The Pain May Not Be Over For Coach Yet

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COH
Coach

Coach (NYSE:COH), a leading American marketer of luxury handbags and other fashion accessories, posted another set of lackluster numbers when it announced earnings for Q3 fiscal 2015 last month. Coach’s sales in North America dropped by 15% year-over-year for the quarter to $929 million, with a 23% fall in comparable store sales in North America. [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 4% on a constant currency basis, with China sales growing at 10% for the quarter (constant currency basis). [2]  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.

The luxury retailer has been suffering for a while and is in the process of undertaking a risky realignment of its business and brand image. For this reason, the downward spiral at Coach may continue for a while yet. In this note, we take a look at three factors which can cause further damage to the company’s bottom line over the coming months.

Awkward Brand Positioning

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One of the changes Coach is making to its business model is going further upscale. The retailer wants to position itself as a modern luxury handbag designer and is taking steps accordingly. Over the last two years, the company has realized that while products ranging in the $100-$300 category have fared quite badly and lost out to competition, sales of products above $400 have continued to do quite well. As a result, 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. [2]

Previously, Coach’s core customer base was comprised of upwardly mobile women, but now the company is shifting focus. By limiting discounts, flash sales, and internet only sale events, and raising the average unit price, Coach is looking towards a more affluent customer. The problem this poses for Coach is that comparable store sales and revenue numbers show that this strategy isn’t really working. Revenue declined by 15% this quarter, with comparable store sales declining 23%, marking two consecutive years of customer loss. [2] This seems to suggest that while the customers that the company built its business on previously, can’t afford the company’s products any longer, while the customers it wants to build its business on in the future, still thumb their noses at the prospect of having to buy its products. It may be a while before the company can reverse that process.

Additionally, Coach’s net profit more than halved in the previous quarter. This is especially worrying if you look at the numbers reported by other companies in the same market segment: Hermes had a very good quarter, and Richemont made a profit if you exclude the impact of currency fluctuations. [3] One reason why this is happening is because Coach is lowering its outlet footprint and minimizing discounts. While both of these are good strategies in the long term for the company, because some outlets were just not performing well enough to justify the extremely high monthly rental payments and discounts were just cannibalizing sales, in the short term they reveal that the company’s problems lie specifically with its particular brand positioning.

China Slowdown

Just a year ago, Coach was reporting growth numbers in excess of 25% in China.  But in the last quarter, the growth rate slowed down to 10%, or 8% in dollars. One reason for this is the slowdown in growth rate in the Chinese economy. Another is the crackdown by Chinese officials on luxury products. [4]  These factors can contribute to make the international growth story for Coach a tough one, as the company expects growth from Asia to be a major pillar of its future business prospects.

As part of its transformation strategy, Coach is trying to grow its men’s business.  Last year, the company generated about $700 million from the men’s business, or just over 14% of revenues. It aims to grow that figure to $1 billion. In Asia, men’s bags have a greater appeal than in the West for utilitarian reasons. Since Asians commute more often by bus, train, and bikes, than by cars, bags worn with long straps around the body are convenient. Coach has noticed that Chinese men tend to carry a lot more cash and cards in their pockets than men in the West, and prefer to put their cash and cards in bags rather than in the pockets of their pants. Additionally, Asian men are more likely to accessorize than their counterparts. According to Coach’s estimates, males account for one quarter of the luxury accessories market in Asia, and the figure is close to 40% in China. [5] Therefore, a significant part of Coach’s expectation of growth in international revenues is the growth expected from the international men’s business.

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Notes:
  1. Coach 8-K, SEC []
  2. Ref: 1 [] [] []
  3. Hermes Q1 sales rise 8 pct in line with medium-term target, Reuters, April 2015 []
  4. China’s Anti-Graft Campaign Shows No Signs Of Slowing For 2015, Jing Daily, December 2014 []
  5. A Men’s Bag Craze Made in Asia, Wall Street Journal, June 2013 []