Earnings Preview: Things To Watch Out For As Coach Announces Its Q4 Results

COH: Coach logo
COH
Coach

Coach Inc (NYSE:COH), a leading American marketer of luxury handbags and other fashion accessories, will report its Q4 fiscal 2014 on August 5. Its North American results will be keenly tracked by analysts as the company has reported disappointing results from the region in the previous four quarters. Comparable store sales have been declining as a result of rising competition from brands like Michael Kors, Kate Spade and Tory Burch. As a result of declining sales, Coach decided to close as many as 70 stores in North America, resulting in a 13% decline in its North America store count. The company finances its stores through operating leases but has to pay fixed cash rentals to obtain premium in-line store locations in malls. The high ratio of fixed costs in the cost structure of its stores means that when sales decline, the company cannot retain its margins by scaling back on inventory. Consequently, the only way to retain its margins is to close its stores. As a result of the closure of these stores, we expect Coach’s revenues to decline. Even adjusting for these store closures, it is hard to see the company posting gains in sales from the stores that are still standing. [1]

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 Q3 2014 Results

Coach’s sales in North America dropped by 18% in Q3 fiscal 2014, with a 21% fall in comparable store sales. Coach’s international sales rose by 2o% in constant dollar terms. 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. The company has major expansion plans in China, guiding for an expansion in square footage by around 25% in the region during the fiscal year. It also forecast 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 double-digit rate for the quarter with comparable store sales gains. [2]

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 the previous quarter showed some progress along this front with the penetration of Coach’s footwear products rising from 6% to 8% in the quarter, in about 174 retail locations. [2] However, this is still too small a contributor to the overall assortment of products offered by the company and growth in this segment cannot offset the decline in the company’s core products. We will be watching the figure closely in this quarter too.

Additionally, Coach has been trying to strengthen its core handbag business by eliminating incentives, reducing the number of flash sales in its factory stores significantly and raising the average prices of its products. In the earnings call for Q2 FY2014, 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. [3] 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 $1,500 and $2,000. 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 Vevers knows well, having previously worked at the European houses of Loewe and Mulberry. [4]

Coach also hosted its first ever discount sale in its retail stores this quarter. The thinking behind this was to attract newer customers to the brand by offering them incentives, hoping that the quality of the product would be enough to keep them coming back in the future. Sales for this quarter will show if these strategies are working. [5] 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 lower 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 Q3 2014, Coach’s international sales rose by 20% 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. [6]

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. [7]

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

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Notes:
  1. Coach to close 70 stores in North America as sales fall, Reuters, June 2014 []
  2. Coach Q3 FY14 Earnings Call Transcript, Seeking Alpha, April 2014 [] []
  3. Coach’s CEO Discusses Q2 2014 Results – Earnings Call Transcript, Seeking Alpha, January 2014 []
  4. Coach Outflanking Vuitton in China With $400 Handbags, Bloomberg, February 2014 []
  5. Coach to Discount Products at Stores in Break With Tradition, Bloomberg, June 2014 []
  6. Coach Q3 FY14 Earnings Call Transcript, Seeking Alpha, April 2014 []
  7. Coach’s CEO Discusses Q2 2014 Results – Earnings Call Transcript, Seeking Alpha, January 2014 []