As a seller of something that many people want, but nobody really needs, Coach (NYSE:COH) is an interesting economic barometer in its own right. Like so many other semi-luxury or luxury brands, Coach knows how much of its future growth rests in China, but the company must also find that sustainable niche of "affordable luxury" that is so hard to maintain in the North American market. While economic weakness is going to have a disproportionate impact on Coach, this stock is a name to watch as a rebound play for when conditions and sentiment turn more positive.
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A Decidedly Mixed End to the Fiscal Year
Coach's fiscal fourth quarter was not brilliant, but neither was it a disaster. Revenue rose 12%, due in large part to high-teens growth in Japan and over 60% growth in China. North American performance was disappointing, as comps rose less than 2% on weakness at the outlets and decelerated for the sixth straight quarter.
Profitability continues to be no problem for Coach. Gross margin improved nearly a point, while operating income rose 19% as management managed to leverage additional operating efficiency on top of that gross margin improvement.
SEE: Understanding The Income Statement
ABC - All 'bout China
Luxury and semi-luxury brands are carpet-bombing China with a flood of new stores and distribution arrangements. While economic conditions in China are not great right now, and sales for big-ticket items like cranes and excavators have fallen off markedly, there's still a large pent-up demand for consumer goods and the savings/income to afford them.
I'll be curious to see how the brands ultimately settle out as China matures. Clearly the sheer size of the country gives ample opportunity for high-end luxury companies like LVMH (OTC:LVMUY), Mulberry (LSE:MUL.L), Hermes (OTC:HESAY), Tiffany (NYSE:TIF) and PPR (OTC:PPRUY). At the same time, if Coach ((and Michael Kors (NYSE:KORS)) can tap into that same "mass-affluent" sensibility, the long-term revenue and cash flow potential could be large indeed.
SEE: Earning Forecasts: A Primer
A Slowdown or a Shift in North America?
I continue to wonder if Coach can maintain its market niche for the long term. There was a time when brands like Benetton, Esprit and PVH's (NYSE:PVH) Tommy Hilfiger were thought of as much more special than they are today; moving to a less exclusive brand image led to a burst of sales and profit growth, but ultimately knocked those brands off their pedestal.
That's more of a concern for another day, though. Right now, the bigger issue is the general economic environment in North America and the company's merchandising issues in the outlet stores. Kors certainly has more momentum right now, as the company's North American comps were up 37% for the spring quarter, but there ought to be room for both in North America and the global market. Still, I'm of the opinion that Coach is too mature to really be a North American growth story in the future.
The Bottom Line
Coach shares look pretty undervalued today on the basis of cash flow. Investors should approach this with caution; consumer growth stories are usually overpriced during their growth phase and transition to value only when the growth starts to dry up. The risk, then, is that value-inclined investors are going to overestimate just how much share and profit momentum Coach can maintain as a mature company.
All of that said, I think there's still fuel in this tank. The company needs to straighten out its issues with the outlet stores, but even as sales growth slows to the mid-single digits in the coming years, these shares look underpriced. Investors need to be cautious with the timing; further declines in North American consumer confidence could easily weigh on these shares, but I would expect them to start moving once investors believe that spending has bottomed out.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.