Why We Remain Bullish On Coach’s Outlook

by Trefis Team
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    Quick Take 

  • Coach’s stock has fallen sharply since its latest earnings report was released on January 23, 2013.
  • Our price estimate for Coach reflects a premium of around 30% to the market price as we think there are various catalysts to Coach’s business in the long run.
  • Coach is undertaking a transformation strategy to move from an accessories brand into a lifestyle brand.
  • International expansion is one of the key drivers for Coach’s business, and we think international revenues will grow rapidly in the future on account of strong demand from China.
  • Growth in its men’s business, which is expected to rise by around 50% in fiscal 2013, provides another tailwind for Coach

Coach Inc (NYSE:COH) is a leading American marketer of luxury handbags and other fashion accessories. Its stock has fallen by more than 15% since its latest earnings report was announced on January 23, 2013. Investors were spooked by Coach’s weak performance in the North American market, which contributes to two-thirds of its sales. Coach’s sales growth in North America dropped to 1% in Q2 2013, along with a comparable stores sales decline of 2%. (Read: Coach Quarterly Results Disappoint Due To Weak N. American Performance)

However, we remain bullish on Coach with a price estimate of $66, reflecting a premium of around 30% to the market price. Notwithstanding Coach’s weak performance in North America in the latest quarter, we believe there are various catalysts to its business in the long run. Coach is transforming its business – to move from an accessories brand to a lifestyle brand. The company will focus on product categories such as footwear and outwear as part of this strategy. We expect this move to help Coach in multiple ways. Firstly, if Coach manages to launch innovative shoes and apparel, the traffic at its stores will rise. We think this will also positively impact sales of Coach handbags and accessories. Secondly, its operating margin could get a boost as these product categories provide incremental sales on a similar cost structure.

In addition, Coach’s expansion in international markets is another major growth driver. We think Coach can double its international handbag revenues in the long run on account of rapid growth in the Chinese market. Further, Coach plans to expand in the markets of Europe, Latin America and Middle East, which will also drive its international sales. The men’s business is also growing rapidly for the company as its revenues are expected to grow by 50% in fiscal 2013. [1]

In this article, we evaluate the key reasons for our bullishness on Coach’s stock. Further, we evaluate the impact of Coach’s strategies on its valuation, and see how they can play out in the long run.

See our complete analysis for Coach

Transformation Strategy Underway In North America And Other Markets

Coach is undertaking the task of transforming its brand, to move from an accessories brand to a lifestyle brand.

According to Lew Frankfort, Chairman & CEO, Coach:

This next evolution of the brand will encompass a full head to toe expression of the Coach women, including a focused ready-to-wear presentation to inspire our customers with a complete Coach point of view that is relevant to how she lives her life. [2]

With this transformation, Coach intends to add more of an emotional tie and loyalty to its brand to ward off rising competition from players such as Michael Kors.

Coach will focus on outerwear and footwear as part of this strategy. It plans to re-launch shoes globally and 170 retail stores are expected to carry shoes in March 2013. [3] In the short term, the company does not plan to increase the store size to keep these additional product categories. Instead, the company will reposition its store space to keep these products, and hence its fixed cost structure will not be altered significantly.

With this transformation strategy, Coach aims to increase the traffic at its stores, which will also positively impact the sales of handbags and accessories products. Further, this strategy is expected to bolster its operating margin as these lifestyle categories allow the company to derive incremental sales on a fixed cost base at its stores.

We believe this is an encouraging move, considering Coach’s sales have lately suffered as the brand has lost some of its appeal to upcoming companies such as Michael Kors. We think this strategy will help Coach elevate its image among consumers.

We currently forecast daily apparel, travel kits, jewelry and fragrance sales per Coach store in North America to increase from $960 in 2012 to $1,140 by the end of our forecast horizon. However, if this figure increases rapidly to $2,000 by the end of our horizon, it represents a premium of around 5% to our estimate. However, higher sales of lifestyle categories will also positively impact sales of handbags and accessories, and hence the impact on valuation could be much more.

Expansion In International Operations

Growth in international operations represents one of the key growth drivers for Coach. While international sales currently account for approximately one-third of Coach’s total sales, we expect this proportion to grow in the future.

Coach is aggressively expanding its international operations by opening new stores in countries such as China, Japan, Singapore, Taiwan, Malaysia and Korea. China is one of the biggest growth opportunities for Coach as it is posting high sales growth from the region. In Q2 2012, its Chinese sales rose by 40% annually. In fiscal 2013, the company aims to achieve Chinese sales of $400 million as compared to $300 million recorded in the previous year. [4] As part of its expansion in China, Coach plans to open 30 new stores in the region during fiscal 2013, and it recently opened an e-commerce site in the country.

Coach also plans to expand in the regions of Europe, Latin America (including Brazil, Venezuela, Columbia, Panama, Chile and Peru), other Asia Pacific countries (Australia, Thailand and Indonesia) and in the Middle East by expanding its distributor network in these regions.

We currently expect Coach handbag revenues in the international markets to increase rapidly from $1 billion to around $2.1 billion by the end of our forecast period. However, if Coach’s growth in China slows down and international handbag revenues reach only $1.5 billion by the end of our horizon, it represents around 10% downside to our price estimate.

Focus On Men’s Business

Focusing on its men’s business is another strategy that has been successful for Coach. Revenues from men’s business doubled in fiscal 2012, compared to the previous year. Moreover, it expects revenues from men’s business to grow by around 50% in 2013 to more than $600 million. [1]

Since the men’s luxury business is significant in Asia, we believe this strategy will further drive Coach’s sales in the international markets.

Growth In E-commerce Sales

Growth in e-commerce sales is another trend that is benefiting Coach. Coach is eyeing higher sales from the Internet and mobile channels on account of growing Internet usage and the rising adoption of smartphones globally. The company aims to leverage coach.com, other global e-commerce sites, marketing sites, third-party flash sites and social networking as part of this strategy. We expect the sales of handbags in North America through the Internet channel to grow rapidly in the future.

Understand How a Company’s Products Impact its Stock Price at Trefis

Notes:
  1. Coach’s CEO Discusses F2Q13 Results – Earnings Call Transcript, Seeking Alpha, January 23, 2012 [] []
  2. Coach’s CEO Discusses F2Q13 Results – Earnings Call Transcript, Seeking Alpha, January 23, 2013 []
  3. Coach’s CEO Discusses F2Q13 Results – Earnings Call Transcript, Seeking Alpha, January 23, 2013 []
  4. Coach’s CEO Presents at Bank of America Merrill Lynch Consumer & Retail Conference (Transcript), Seeking Alpha, March 12, 2013 []
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