Coach Inc (NYSE:COH), a leading American marketer of luxury handbags and other fashion accessories, posted net sales growth of 6% annually to $1.22 billion in Q4 2013. The weaker yen proved to be a headwind during the quarter as net sales rose by 9% in constant currency terms. Gross margin was recorded at 72.6% and operating margin decreased to 26% compared to 30.4% in Q4 2012. Profits dropped due to the acquisitions of distributor businesses in Asia and recognition of a $53 million charge on unusual items such as corporate restructuring related charges, impairment charges, and write-down of a small portion of inventory.
Weak North American results were the highlight of the quarterly results as comparable store sales dropped by 1.7% in the region. Coach’s share price fell by around 10% after the earnings were released. While Coach is trying to accelerate growth in North America by undertaking a transformation strategy as well as strategic management changes, we believe the results in this region could continue to be weak for a few more quarters. We think that Coach’s international sales and its growing men’s business add some upside to the company’s outlook. However, the weaker yen would continue to impact the dollar sales growth over the first half of fiscal 2014.
Disappointing performance in the North American women’s handbags and accessories market
Coach’s North American sales grew by 6% in Q4 2013 on a 5% rise in direct sales and 1.7% decline in comparable store sales. We believe the drop in comparable stores sales is discouraging as it indicates that Coach could lose some of its 30% market share in the North American women’s handbags and accessories market to upcoming fashion companies such as Michael Kors, Kate Spade and Tory Burch. While we previously estimated that Coach could retain its market share, these results could prove us wrong.
The company is making efforts to enhance growth in the North American market. It is undertaking a transformation of its brand image to move from an accessories brand into a global lifestyle brand anchored in accessories. To this end, the company launched footwear in more than 170 retail stores in North America. Some success was seen with this strategy as footwear sales comprised 12% of total sales at these stores as compared to 7% in the same quarter previous year.  However, this brand strategy did not result in increased traffic at its stores.
Coach plans to accelerate this transformation by focusing on areas such as products, stores and marketing. The company will launch an innovative capsule collection of lifestyle categories such as bags, outwear and footwear in the holiday quarter. Coach is also making changes to its retail store presentation and enhancing its marketing efforts to add more emotion into its brand. It has added new talent and reorganized its executive management team as part of this strategy. We believe the brand transformation will take some time to yield significant results and North American comparable stores sales could continue to be weak in the next few quarters.
The company plans to grow its square footage in North America by 7% in fiscal 2014 as compared to 10% in the previous fiscal.  Most of the new store development will be focused towards factory store channel and certain full price stores will be closed during the year. We believe these growth plans correspond to softness in demand for the company’s products. At the same time, Coach aims to expand its distributor business in North America.
International sales continue to grow at a strong rate but weaker yen poses a headwind
Coach’s international sales rose by 7% in dollar terms and 17% in constant currency terms in Q4 2013. China continues to be the centerpiece of Coach’s international growth story as Chinese sales grew by 35% during the quarter on enhanced distribution and double digit comparable stores sales growth. In fiscal 2013, its Chinese sales rose by 40% to $430 million and the company forecasts this figure to rise to $530 million in fiscal 2014. It will open 30 new stores and expand its total square footage by 25% in China in the current fiscal. 
Coach’s sales in Korea, Taiwan, Malaysia and Singapore also grew at a healthy rate during the quarter. In fiscal 2014, the company plans to enhance productivity of its stores in these countries by focusing on aspects such as training and store environment to bolster its brand image.
Japanese sales increased by 4% on a constant currency basis; however, dollar sales fell by 15% owing to the weaker yen. Coach plans to expand its square footage by 3% in Japan in fiscal 2014. 
Coach recently gained direct control over its business in the U.K and Europe by purchasing its partner’s stake in the European joint venture. It will expand aggressively in this market as it expects to open 70 wholesale and 10 retail stores across the region during the fiscal. 
Moreover, Coach aims to grow its distributor-run business in Latin America, other Asia Pacific countries (Australia, Thailand and Indonesia) and in the Middle East. Owing to this strategy, we expect the proportion of international sales in total sales to increase in the long run.
Men’s business continues to add upside to the company’s outlook
While Coach has underperformed in the women’s handbags and accessories market, its growing men’s business represents a long-term growth driver for the company. Men’s sales rose by around 50% in fiscal 2013 to approximately $600 million. We believe Coach’s men business will continue to grow at strong rate in the future and help fuel its North American and Asian sales.
We are in the process of updating our price estimate for Coach’s stock.Notes: