Coach is Facing Margin Headwinds on Rising Costs & Discounting

April 5th, 2011 by Trefis Team
COH: Coach logo
COH
Coach

Coach (NYSE:COH) is a leading American marketer of luxury lifestyle handbags and other fashion accessories for both men and women. The firm competes with other premium apparel and accessories players like Polo Ralph Lauren (NYSE:RL), Liz Claiborne (NYSE:LIZ), and AnnTaylor (NYSE:ANN), as well as high-end brands like Louis Vuitton, Hermes, Gucci and Prada.

The handbags division is the most valuable segment for Coach contributing more than 50% to the stock value. However, Coach’s handbags profit margin has been declining consistently from a historical high of above 40% in 2007. The decrease was a result of a combination of factors: promotional activities and price reduction to induce consumer spending during the recession, higher expenses from Coach-operated stores in North America, Japan and China, and a declining proportion of department stores & other retailers in Coach’s total handbags revenues.

We believe the above factors will continue to affect Coach’s sales in the coming years. While we anticipate Coach’s handbags EBITDA margin will decline to 32% by the end of Trefis forecast period, Trefis members expect a smaller decline in the margin, reaching 34%. The member estimates imply an upside of 4% to our price estimate for COH stock.

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We currently have a Trefis price estimate of $57.04 for Coach’s stock, ahead of the market price of around $53.

Higher Revenue Share for Coach Stores than Department Stores

Coach is focusing on improving its store revenues (as a percentage of sales) as this channel provides greater control over its business. We expect Coach store handbag revenues (as percentage of total division revenues) will continue to increase though at a slower rate than historically as Coach continues to lay emphasis on its own run stores. Since EBITDA margins for Coach-operated stores are significantly lower than margins for department stores & other retailers, an increase in Coach store division revenues (as a percentage of total division revenues) will lead to a decline in handbags EBITDA margin.

Higher Factory Outlet Sales, Rising Costs

In Q2 2011, Coach’s profits increased 26% over Q1, but its margins fell as Coach relied more on its factory outlets channels that typically have lower margins than full-priced stores. Rising labor costs in China are also weighing on the company.

Coach announced plans to move part of its production from China to relatively cheaper destinations like India and Vietnam and is trying hard to drive more sales in order to offset declining margins. [1] Coach reduced the average handbag price by about 10% to induce demand during the economic downturn. The company is expanding its presence in emerging markets like China which has seen double-digit growth where the company expects its China sales to rise to $500 million by the of 2014. [1]

Our complete analysis for Coach’s stock is here.

Notes:
  1. Coach profit rises 26%, but margin falls short, Marketwatch.com, Jan 25, 2011 [↩] [↩]