Coach Earnings Preview: Better Segmentation Of Products Should Improve Sales In North America

COH: Coach logo
COH
Coach

Coach Inc (NYSE:COH), a leading American marketer of luxury handbags and other fashion accessories, will report its Q3 fiscal 2014 on April 29. Its North American results will be keenly tracked by analysts as the company has reported disappointing results from the region in the previous quarters. With a decline in consumer spending due to the cold weather, heavy discounts and a shift to online spending, it is likely that Coach’s sales will not improve in this quarter. Moreover, since holiday season sales are often made at heavy discounts, it is possible that Coach’s margins might suffer. North America has been a tough market for the company in the recent past due to rising competition from upcoming fashion companies such as Michael Kors, Kate Spade and Tory Burch.

We believe that the company’s North American results will remain weak in the near term. Since these operations account for about two-third of Coach’s sales, the retailer’s overall results will also feel the negative impact. However, Coach’s international and men’s business hold some upside for the company’s results, and this could be a highlight in its release.

It will be interesting to see Coach’s progress on its brand transformation strategy, as its success is the key for the company to sustain its market share in the North American handbags and accessories market. The strategy has had some time to come into effect and it will be interesting to see if the buzz generated by the campaigns based around the strategy will translate into more sales for the companies’ products.

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See our complete analysis for Coach

Recap Of Q2 2014 Results

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. Coach’s international sales fell by 2% in dollar terms. However, sales rose by 11% on a constant currency basis. China continued 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. Operating margins fell to 27.9% compared to 28.6% in Q1 2013, owing to costs related to the acquisition of the joint venture with Pepe Jeans in Europe and the opening of new stores in Asia. [1]

Brand Transformation Strategy

Coach is undertaking a brand transformation strategy to position itself as a global lifestyle brand anchored in accessories. It is re-aligning its products, stores, marketing and executive management team as part of this strategy. We believe the positive results of this transformation will start to be seen from the holiday quarter, but the overall transitioning will take a few years to complete. Therefore, the results for this quarter will show if the transformational strategy is beginning to bear fruit.

In the earnings call for Q2 F2014, the company’s management pointed out that average unit prices (AUP) had risen by 7% last year as it added newer product and designs. Moreover, the company expects the  AUP to continue to increase as the first products from Stuart Vevers, who replaced Reed Krakoff as executive creative director last summer, reach stores in September. [2] However, Coach still continues to be very active in the $200-$400 pricing category of products. Furthermore, the company is beginning to focus across channels in a more targeted way. The company has plans to diversify its product portfolio and target each channel specifically. It means that in the future, assortments from Coach in the highly price sensitive wholesale channel will be different from those in its flagship stores and those intended for sale in the secondary markets. The trend towards a higher AUP shows that the company has identified an opportunity in the >$400 price point range. Coach’s European competitors, like Louis Vuitton, Hermes and Burberry, do not sell leather bags below $1500 and $2000. There is an opportunity for Coach here to enter with lower prices, but with higher perceived value and quality, consistent with its brand name. It is a space that the company’s new creative director, Stuart Vevers, knows well, having previously worked at the European houses of Loewe and Mulberry. [3]

Sales for this quarter will show if these strategies are working. Coach’s sales in the $200-$400 dollar space have suffered over the past quarters due to a higher percentage of its sales being made through the factory channel, through which products are sold at cheap prices. This has resulted in the company’s products becoming more and more visible which has affected its appeal as a luxury product. However, the company’s products priced above $400 have recorded strong sales, which shows that the company still has a strong brand presence and makes high quality products. It will be interesting to see how each of these segments performs in this quarter.

International Sales Will Continue To Grow At A Healthy Rate

Growth in international sales represents one of the key long term growth drivers for Coach. In Q2 2014, Coach’s international sales rose by 11% in constant currency terms, on the back of a solid 25% rise in Chinese sales. Chinese results will continue to be the focus this year as Coach estimates Chinese sales to grow to $530 million in fiscal 2014, as compared to $430 million in fiscal 2013. Coach’s expansion plans in China during the fiscal year include 30 new stores, which will enhance its total square footage by 25% in the region. In addition, Coach’s sales in the Asian markets of Korea, Taiwan, Malaysia and Singapore continue to rise at a healthy rate. [2]

Coach aims to grow aggressively in Europe as it plans to open 70 wholesale and 10 retail stores across the region during the fiscal year. Coach also intends to enhance its distributor-run business in Latin America, other Asia-Pacific countries (Australia, Thailand and Indonesia) and in the Middle East. As a result, we believe the proportion of international sales in Coach’s overall sales will rise in the future. [2]

Our $59.5 price estimate for Coach’s stock, represents 20% premium to the current market price.

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Notes:
  1. Coach Inc. 10-Q []
  2. Coach’s CEO Discusses Q2 2014 Results – Earnings Call Transcript, Seeking Alpha, January 2014 [] [] []
  3. Coach Outflanking Vuitton in China With $400 Handbags, Bloomberg, February 2014 []