Why Coach Isn’t Fashionable With Investors

By Jonathan Berr | October 23, 2013 AAA

Shares of Coach (NYSE:COH) plunged about 8% yesterday after the largest maker of high-end handbags reported worse-than-expected quarterly results, underscoring concerns that the company is losing ground to Michael Kors (Nasdaq:KORS) and other rivals.

Net income at the New York-based company fell 1.6% to $217.9 million, or 77 cents per share, compared with $221.4 million, or 77 cents, a year earlier. Revenue fell to $1.15 billion. Analysts had expected profit of 76 cents on revenue of $1.19 billion. The company has disappointed investors for three out of the past four quarters.

The results had plenty of red flags to worry investors. North American sales fell 1% to $778 million while international revenue was little changed at $365 million. Comparable sales, a key metric of stores open for at least a year, fell 6.8% in North America during the quarter, which was worse than the 2.9% drop Wall Street expected. Operating margin fell to 27.9% versus 28.6% a year earlier, and this number will decline further for the rest of the year. Inventory jumped 6.5%.

Under CEO Lew Frankfort, New York-based Coach has tried to transform itself into a global lifestyle brand by adding additional products geared toward men (sales of which gained 25% in the quarter). They are expected to hit $700 million in 2014, an increase of about 20%. Coach also is expanding internationally and boosting its presence online.

In an interview with CNBC, Frankfort noted that sales in North America were weak, “Otherwise we performed to and exceeded expectations .… We were late to respond to competition. The competition is doing extremely well.”

Selling general and administrative (SG&A) expense as a percentage of net sales were 43.9% versus 44.2% a year ago. These costs are expected to rise as the company ratchets up marketing in Europe and what it refers to as “brand transformation initiatives.”

Coach is betting that customers will be moved by new collections such as the Coach Borough Bag line, which sells for $378 to $1,198, as it tries to counter the perception that it is losing ground to rivals such as Michael Kors, Marc Jacobs, Tory Burch and Fifth & Pacific Cos.' Kate Spade. As the Wall Street Journal noted, North American sales at Michael Kors has surged more than 50% in each quarter since its December 2011 IPO, far better than the 9% gains Coach has seen. Though it also is offering footwear, Coach denies that it's losing focus.

“Handbags and accessories has been and will continue to be a key core category for Coach and the main driver of our business,” Frankfort said on the earnings conference call. “We have a great team in place and certainly we don’t know of another brand in our core space that has the experience and the execution of transformations in their path as we do, and we’re excited about writing this chapter and the journey ahead.”

That’s a journey that Frankfort will not be leading. Earlier this year, he announced plans to leave Coach, where he has worked since 1979. Frankfort will stay on as executive chairman after his successor Victor Luis takes over in January. Executive creative director Reed Krakoff, who acquired his namesake brand from Coach, has also resigned, and he has been replaced by Stuart Vevers.

The Bottom Line

Coach shares are cheap, trading at a price-to-earnings multiple about 15, near a 5-year average low. Frankfort, for one, told CNBC that he will buy shares when the company’s quiet period ends. “Early indications are extremely encouraging,” he said, regarding next year. Investors should follow Frankfort’s lead because the company is an iconic brand that might attract a buyer if its turnaround strategy falters.

Disclosure - At the time of writing, the author did not own shares of any company mentioned in this article.

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