Coach Earnings Preview: North America Weakness To Dampen Overall Performance

COH: Coach logo
COH
Coach

Coach Inc (NYSE:COH), a leading American marketer of luxury handbags and other fashion accessories, will report its Q2 fiscal 2015 next week. Its North American results will be keenly tracked by analysts as the company has reported disappointing results from the region in the previous six quarters. Comparable store sales have been declining as a result of rising competition from brands such as 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 American 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. (See: The Real Reason Why Coach Has Been Struggling) 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. Additionally, Coach has completed the acquisition of shoe maker Stuart Weitzman. (See: Here’s Why Coach Is Being Cited As A Potential Suitor For Stuart Weitzman)  It will be interesting to hear how the management plans to integrate this business into Coach’s overall operations.

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See our complete analysis for Coach

Recap Of Q1 2015 Results

After five consecutive disappointing quarters, Coach posted another set of lackluster results in Q1 fiscal 2015. Coach’s sales in North America dropped by 19% for the quarter to $634 million, with a 19% fall in direct sales and a 24% fall in comparable store sales. [2]  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 6% on a constant currency basis, with China sales especially growing at 10% for the quarter.

However, there was a silver lining: the company managed to grow its men’s business to about $700 million in annual sales in fiscal 2014. [2] 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. [3]

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. Over the past few quarters, Coach has reduced its dependence on flash sales, factory sales, and discount coupons. Additionally, the company has been trying to raise the average unit price of products. Coach’s handbags priced above $400 have been some of the best performing products for the company over the past year.

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. [4] 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. [4] 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). It is in this regard that the acquisition of Stuart Weitzman is interesting. Stuart Weitzman made about $300 million in revenues in 2014. The addition of this figure would have raised Coach’s annual revenue by 6% and that of Coach’s footwear business by 50%. It will be interesting to hear what the management has to say regarding their revenue and profit expectations from the integration of this business.

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 Q1 2015, Coach’s international sales rose by 6% in constant currency terms, on the back of a 10% rise in Chinese sales. In addition, Coach’s sales in the Asian markets of Korea, Taiwan, Malaysia, and Singapore continue to rise at a healthy rate. [5] Coach aims to grow aggressively in Europe as well. 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. [6]

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Notes:
  1. Coach to close 70 stores in North America as sales fall, Reuters, June 2014 []
  2. Coach 8-K, SEC [] []
  3. Coach Q1 FY15 Earnings Call Transcript, Seeking Alpha, October 2014 []
  4. Coach Q4 FY14 Earnings Call Transcript, Seeking Alpha, August 2014 [] []
  5. Coach Q3 FY14 Earnings Call Transcript, Seeking Alpha, April 2014 []
  6. Coach’s CEO Discusses Q2 2014 Results – Earnings Call Transcript, Seeking Alpha, January 2014 []