This Luxury Retailer's Risky Identity Crisis Could Burn Investors

It was an exciting week for the stock market, as companies from all walks of industry stepped into the limelight to report quarterly earnings. Among them was luxury handbag maker Coach (NYSE: COH  ) . Unfortunately, Coach announced fiscal second-quarter earnings that left a lot to be desired. Shares plummeted more than 15% on the news.

However, it wasn't just disappointing quarterly results that caused the stock to have one of the worst trading days in its history. We'll get to the company's second-quarter sales results in a minute. But first, let's take a closer look at what's really driving down shares of Coach, and whether this creates an opportunity for shrewd investors.

What's in the bag?
Coach is attempting to reinvent itself as a "lifestyle" brand. It seems the leather goods company is in the midst of an identity crisis as it struggles to keep up with fast-growing competitors, such as Michael Kors (NYSE: KORS  ) . The company's new brand strategy is worrisome for more than a few reasons.

For one thing, Coach should be working to differentiate itself from the competition -- not mimic it. Regardless of this, the leather goods maker plans to put a heavier focus on apparel and accessories, much like Michael Kors' namesake brand.

However, unlike other successful lifestyle brands including Ralph Lauren (NYSE: RL  ) , Tory Burch, and, yes, Michael Kors, Coach's brand doesn't share its name with a famous fashion designer. As a result, the retailer will likely have to spend significantly more on marketing to successfully position itself in the lifestyle category, according to Bloomberg.

Another concern is that margins could suffer as Coach puts more of an emphasis on women's apparel and accessories. Coach currently trumps rivals in terms of margin strength, generating a gross margin of more than 72%. Meanwhile, both Michael Kors' and Ralph Lauren's margins come in around 59%.

Bag it or buy it?
The sudden shift in strategy comes on the heels of a weak holiday season for the retailer. In fact, The Wall Street Journal reported that Coach's North American sales grew more slowly than the broader handbag market for the first time since the company went public more than a decade ago. Investors are right to worry, particularly when North America makes up a whopping two-thirds of Coach's revenue.

In hopes of turning its luck around, Coach launched the Legacy line of handbags ahead of the all-important shopping season. However, the initiative failed to boost sales for the retailer. As a result, the company reported earnings of $1.23 a share for its second quarter, whereas analysts were expecting $1.28 a share for the period. Revenue also came up short at $1.5 billion, compared to analysts' average forecast of $1.6 billion.

But it wasn't all bad news. On a positive note, Coach's international growth strategy is starting to pay off. For its second quarter, global sales increased 12% with particular strength coming from China. Revenue from China was up 40% in the quarter, while comps out of China grew at a double-digit rate. Coach said it now expects to generate at least $400 million in sales this year in China alone.

As of this writing, the stock was trading around $51, with shares down more than 8% year to date. For comparison, let's see how rival lifestyle brands have performed thus far in 2013.

COH Chart

COH data by YCharts.

As you can see, Coach is markedly underperforming its peers in terms of price performance. But with shares trading at just 14 times earnings, the recent sell-off could create a favorable entry point for patient investors. I say this with an emphasis on patience. It will take both time and money for Coach to rebrand itself as an authentic lifestyle brand.

While the company's new direction comes with risks, it's also rife with opportunity. True, Coach may not borrow its name from an iconic designer like Michael Kors, but it's also not a stranger to the lifestyle brand. Coach already sells footwear, watches, and jewelry. By focusing less on its core handbag business and more on the extension of these categories, Coach may be able to win back some market share from Michael Kors.

Investors who currently own shares of Coach should sit tight as we wait to see how well the brand resonates with consumers as a lifestyle brand.

Michael Kors, on the other hand, is one of today's hottest high-end lifestyle brands, and that's translated into one of the best-performing stocks in retail -- since its debut on the market in late 2011, the share price has more than doubled. But with all that growth, has the stock finally become too expensive, or is there still room left to run?

The Motley Fool's new premium report on Michael Kors gives investors all the information they need to make the right decision. We cover the key must-watch areas, opportunities, and threats to the company that investors need to know. To claim your copy, simply click here now for instant access.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 25, 2013, at 4:10 PM, markpatel wrote:

    i think you so ignorant coach

    is a dying company with the new generation

    it's not interested in coach -- they want micheal kors

    by pumping coach all along .. motley

    fool has screwed its followers ..

    you don't promote stocks with low pe ratios

    their is reason why these companies

    have very low pe ratios their is no growth

    and wall street loves growth

  • Report this Comment On January 26, 2013, at 10:18 AM, EquityBull wrote:

    Kors has the hot hand now. Their earnings are going to be blowout with another incredible same store sales. I do various checks to get my pulse on things and they all come up with Kors on fire.

    Fashion is fickle. Will Kors remain the hot hand? They have been around for over a decade and just recently went into super hyperdrive.

    Kors has the tailwind now. Coach has to fight to stay in the game as demand for their products fall. The luxury pie is growing but Kors is eating it up at Coach's expense right now.

    I've laid some bets on Kors and wrote some calls against coach to recover some of the recent drop and hedge any downside. If I get called out I'll probably move that cash to Kors until I see a change in women's buying habits

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