Coach Crashes After Earnings: Buying Opportunity or Time to Sell?

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Coach (NYSE: COH  ) crashed by more than 6% on Wednesday, after the company's earnings report came in materially below expectations. Is this a short-term overreaction from investors, or will competitors like Michael Kors (NYSE: KORS  ) continue gaining market share versus Coach in the coming years?

The numbers
Total sales for Coach's fiscal second quarter ended on Dec. 28 fell by 6%. On a constant currency basis, revenues declined by 3% versus the same quarter in the previous year. North America was a particularly weak market for the company; sales in the region fell by 9% to $983 million during the quarter, and comparable-store sales in North America declined by a worrisome 13.6% year over year.

International markets performed better, though. Sales in international markets increased 2% to $425 million, while international revenues on a constant currency basis grew by a healthy 11%.

China has been especially strong for the company lately, and this last quarter was no exception at all, with sales in the country jumping by a remarkable 25% versus the same quarter in the previous year and comparable-store sales in China growing "at a double-digit rate." Management expects to achieve its annual target of $530 million in China sales for the current year.

In Japan, another important market for the company, Coach is reporting uninspiring performance: Revenues on a constant currency basis fell by 2%, and the big depreciation of the Japanese yen during the quarter produced a 21% decline in sales measured in U.S dollars.

Gross margin fell to 69.2% of sales versus 72.2% in the year-ago quarter, and operating margin also declined to 30.7% from 35% of sales in the same quarter of 2012. Coach is still a substantially profitable company with margins at above-average levels; however, pricing discounts and falling sales are affecting the company's profitability.

Earnings per share of $1.06 were a 13.8% lower than the $1.23 per share the company delivered in the same quarter of 2012, and the number was also below the $1.11 per share analysts estimated on average.

Moving forward
This is not the first time the company delivered disappointing financial figures, North America has, in fact, been a weak spot for the Coach over the past several quarters. The company's aggressive expansion in recent years seems to have diluted its brand value and pricing power, and competitor Michael Kors is growing at full speed and gaining market share versus Coach in the high-end segment of the pricing spectrum.

Michael Kors is a younger and more innovative brand, and demand for its trendy designs remains red-hot. Sales have been booming at a growth rate of 47.5% annually over the past five years, and comparable-store sales are still rising. There's no slowdown at sight for Michael Kors, and it clearly represents a considerable competitive threat for Coach.

On the other hand, the handbags and accessories market is not a zero-sum game in which the winner takes all. Coach is still a leading industry player with a widely recognized brand and big customer base. If the company manages to get back on track with its products and designs, there's no reason to believe the market won't offer enough room for both Coach and Michael Kors to do well over time.

Coach is in the midst of a reorganization in its top management. The company's new CEO, Victor Luis, is a veteran with a 34-year history in different positions at the company, but incoming creative director Stuart Vevers is coming from outside the company and bringing a new and fresh perspective to the company's designs.

Coach will be introducing the inaugural collection from Stuart Vevers during New York Fashion Week in February, and those designs will be available in-store this fall. Investors may want to watch how this collection performs to evaluate whether the new management team can, in fact, reinvigorate the brand and reverse the declining sales trend in North America.

Bottom line
Falling sales in North America represent a serious problem for Coach. Even if China is partially compensating that weakness, the company needs to turn things around in its biggest region to provide more visibility about its competitive strengths and long-term growth prospects. The new collection from Coach's incoming creative director should provide important clues to evaluate the future of the company in the coming months.

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Andrés Cardenal

Andres Cardenal, CFA is a tenacious researcher of the best investment opportunities around the world. Andres is an economist and CFA Charterholder living in Buenos Aires, Argentina. Naturally flavored. Follow me on Twitter for more investment ideas:

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8/28/2015 1:00 PM
COH $30.15 Up +0.05 +0.17%
Coach CAPS Rating: ****
KORS $43.44 Up +0.16 +0.37%
Michael Kors Holdi… CAPS Rating: ****