Coach Says See You in September

The well-traveled designer (everywhere from Calvin Klein to Louis Vuitton) Stuart Vevers is now the future with his first Coach (NYSE: COH  ) designs hitting stores in the back half of 2014. If he succeeds, Coach will be back, and if he misses --let's not go there. He carries a heavy weight with the fate of America's sweetheart all-American bag brand in his hands, but that's what it comes down to for Coach these days as it sees its North American sales slip through its fingers. Coach now only gets mentioned as an underperforming footnote to Michael Kors (NYSE: KORS  ) and the newly reorganized kid on the block Kate Spade (NYSE: KATE  )  -- both stars in the aspirational-luxury sector.

Victor Luis presides over his first Christmas, and it's not merry
Coach's second quarter includes Christmas and holiday sales didn't save Coach.

Second-quarter revenue slid to $1.42 billion -- a 6% decline year-over-year with North America down 9% and international sales increasing only 2%. When adjusted for currency effects, total revenue was down 3% and international sales rose 11%. Same-store sales in North America were a Scrooge-ish (13.6)% for the worst number Coach has seen in the last seven quarters.

Coach earned $1.06 per share versus $1.23 in the year-ago period and it has disappointed investors in every quarter since last summer. With every unhappy conference call the shares sell off. Investors may have been hoping for a Christmas miracle with a short-lived recovery of the share price in December but that was swiftly squashed after the Jan. 22 conference call.

The Wall Street consensus for the second quarter of 2014 called for $1.11 in earnings per share and $1.502 billion in revenue, and Coach fell far short. While it's seldom important for investors to care what analysts expect, the market took Coach's share price down to 52-week lows.

For the most part, Coach blamed the miss on the steepest decline in mall retail sales in six years and disappearing in-store traffic. Consumer traffic apparently failed to find Coach's doors, as shoppers were waylaid by Michael Kors. Over the Christmas quarter KORS' net sales increased 59%, comparable sales were up 27.8%, and the shares climbed to historic highs. Kate Spade managed revenue growth of 48% in the Christmas quarter with a 61% increase in revenue for 2013 on comparable sales of 28%. With Michael Kors firmly in place as the aspirational-brand market leader, Kate Spade may be the turnaround retail story of 2014.

Coach's sales in China were respectable, increasing 25% with double-digit comps. Coach never gives a number for China's same-store sales -- it just describes them as "double-digit" increases. During the second quarter Coach opened 10 net new locations in China to bring the total to 142 from 117 in December 2012. For the first six months of 2014, international sales were only 31% of Coach's total revenue and while China's hot, it's a small part of the total business.

Is it all or nothing for Coach this fall?
Coach is not catching fire in North America and sales continue to fall as stores lose traffic and fail to keep pace with the competition. In an effort to resurrect the Coach cachet, the company has made a big bet on the magic of Stuart Vevers. It looks like an all-or-nothing gamble on one fashion plunge.

Victor Luis -- new CEO:

Importantly, we continue to advance our transformation initiatives and position Coach to launch Stuart Vevers' first collection in September.

 We are extremely excited by the initial steps we're taking. Stuart is providing us with a rich context for us, not only in terms of rediscovering what is great about Coach, which is a story on quality, great purity of design, understanding materials and craftsmanship, but also providing a fashion relevance for the brand like we've never had.

When asked about the timing of a Coach turnaround, Luis admitted he wouldn't know when until he sees it, but traffic will be the harbinger of change. Apparently there is no end in sight for at least the next three quarters unless North American store traffic moves back into positive territory. That will be a key number to follow. Most of what Victor Luis had to say about the reversal of Coach's fortunes was generic retail-speak with the exception of pointing out the importance of Stuart Vevers to the company. If he fails it will be epic. 

It's not all bad
The six-month cash flow from operating activities for Coach was $564.5 million and with capex spending of only $107 million, free cash flow was $457.5 million for the first six months of 2014.

Coach has no long-term debt and only $485,000 in short-term debt. Growth and new stores are funded with cash flow and in spite of slowing revenues and tapering comps, Coach generates a lot of cash.

The company does keep shareholders in mind and it has spent $350 million so far in 2014 to repurchase 6.6 million shares at an average cost of $53 per share. Share count has decreased year-over-year by around 4 million shares. The company paid out $190 million in dividends and the current dividend is $1.35 for a 2.8% yield.

The new concept stores are flourishing and according to the conference call Coach plans to learn what's working and it will begin to roll out remodels that reflect the most successful parts of the concepts.

In the end numbers tell the story
Coach's numbers tell a sad story. Margins are shrinking as the company slashes prices, and even that failed to move inventory. 

Margins have been in a downward spiral as Coach depends on promotions and outlets to move merchandise. A 5% slide year-over-year is significant and this tells the tale of the state of the business and its demotion to an also-ran behind Michael Kors. Coach's product is no longer a fashion force in North America and with North America at 70% of the business, the company needs to fix the problem.

Inventory bloat is a retail red flag and the company says it will be blowing this excess out the doors over the next few months. Expect margins to stay down because jettisoning unwanted inventory means more markdowns.

These speak for themselves and don't have much to say except for how hard Coach's business is falling.

Coach is still a great business and selling $1.4 billion in bags, shoes, and watches is phenomenal if you stop to think about just how much stuff that is -- a lot of consumption goes on in Coach stores. However, it may be best to check back in September and hope Stuart Vevers has the key to the next big thing in aspirational luxury.

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