Coupons, Macro, and Michael Kors – Can Coach Overcome These Headwinds?

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Coach’s (NYSE:COH) stock price has fallen close to 30% since its peak in late March. This decline has been primarily driven by weak consumer spending in North America and concerns of intensifying competition from Michael Kors. Analysts have also noted that it abandoned coupons at its outlet stores in North America earlier in the year as another driver of weak domestic sales. In its last earnings release, Coach reported same store sales growth in North America of 1.7% versus double digit growth a year ago and 6.7% in the quarter before. Macroeconomic concerns in China have also contributed to the stock’s decline but to a lesser extent given that China makes up only 6% of Coach’s sales.

Though near term macro concerns seem to be weighing on Coach’s share price, we believe that the company has a bright long-term future and estimate a valuation for the company that is 50% above the current market price. We have an $83 price estimate for the stock.

See our full analysis for Coach

Possible scenarios going forward

As of FY ’12, Coach’s North American segment contributed close to 70% of its total sales, highlighting the importance of this market to Coach’s performance. Given the recent headwinds in this market and the weak results that Coach reported in North America, we see three possible scenarios for Coach going forward.

First, Coach could continue to lose share in North America and its comparable sales could turn negative in the quarters ahead. Unless the macro in the US takes a significant turn for the worse, this scenario we think is unlikely since Coach has been a dominant brand in the US for over a decade and is adept at dealing with competition and introducing new product lines to win customers back.

The second scenario that could result is a soft, slow recovery macro environment in the US combined with a gradual erosion of share due to competition. This would result in Coach experiencing flat to low single digit growth in comparable sales in North America.

The third scenario that could result is Coach bouncing back from its recent slump and improving its comparable sales growth in the US. We believe this is the most likely scenario and explains our divergence in valuation from the market.  Below, we discuss in detail the assumptions and factors driving our valuation.

Coupons and Macro

Coach’s brand is well recognized by customers in the US. Though the company has seen some slowing in its domestic market, we believe that its brand and cachet will remain strong. Investors have been spooked by the company’s latest quarterly same store sales of 1.7% in North America. This, however, should prove to be a temporary blip as the company continues to execute on its long term growth plan.

The company in January decided to become less promotional and did away with coupons at its North American factory stores. This we believe has been a major driver for the slowdown in sales. The company has recently reinstated coupons and the company mentioned in its FY Q4 ’12 call that once it started offering coupons again it saw a speedy improvement in its factory stores.

Additionally, the macro environment in the US has gotten better in the past few months. Consumer confidence increased in September. [1] and the company’s own survey indicated that two thirds of the customers surveyed would consider purchasing a Coach product in the next twelve months.

Moreover, the company has recently launched a new Legacy lifestyle collection that has resonated well with consumers. This new collection uses archived designs that have been modernized with slightly different shapes and brighter colors. Finally, the company has been aggressively growing its men’s business globally, and especially in North America. In Fiscal 2012, Coach’s men’s business sales doubled to over $400MM and the company plans to continue to drive this business in North America by adding new stand-alone men’s stores and by increasing shelf space for men’s products within its existing stores.

Given the reinstating of its coupon strategy, the improvement in macro, and the expected tailwinds from the Legacy lifestyle collection and the men’s business, we believe that comparable sales growth in the quarters ahead will be stronger than expected and the share price should react positively.

Competition from Michael Kors

Michael Kors has been growing rapidly in the US, bucking the slowing consumer spending trend. Many analysts and investors have been worried that Kors and other brands such as Kate Spade are stealing share away from Coach. KORS’ first quarter results showed an impressive 38.4% same store sales growth in North America and KORS’ share price has nearly tripled from its $20 IPO price in December 2011. However, we believe that it is possible for Coach and Michael Kors to both do well in North America.

Coach has dominated the handbag market for almost a decade and given the company’s strong marketing and new product development platform, we don’t see it losing share to Michael Kors going forward. Coach in its FY Q4 ’12 earnings call noted that the addressable women’s North American handbag market grew at ~10% in FY ’12 and that its direct channel sales of women’s handbags in North America grew at a similar rate, implying that its share in this segment remained steady through the year. Furthermore, the recent launch of the Legacy collection should renew customers’ interest in the company’s products and stem any future share losses.

Increasing demand for luxury goods in China and other emerging markets

In Fiscal 2009, the company acquired its retail operations in China from its former distributor, the ImagineX group. Since then the company has been rapidly increasing distribution in the region growing stores from 41 in Fiscal 2010 to 96 in Fiscal 2012. In FY ’12, Coach’s sales in China exceeded $300 MM, growing 64% year on year. The company plans to open another 30 stores in China in Fiscal 2013, bringing the total to ~125 stores.

Though recent macro concerns in China and weak results in the region from luxury players such as Burberry have signaled a slowing market for luxury goods, we continue to believe that China offers a tremendous long term growth opportunity for Coach.

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Notes:
  1. Consumer Confidence []
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