chanel, and 44 percent own Christian Dior (Euronext PAR: CDI). Consumer habits such as these have driven a growing number of the world's luxury retailers to open stores in Japan to better meet consumer demand.

The most recent big name luxury entrant into Japan's lucrative market is Coach (COH), which arrived in 2001 and now derives more than 20% of its global revenue from Japan, its second largest market outside North America. Let's take a further look at what's going on at Coach Japan.

First, I must give credit to JETRO, the trade arm of the Japanese government that just published a report on the Japanese retail market with the above mentioned statistics and a case study on Coach. Also below I will use Coach's Q2-'06 (quarter ended Dec. 31, '05) earnings conference call transcript to highlight Coach Japan's activities and achievements.

Within the JETRO study it's stated, "Foreign luxury retailers also have established R&D facilities to refine their products to meet Japanese consumer standards, which then serve as a benchmark for worldwide success of their products." And Richard Collasse, president of Chanel K.K., is quoted saying, "Looking at our efforts in innovation, we established our own R&D unit in Japan, since this country unquestionably has the most advanced technology in cosmetics. We made this investment because we concluded that we needed to develop products for not only Japan but also the global market."

JETRO on Coach

    • Coach Japan is a wholly-owned subsidiary of Coach

    • Fastest growing imported handbag and accessory brand in Japan

    • Holds #2 market share for imported handbags and accessories

    • 106 stores in Japan

    • Recorded 39.6 billion yen (US$367 million at arbitrary rate Y108/US$1) in sales in FY05 (7/04-6/05)

    • Plans to double domestic Japan sales over next four years to 80 billion yen (approx. US$695 million at Y115/US$1)

Coach Earnings CC Key Points Regarding Coach Japan

    • Market share in Japan has grown to 8% with goal of expanding to 15% over next four to five years

    • New growth driven in Japan by opening new stores and expanding existing ones

    • Based on Coach's U.S. multi-channel distribution model it's expected Japan could support at least 150 locations

    • 6 net new locations planned in Japan for remainder of FY06 including one flagship in Kobe

    • At least 12 total net new locations estimated for FY06 (to bring total to 112 locations)

    • Plan to expand about 10 of most productive shop-in-shops, adding 3% to retail base in FY06

    • Q2 FY06 sales increased 20% in yen and 7% in dollars

    • Expecting constant currency sales to increase by over 20% in FY06 y-o-y

    • Increase in FY06 sales primarily to come from distribution growth with mid single-digit comps expected during the rest of this fiscal year

    • Bought out Sumitomo's 50% stake in Coach Japan in '05 consequently offsetting overall firm's strong free cash flow

    • Very large opportunity to grow "limited edition" business. It’s actually somewhat less developed than our businesses in the United States running about 3% of sales compared to 6% in U.S.

    • Total impact of the yen on rates of profitability is relatively small. Coach Japan operates the business completely in yen and their full-fledged financial statements are then converted back, so every line of the P&L is effectively reduced from the top line to net income but changed only by the change in rate of the yen, so the pure conversion does not move our earnings per share materially. Where it does impact rate of profitability is through the gross margin line, and as I mentioned earlier, that was a assist [sic] to us in Q2 and will have a negative impact on gross margin in the second half of the year, but we’ve built that into the guidance as we’ve talked about earlier on this call.

COH 1-yr chart: