What Does the Future Hold for Coach?

Will Coach be able to turn things around after its second quarter result?

Apr 23, 2014 at 8:00AM

Coach (NYSE:COH) and Kate Spade & Company (NYSE:KATE) have fallen victims to the same tough retail environment that has taken a toll on the earnings of many fashion designers. While Michael Kors Holdings (NYSE:KORS) has successfully weathered the storm, most of these companies have had to revamp their business strategies.

Let's take a detailed look at Coach and see what the future holds.

Second quarter result
In the second quarter, Coach's per-share earnings plunged 22% to $1.06 per share, down from $1.23 a share in the comparable period last year. Revenue fell to $1.42 billion from $1.50 billion in the year-ago quarter. Both earnings and sales took a hit because of weak performance in North America.

Net sales in North America declined by 9% to $983 million. Lower than anticipated sales for women bags and accessories contributed toward anemic sales in the region. The international segment's revenue grew 2% to $425 million. In China, sales climbed by 25%, while they fell by 2% in Japan. A weaker Japanese yen against the U.S. dollar was the primary reason for lower sales in the country.

What is Coach up to?
A recent article from Bloomberg identified the growing scope of luxury accessories in China. As per Bain & Company, Chinese consumers account for approximately 25% of money spent on luxury goods worldwide. This means China has huge growth potential for U.S. brands like Coach, Michael Kors, and Kate Spade, as these retailers offer luxury accessories at lower prices. But up until now, U.S. retailers haven't been able to benefit from the Chinese market to the fullest because of their weak distribution network in the region.

It will take some time before these American retailers will be able to expand their distribution networks in China; meanwhile, a lot of Chinese nationals are flooding the U.S. for shopping. Since the Euro gained a lot against the U.S. dollar in the last few quarters, shopping in America has become relatively cheaper than Europe. In order to benefit from this growing number of tourists, the U.S. government has also eased its visa restrictions for Chinese nationals. Coach has capitalized on this by adding Chinese speaking staff at its outlets. Furthermore, it is also using social-networking apps like WeChat to promote its products and deals. As a result, the company's comparable sales in China are now growing rapidly.

In an effort to develop the company's next generation retail concept, Coach has once again partnered with the world famous creative firm Studio Sofield. The first store under this collaboration will be inaugurated at Beverly Hill, CA, in fall 2014, which will be followed by another store at the Time Warner Center in New York City. In addition, the company will open a new location in Tokyo as well.

According to Coach, the new retail concept will create more brand value for the company. Stuart Vevers, Coach's executive creator director, had this to say: "As we continue on the path of transformation, I want our new store environment to organically trigger a significant change in the perception of our brand. A space that feels authentic to Coach, confident, modern and inviting, with honest construction and rich, warm materials."

Industry peers
Kate Spade, formerly known as Fifth & Pacific, looks to be on the right track. In its latest quarter, the company's sales surged 22% to $426.9 million driven by strong growth of its core Kate Spade brand. Earnings for the quarter climbed to $1.48 per share from $0.57 a share, coming in well above analysts' estimates of $0.29 per share. The drastic jump in earnings was largely attributed to the company's trademark sales, which accounted for about 96% of the company's total profit. Kate Spade's direct-to-consumer sales rose 30%, while net sales for the brand increased 48% to $256 million.
 
Michael Kors also posted solid numbers in its most recent quarter. The company earned $1.11 per share, while analysts had estimated $0.86 a share in earnings. Revenue grew 59% year over year to $1.01 billion, beating the Street's estimates of $860 million. In contrast to Coach's weak performance in North America, Michael Kors reported a 51% jump in sales in the region. The company also gained double-digit growth in Europe despite the economic downturn in various European countries. Since the company is growing at a tremendous pace, it appears to be heading in the right direction.

Final thoughts
Coach's latest quarterly report has disappointed investors, as earnings along with sales kept declining. The only good news came from the Chinese market, where luxury accessories are selling at a fast pace. In order to capture significant market share in China, Coach will have to expand its distribution network quickly. Otherwise, rivals will soon catch up and the market will be shared. Moreover, Coach's collaboration with Studio Sofield promises to be a fruitful deal, as it will create more brand awareness among consumers in the coming years.
 
Coach is still trying its best to achieve a major turnaround, and it hasn't been able to grow its profits during the recent past. As the company needs more time to recover, I won't recommend buying it at this point in time.
 

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Zahid Waheed has no position in any stocks mentioned. The Motley Fool recommends Coach and Michael Kors Holdings. The Motley Fool owns shares of Coach and Michael Kors Holdings. 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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