Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.



Coach and Michael Kors: The Widening Gap Indicates the Clear Investment Winner

Don't let it get away!

Keep track of the stocks that matter to you.

Help yourself with the Fool's FREE and easy new watchlist service today.

If you read Coach's (NYSE: COH  ) quarterly report or listened to the conference call, then there's not much to create excitement. The company is clearly, and admittedly, losing share to Michael Kors Holdings (NYSE: KORS  ) , but a planned turnaround effort has some investors optimistic. Hence, is Coach a good investment, a Fossil (NASDAQ: FOSL  ) in the making, or should it be avoided?

The Coach/Kors fundamental disconnect is growing
The one single strength of retail amid pricing competition and e-commerce growth has been the luxury space. Coach once owned this space in the handbag/accessory arena but has fundamentally fallen off a cliff.

In the company's fiscal second quarter, it reported revenue of $1.4 billion, which represents a 5.3% year-over-year decline. Given the aggressive pricing within the industry, a 5.3% decline isn't all that surprising. However, what's mind-boggling is the company's 13.6% drop in North American comparable-store sales, which has historically been its best market. This decline represents a cliff-dive, and the fact that no real sales guidance was provided is reason to be pessimistic looking forward.

In the meantime, Michael Kors continues to thrive! Last year, the company saw comparable sales growth of 41%, and for 2014, Wedbush retail analyst Corinna Freedman expects comps growth in the neighborhood of 20%-plus. Compared to Coach's double-digit decline, the distance between these two competitors is growing fast.

Is Coach now a buy?
At some point even a fundamentally declining business reaches a point where its valuation suggests it may be a buy. Investors are often willing to buy such stocks if they believe a turnaround is possible, or if the valuation disconnect between it and its peers  is so large that stock value is evident.

The problem is that given the declines we're seeing, Coach hasn't reached this point yet.

Coach trades at 12.7 times forward earnings and 3.0 times sales. At first glance you might think that Coach is presenting value. However, Michael Kors trades at 23 times future earnings with a price-to-sales ratio of 6. Essentially, Michael Kors is twice as expensive as Coach according to both of the key valuation metrics used by retail investors.

Yet isn't Kors worthy of that premium? Doesn't the fact that Kors is growing by more than 20% and Coach is declining by double digits weigh in the favor of Kors? Sure, Kors is more expensive, but it's well deserved.

Until Coach shows a recovering or even a stabilizing business, it's really hard to value its stock, as we don't know how far this ship can sink. With that said, Kors keeps growing, Coach keeps losing, and most investors would agree that a growing retailer is worth far more than one that's not.

Are Coach's problems temporary or macro-related?
Coach "longs" point to new product launches as a reason to be optimistic. In the past, we've seen new product innovations and launches drive specialty and luxury retailers higher, such as with Fossil.

Fossil saw its stock fall from $130 to $70 back in 2012 when a softening macro environment affected growth and created margin pressure. The problem for Coach is that this "horrible" quarter for Fossil still included growth of nearly 10%, and as of its last quarter, the company saw growth of 18% year over year.

Hence, Fossil recovered, and looking ahead to this year, is expected to grow 10%. Furthermore, at 16 times forward earnings, Fossil isn't too much more expensive than Coach, a company that's clearly not operating on the same level.

Moreover, as we've seen in this luxury or trend-setting retail space, once a brand begins to lose momentum or fall out of favor with consumers, it is very hard for it to recover. As of today, Coach doesn't seem to have a plan to compete, and that definitely weakens the investment outlook.

Final thoughts: Questions without answers
Looking at Coach, there just seem to be too many questions.

The company gets 50% of its sales from an outlet-store channel that is declining faster than brick-and-mortar retail as a whole. Therefore, how does it effectively change this dynamic?

The company's creative head, Reed Krakoff, who was a lead designer throughout Coach's growth years, is no longer with the company. After 16 years Krakoff left to pursue his own brand. Now, Stuart Vevers, who previously held positions at Loewe and Mulberry, is the new executive creative director. While Vevers has had success in the past, handbags are different from coats, and there are many questions as to whether he will make too many changes to the trademark Coach brand, causing further problems. Anytime a new creative director replaces a legendary one, questions arise, and Vevers must prove his place at Coach.

Last, and most important, how long can Coach operate at this pace without having to cut costs? A business can't lose 13.6% of its comp sales and continue to pay a 2.8% annual dividend, expand internationally, develop new products, and advertise aggressively. Hence, what gets cut, and how does the market respond?

The bottom line: The future is uncertain for Coach, and as of now, this is a business with a double-digit loss in North American comp sales, its most important market. Thus, Coach is definitely a risky investment, even after a 7% post-earnings loss.

3 stocks with a brighter future
As every savvy investor knows, Warren Buffett didn't make billions by betting on half-baked stocks. He isolated his best few ideas, bet big, and rode them to riches, hardly ever selling. You deserve the same. That's why our CEO, legendary investor Tom Gardner, has permitted us to reveal The Motley Fool's 3 Stocks to Own Forever. These picks are free today! Just click here now to uncover the three companies we love. 


Read/Post Comments (0) | Recommend This Article (3)

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.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2806063, ~/Articles/ArticleHandler.aspx, 9/2/2015 8:59:13 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Brian Nichols

Brian Nichols is the author of "5 Simple Steps to Find the Next Top-Performing Stock: How to Identify Investments that Can Double Quickly for Personal Success (2014)" and "Taking Charge With Value Investing (McGraw-Hill, 2013)". Brian is a value investor, but emphasizes psychology in his analysis. Brian studied psychology in undergrad, and uses his experience to find illogical value in the market. Brian covers technology and consumer goods for Motley Fool. Brian also updates all of his new and current positions in his Motley Fool CAPs page. Follow Brian on Twitter and like his page on Facebook for investment conversations and recent stories.

Today's Market

updated 11 hours ago Sponsored by:
DOW 16,058.35 -469.68 0.00%
S&P 500 1,913.85 -58.33 0.00%
NASD 4,636.11 0.00 0.00%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/1/2015 4:01 PM
COH $29.59 Down -0.66 +0.00%
Coach CAPS Rating: ****
KORS $42.79 Down -0.67 +0.00%
Michael Kors Holdi… CAPS Rating: ****
FOSL $59.69 Down -1.89 +0.00%
Fossil CAPS Rating: ***