Coach (NYSE:COH), a leading American marketer of luxury handbags and other fashion accessories, posted lackluster results in Q2 fiscal 2014, and saw its shares drop by more than 7% since the earnings announcement. 
Coach’s sales in North America dropped by 9% in Q2 fiscal 2014, with 8% and 13.6% fall in direct sales and comparable store sales, respectively. The significant decline in comparable stores sales indicates that Coach is losing market share to fashion players such as Michael Kors. North America contributes around two-third of Coach’s sales, and we believe intense competition in the women’s handbags and accessories market in the region will be closely tracked by the market in the coming months. We believe Coach will continue to struggle in the North American market in the near future due to increased competition. 
Coach’s Transformation Strategy Aimed AT Boosting Sales
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For the past 15 years, Coach has stuck to its ‘house of leather’ image but now is looking to transform its brand. The company is moving from its core competency of handbags to head-to-toe offerings. Coach has decided to leverage its brand name and expand into footwear, accessories, apparel, jewelry and eye wear categories. The company says it will have new designer products out later this year to reignite interest in the brand, and will increase its retail footprint by close to 9%. Additionally, Coach is focusing on the look and feel of its stores, and marketing to reflect a dual-gender brand. We believe the results of this strategy will take some time to yield results as a full reflection of this new brand image may take a few years. 
International Business Represents Long-Term Growth Driver
Coach’s international sales fell by 2% in dollar terms. However, it rose by 11% on a constant currency basis. China continues to be a sweet spot for the company as sales grew by over 25% in the region, driven by increased distribution and double digit comparable stores sales growth. The company has major expansion plans in China as it expects to grow its square footage by around 25% in the region during the fiscal year. It also forecasts sales to grow by more than 20% in China during the entire fiscal year.
Coach’s sales in the other Asian markets of Korea, Taiwan, Malaysia and Singapore also continued to grow at a strong rate. The fashion retailer has completed the acquisition of its European joint venture created with Pepe Jeans, and plans to open 50 wholesale and 10 retail stores across the region during the fiscal year.
Japanese sales fell by 2% on a constant currency basis, however, in dollar terms it decreased by 21%. We believe that a weaker yen will continue to pose a headwind to the company’s sales in the region in the coming quarters.
Coach also aims to grow its distributor-run business in Latin America, other Asia-Pacific countries (Australia, Thailand and Indonesia) and in the Middle East. Due to these measures, we think the proportion of international sales in Coach’s overall sales will increase in the future. 
Men’s Business Another Growth Driver
The men’s business, which grew by approximately 50% in fiscal 2013, continues to be a long-term driver for the company. Coach continued to drive its men’s business globally, through new standalone and dual gender stores, and by dedicating more space for a broader men’s assortment in existing retail stores. In the second quarter, Coach’s sales of men’s bags and accessories increased nearly 20% globally. Looking ahead, the company remains bullish about the prospects for its men’s global business, continuing to target about $700 million in sales in FY14, up about 20% from last year, and $1 billion in sales in three years. We believe this business will continue to rise at a strong rate in the future and help drive both its North American and Asian sales. 
We are in the process of revising our $59.50 price estimate for Coach’s stock.Notes: