Why Coach's Future Hangs in a Delicate Balance

Replacing a retail genius could prove impossible for a storied luxury brand.

Feb 27, 2014 at 6:00PM

The game of fashion retail can be feast or famine for the companies that participate. While former giants like J.C. Penney struggle to stay relevant, brands like J.Crew are riding a wave of momentum. The former, over the past five years, has watched its market capitalization shrink in half; the latter's is expected to double should it go public this year.

In many ways, the luxury brand Coach (NYSE:COH) is caught in the middle. After decades of standing atop the fashion food chain, Coach is in the throes of a leadership transition while sales are slacking. As former CEO Lew Frankfort hands over the reins to Victor Luis, Coach shareholders are hoping for a new spark.

Frankfort's run, however, was unique and impressive, and many onlookers underestimate how difficult the transition could be. For perspective, J.Crew's CEO, Millard Drexler, shed some insight on the unpredictable art of executive succession in 2012.

Are great leaders replaceable?
For more than 40 years, Drexler, also known as "Mickey," has seen it all. He paid his dues at department stores like Bloomingdale's, then became a modern-day retail legend after successful -- though often volatile -- turnarounds at Ann Taylor, Gap, and most recently the privately held J.Crew. He has a keen eye for fashion, and industry insiders have anointed him with nicknames like the "merchant prince" and the "master of merchandising" because of his retail wizardry.

When Millard speaks about his experiences, followers of high fashion listen. With that said, investors in Coach might want to parse through his thoughts on CEO succession given the company's current predicament.

For all its success and staying power, Coach has been on a roller-coaster ride over the past year. After its most recent lackluster earnings report, shareholders have their hopes pinned on Stuart Vevers, Coach's new executive creative director, to reignite the brand.

But reviving Coach's product line and competing with a trending Michael Kors brand could prove to be a monumental task. In Coach's core North American market, same-store sales have slipped repeatedly; the most recent quarterly results show a 13.6% drop in comps versus the prior year.

Despite Vevers' impressive track record, new CEO Luis is the man under the true spotlight. Many believe the transfer of the leadership baton will go smoothly given that Frankfort plans to stay as a full-time chairman of the company he's worked at for 35 years.

But more often than not, leadership transitions are anything but smooth, and Drexler, for one, believes that fashion poses more difficulties than other industries. When asked at a Stanford business school lecture in 2012 whether he believes "a good leader will ultimately make himself replaceable," Drexler responded as follows:

I don't really believe that. ... I don't think most leaders are in fact replaceable. The fact is if you look at great companies, they don't last forever nor should they. ... I always used to laugh. It's like plan succession for Pablo Picasso. ... It's a long philosophical discussion. I don't believe in it because I've been listening to it for 40 years now. And I look at companies and I don't know where you can say there's been a seamless fantastic person to take over. ... It's probably easier to do the banking business than it is to do the art business if you're a painter. If you're a retailer who has a "sense" it's probably more difficult to have a succession. Costco, which is a great company, probably is less difficult, because I think the two founders there did a spectacular job and it's a great company.

Speaking broadly about the idea of succession planning, Drexler was not referencing the current transition at Coach. To my knowledge, he has not commented on Coach, but his thoughts on succession are clear: Industries that require high levels of intangible leadership qualities -- what he characterizes as a "sense" of fashion -- are prone to experience difficult transitions. Good luck, in his words, replacing "Picasso."

Forecasting a tenuous future
What's disconcerting for Coach is that Frankfort has been one of the extraordinary artists of the fashion industry for nearly 20 years. Consider that Coach was a $550 million retail shop in 2000 and a $5 billion powerhouse a decade later. Frankfort kept his finger on the pulse of an increasingly skittish market and steered the company with a steady hand. And it's that finesse, for lack of a better term, that's difficult to replicate at Coach compared to a more factory-like operation at Costco, for example.

While leadership and an adherence to values are crucial at Costco, the operation of a warehouse club relies heavily on researching what products consumers are buying and then finding a way to provide those products at a lower cost. In fashion, research like that can be meaningless. Drexler, for example, loathes consumer research, and spoke to this point in the same lecture: 

A lot of what I do is based on intuition, experience, wisdom, lots of failure, and hopefully a bit more success. ... I don't do research on what the customer wants ... No one will tell you where the puck is going. They'll always tell you where it is.

Neither Coach nor Costco are "turnkey" operations, to be sure, but one might consider the big-box retailer's strategy to be more of a science than an art. The opposite, then, would be true for Coach. Creating products that speak to the aspirations of high-end shoppers could be considered a more intuitive, difficult-to-replicate skill than running a time-tested membership model.

Despite its 70-year history as a premium brand, only time will tell how Coach's succession will play out and whether the stock will rebound. Shareholders, meanwhile, are left to wonder just how long it could take.

At the apparel company Nike, which operates in the slightly less-tumultuous world of athletic gear and shoes, founder Phil Knight worked for several years with two different CEOs to place the company in good hands. Even this seemingly successful transition -- of which there are few -- was harshly criticized along the way.

Unless investors have an uncanny ability to identify a fashion visionary, there's no telling how Coach's future will take shape.

Foolish takeaway

From my perspective, Coach might have a truly astounding international opportunity, and shares could look tantalizingly cheap at merely 13 times forward earnings. Nevertheless, nearly 70% of the company's revenue stems from North America. This home market remains the heart of the company for the time being. Until leadership can prove it has resuscitated a stagnating American brand, I would leave Coach on the sale rack for now.

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Our legendary co-founder and investor Tom Gardner believes truly great companies can create a vast amount of wealth for shareholders. Coach and Costco have been prime examples of winning stocks over the past decade. Looking ahead, Tom reveals the companies he believes are poised for similar success in our special report "The Motley Fool's 3 Stocks to Own Forever." These picks are free today, so click here now to uncover the three companies we love.

Isaac Pino, CPA, has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Coach, Costco Wholesale, Michael Kors Holdings, and Nike. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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