Ripping Apart Coach's Bad Quarter

 | Jan 23, 2013 | 8:48 AM EST
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I normally don't cut and paste press release text, but want to make an exception to that rule with Coach's (COH) quarter.

"During the holiday quarter we drove modest growth and continued to gain overall traction on our key strategies. We posted strong international results, leveraged the Men's opportunity globally and strengthened our digital capabilities. However, we were disappointed by our performance in North America, where the holiday season proved challenging.  Most broadly, the consumer was impacted by a muted macroeconomic environment, while in the Women's handbag category competition intensified and promotional activity increased. Importantly, we maintained our pricing strategies despite the retail climate, protecting our brand proposition."

'Modest growth'

Modest growth during a holiday season, and on a very hyped company (numerous Buy ratings reiterated pre-earnings on super-lofty valuation assumptions) no less, will force the market to readjust. Specifically, the market will readjust to one thing:  a probability for continued modest growth with higher-than-normal downside risk given clear fundamental challenges in the business, as implied in the commentary.

'Disappointed by our performance in North America, where the holiday season proved challenging'

This tells me Coach has set unrealistic expectations for the Street, something confirmed by too much inventory being on the books relative to sales after the holidays.  In other words, market dynamics have begun to shift quicker than Coach's management has internally planned. This causes #GuidanceRisk.

'Women's handbag category competition intensified and promotional activity increased'

This is perhaps one of the first times in the eight years I have covered Coach (even thinking back to the 2009 period off the top of my head) in which it acknowledged intensified competition. As I said throughout the holiday season, Coach's product looked straight-up stale and the soft traffic reflected that (not sure what others were seeing). 

A simple exercise I did at peak holiday time was to stand back and look at Coach and Michael Kors stores that are positioned next to one another to get a feel of the traffic and how the product looked visually. The bottom line is that Michael Kors crushed Coach in this non-spreadsheet test as it also did when applying the test to department store shop in shops.  By the way, yes, Coach appeared to be abnormally promotional at department stores since the first week of December.

In the last paragraph of the press release, Coach notes "near-term challenges in North America," a comment that I think will hang over any modestly positive tidbits on the earnings call. To me, there are structural issues in play, such as aggressive international and men's expansion plans, in addition to intense competition from very viable competitors that do not square with the stock's present valuation. Moreover, I just do not see the appetite for splurge on the part of the aspirational consumer (this was on display in Tiffany's (TIF) holiday bomb).

October 24, 2012 Client Note: You Should Relax with the Coach Hype Playaz

Looking at the market's response to Coach's earnings, you would have thought the company had returned to high-growth mode and was deserving of its premium P/E multiple relative to others in specialty retail. Heck, opening up the hood on Coach showed these fun facts: (1) 5.5%  same-store sales gain, a sequential acceleration amid an improvement in factory store sales, plus a non-horrendous consumer response to products that are designed from Coach's extensive catalogs (Legacy line) (2) announcement of a new $1.5 billion share purchase plan that was rumored to be in play given Coach's cash balances and dwindling authorization on a previous program (3) the true profit margin story was not as a bad as appeared when excluding recent international distributor acquisitions. Of course, it was so very refreshing to see China sales pop 40% when so many other companies, from industrials to Nike (NKE), are experiencing tepid gains at best inside a slowing macro environment. But, #HonestAbe thinks Coach is not where to look in retail and here are the reasons why.

  • A +5.5 same-store sales figure resulted despite a major new program launch across gender, lightyears away from anything produced by Michael Kors even while a significant chunk of marketing dollars were thrown behind Legacy in stores and in the digital sphere (Facebook). Coach had two important quarterly drivers in Legacy and improved traffic at factory with coupons and in that context a stronger same-store sales reading should have been delivered. Takeaways: competitive threats, validation of Burberry comments on aspirational consumer weakness.
  • #HonestAbe is well aware the Street loves to extract anything that doesn't fit with a majority-held Buy rating (I have played the game and know the drill), but Coach's reported margins will continue to be under pressure for the next few quarters as newly-acquired businesses are integrated. That, in turn, should cap the earnings upside that is needed to first validate Coach's present P/E multiple and then expand it.
  • The rate of China total sales growth slowed quarter over quarter to +40% from +60%. That's the deal and it happened as Coach continued to trumpet strong purchase intent/trends.   
  • Shipments to North American department stores down AND planned lower into a holiday season, indicating share loss on the sales floor. This fits well with my checks on Coach's presentation on the department store floor. It's being out-merchandized.

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