Earnings Review: North America Weakness Dampens Progress Made On Brand Transformation Front For Coach

COH: Coach logo
COH
Coach

Coach (NYSE:COH), a leading American marketer of luxury handbags and other fashion accessories, posted another set of lackluster results in Q2 fiscal 2015. Coach’s sales in North America dropped by 20% for the quarter (year-over-year comparison) to $785 million, with a 22% fall in comparable store sales. [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 some international geographies. For the quarter, international sales increased by 5% on a constant currency basis, with China sales, especially, growing at 13% for the quarter.  ((Coach 8-K, SEC))  North America contributes around two-thirds 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. ((Coach 8-K, SEC)) 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] The company is targeting $1 billion in sales from its men’s business by 2017. For the quarter, sales in the men’s category remained flat, impacted by the weakness of the yen and reduced promotion in North America. However, Coach recently launched its first men’s ready-to-wear line in London. We expect this to boost the company’s earnings in the coming quarters because of a combination of good product quality and affordable brand positioning. (See: Men’s Business A Key Pillar Of Coach’s Brand Transformation Strategy)

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. Over the quarter, its penetration increased from 8% last year to 12% in  North American retail sales. [3] This is encouraging 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. The company remains focused on building its market share within the highly fragmented global premium footwear category, which it estimates at about $25 billion. ((Coach Q2 FY15 Earnings Call Transcript, Seeking Alpha, January 2015)) 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).

North America Continues To Disappoint

Total revenues in North America fell by 20% compared to last year with a decline in same store sales of 22%. In the second quarter, Coach concentrated on the implementation of initiatives for brand transformation. These initiatives involved:

  • The company has cut down on promotional events in both retail and wholesale channels. As a result, its internet comps were down. The number of flash sales events have been reduced from around 12 a month last year, to only about 4 per month in this year’s holiday period.
  • The company had no preferred customer events in its retail stores nor any COACH days in its North America departmental stores.
  • Additionally, the company has reduced its total stock keeping units (SKU) by about 25%, focusing more on higher margin products. The elevated products (products priced above $400) continued to do well this quarter and increased in penetration to around 30% of handbag sales compared to 20% last year. The number of units sold of this elevated product increased by around 12% compared to the same quarter last year. [3]

Overall this quarter, traffic in its stores was down year-on-year and conversion was also negative, but the average transaction price rose.  The company management stated that it plans to reduce square footage in its directly operated stores by about 5%, involving the closure of 70 retail stores and 50 outlet stores by the end of FY15. The reduction will be offset by a modest increase in footprint at departmental stores.  The company plans to add 40 new locations this fiscal year — implying a square footage growth of 3%-4% — and the conversion of more than 300 locations from case line presentation to open sale. [2]

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Notes:
  1. Coach 8-K, SEC []
  2. Coach Q1 FY15 Earnings Call Transcript, Seeking Alpha, October 2014 [] []
  3. Coach Q2 FY15 Earnings Call Transcript, Seeking Alpha, January 2015 [] []