Coach Loses Ground to Michael Kors in Second Quarter

Coach (TPR 1.68%), the high-end designer brand famous for its handbags, accessories, and leather goods, fell short in its second-quarter earnings for fiscal 2014. On Wednesday, Jan. 22, Coach, announced its second-quarter earnings for the period ended Dec. 28. Not only did Coach miss analyst estimates, but it also stumbled in almost every category. News of its second-quarter performance spread quickly on Wall Street, causing the company's stock to drop 7% as investors reacted negatively to the dismal results.

Could it be that Coach is losing the war with Michael Kors Holdings (CPRI 2.10%) and Ralph Lauren(RL -0.27%), or was its weak performance caused by other issues?

Second-quarter results
Analysts and investors could not have been more surprised on Wednesday, Jan. 22, as Coach announced earnings per share of $1.06 versus the consensus estimate of $1.11 per share. To make matters worse, net sales dropped 5.3% to $1.4 billion from $1.5 billion reported in the second quarter of fiscal 2013. Due to the drop in sales, Coach's gross margin also declined from 72.2% in the second quarter of fiscal 2013 to 69.2% a year later. Part of the problem was that consumers in North America were more hesitant this year to pay the high prices for holiday gifts.

In addition, net income declined by 15.9% to $297 million when compared to the same period a year prior in which net income totaled $353 million. Net income could have been much worse had it not been for sales in footwear and mens, which continued to experience strong sales growth.

North American sales versus the rest of the world
International sales were the one bright spot in the beleaguered retailer's results. Thanks to its global expansion into Europe, China, Japan, and other parts of Asia, Coach has been gaining more attention and popularity within these markets. Its diverse geographic presence has allowed Coach to introduce its many collections of handbags, footwear, jewelry, fragrance, apparel, and accessories for both men and women to new audiences, who over time have become obsessed with the luxury brand's classic designs.

For the second quarter of fiscal 2014, international sales increased 2%, while North American sales decreased 9% along with a decrease in same-store sales of 13.6%. In China, sales of Coach handbags and accessories jumped 25% -- the highest of any other market. China also opened more Coach stores than any other geographic location. This tells us that the Chinese demand for Coach will continue to increase as the country continues to grow its middle class.

First six months in 2014
Coach has not had the greatest of performances in FY 2014. Year over year, these last six months show Coach increasingly on the defensive due to fierce competition among other designer brands in North America. Overall, in its first six months of fiscal 2014, Coach's net sales fell 4% to approximately $2.6 billion over the same period in fiscal 2013.

In addition, net income for the first six months of the current fiscal year fell from $574 million in fiscal 2013 to $515 million, with EPS declining $0.18 from $2 in the first six months of fiscal 2013 to $1.82 so far this year. Adding insult to injury, the rest of the year doesn't look to be any better. 

Looking ahead
Analysts estimate that Coach's EPS in the third quarter ended in March will reach $0.72 with revenue of approximately $1.2 billion. As long as international sales remain strong, Coach is likely to reach these earnings. However, its North American sales in both handbags and accessories could pressure sales and net profit, causing the gross margin to decrease further.

For North America, it's still up in the air as to whether or not Coach will give a better performance; for China, on the other hand, Coach has stated that its guidance remains on point. Currently, Coach is in the process of shifting its image to that of a lifestyle brand in order to cater to customers' everyday styles and by further developing its collection of apparel.

Foolish takeaway
Despite Coach having a rough second quarter, Foolish investors should not be thinking the worst. It is true that Coach will have to fight harder to keep Michael Kors from taking hold of its market position. Unfortunately for Coach, this latest earnings loss is a gain for Michael Kors and Ralph Lauren.

All is not lost, though, as Coach has a great competitive advantage with its growing geographic presence in the Japanese and Chinese markets. Foolish investors would be wise to keep their eye on Coach's stock and monitor the company's latest developments to decide if the designer brand fits well within their portfolio.