Coach Earnings Review: Decline In North America Business Continues To Dampen The Coach Story

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Coach

Coach (NYSE:COH), a leading American marketer of luxury handbags and other fashion accessories, posted another set of lackluster results in Q4 fiscal 2014. Coach’s sales in North America dropped by 16% for the quarter to $691 million, with a 15% fall in direct sales and 17% fall in comparable store sales. [1] For the full fiscal year, North American sales declined by 11% to $3.1 billion compared to ~$3.5 billion in 2013, with direct sales and comparable sales down by 10% and 15% respectively. [1] Given the overwhelming dependence of Coach’s business on its operations in North America the significant decline in North American sales was enough to offset the gains made by Coach in its men’s, footwear and international businesses. For the quarter, international sales increased by 9% on a constant currency basis, with China sales especially strong at a growth rate of 20% for the quarter. [1] For the full year, international sales grew by 12% on a constant currency basis, with China growing at a strong 25%. [1] North America contributes around two-third of Coach’s sales, and the company has been losing market share to competitors like Michael Kors, Kate Spade and Tory Burch over consecutive quarters. We believe Coach will continue to struggle in the North American market in the near future due to increased competition.

We are in the process of revising our $59.50 price estimate for Coach’s stock to incorporate the changes due to the latest quarterly earnings.

Men’s Business Growing But Footwear Business Disappoints

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Over the past few quarters, Coach has changed its approach to products, stores and marketing. The company is moving from its core competency of women’s handbags to becoming a dual-gender lifestyle brand. Additionally, Coach has decided to leverage its brand name and expand into footwear, accessories, apparel, jewelry and eye wear categories. The company managed to grow its men’s business to about $700 million in annual sales in fiscal 2014. [1] This means that the men’s business now contributes about 23% to the company’s overall revenues compared to about 15% in fiscal 2013. It needs to be noted, however, that the increase in penetration is only partly due to increasing sales of products designed especially for men: a large part of the increase in contribution is due to the overall decline in the company’s revenues. According to the company’s estimates, the global spend on men’s luxury wear is about $7 billion, which represents 18% of the total spend on luxury products. The figure is expected to increase at about a 10% rate in the next five years. [2]

Additionally, Coach has been trying to increase the penetration of footwear products in its overall sales. The footwear line was relaunched in March in about 170 retail locations but its penetration over fiscal 2014 failed to increase from 12% in retail sales. [2] This is highly disappointing as the footwear segment represents a great opportunity for Coach to make up for its falling market share in the women’s handbags business and still keep its business equally profitable. Nevertheless, the company remains focused on building its market share within the highly fragmented global premium footwear category, which it estimates at about $25 billion. [2] Coach has been expanding its distribution of footwear to both international stores and wholesale outlets. It has also been trying to maximize the productivity of footwear to its overall business through a sales mix with increasing contribution of products with higher average unit prices(AUP).

International Business Represents Long-Term Growth Driver

Coach’s international sales rose by 12% in constant dollar terms to reach $414 million from $388 million last year. China continues to be a solid growth area for the company as sales grew by over 20% in the region, driven by increased distribution and double digit comparable stores sales growth. [1] The company expanded majorly in China in 2014, growing its square footage by around 25% in the region during the fiscal year. Sales in China grew by 25% in constant currency terms for the full fiscal year. [1] For fiscal 2015, the company is being more conservative about its China planning. It plans to open about 20 stores and close about 10 currently standing stores, resulting in around 10 net openings. Even so, it has guided for China sales of over $600 million, driven by both increased distribution and positive growth in comparable store sales. [2] In Japan, the company realized a 6% loss in constant currency terms due in large part to a weaker yen. For the full year, Japan sales were flat compared to the previous year but declined 14% on a constant dollar basis, reflecting the weakness of the Japanese yen.

North America Disappoints Again

Total revenues in North America fell by 16% for the quarter with a decline in same store sales of 17%. During the earnings call, management pointed out that according to the ShopperTrak retail traffic index, in-store traffic at Coach’s outdoor lifestyle and outlet malls was down by about 8% for the quarter. [2] While in the recent past, the company has been able to minimize the impact of slowing in-store traffic through internet sales, its online business did not contribute positively to overall North America sales over the last two quarters. Year-on-year comparisons suffered due to the strategic decisions to eliminate third-party flash events in fiscal 2014 and limit the access and invitations to its factory flash site. [3]

On the positive side, Coach’s higher priced products exhibited strength as the above $400 price bucket grew in penetration and represented 21% of handbag sales compared to 16% last year, with products priced $600 and higher performing the best. However, it is clear that the performance of the company’s $200-$400 products continues to suffer. Given the low contribution of footwear sales to the company’s top line, a decline in the company’s core business is very worrying. [2]

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Notes:
  1. Coach 8-K, SEC [] [] [] [] [] [] []
  2. Coach Q4 FY14 Earnings Call Transcript, Seeking Alpha, August 2014 [] [] [] [] [] []
  3. Coach Q3 FY14 Earnings Call Transcript, Seeking Alpha, April 2014 []