1 Retail Stock Embarrassing Coach, Inc.

Coach's recent weakness has correlated well with Michael Kors' success; and in looking at Coach's most recent quarter, the latter's upside may be apparent.

May 3, 2014 at 10:00AM

Coach (NYSE:COH) shares are once more falling lower after the company's comparable North American store sales fell 21% in its fiscal third quarter, thus confirming that the luxury retailer has lost its appeal in the region. However, while Coach and peer Vera Bradley (NASDAQ:VRA) struggle, this comes as great news for Michael Kors Holdings (NYSE:KORS), a competitor that has excelled in Coach's weakness.

A look back at the holiday season
The holiday season of 2013 was plagued by harsh weather and competitive pricing pressure. As a result, luxury retailers, which historically have high margins, had to sacrifice profits in order to attract consumers.

Specifically, Coach was the biggest loser, as its 13.6% decline in comparable North American sales was a shock to investors and analysts. This is a company that had been touting its new product line and promising investors innovation that is yet to be reflected on its income statement.

Competitor Vera Bradley didn't perform much better. The designer's stock traded higher following earnings; but in the holiday season, comparable sales fell 10.2%. And in a real testament to the pricing pressure within the sector, Vera Bradley's gross margin declined by 500 basis points, a rather serious problem that investors don't see improving.

With that said, the only real exception to the luxury-retail rule for the holiday season was Michael Kors, as its revenue grew 57% over the same period last year and its comparable-sales increased 28%. Furthermore, its gross margin actually increased 100 basis points, with the company noting that it felt no pricing pressure. Needless to say it didn't feel the need to discount.

In that regard, Vera Bradley does compete with Michael Kors and Coach to some level. But the real competition is between Kors and Coach, specifically in high- margin handbags. In Coach's fiscal second quarter, announced in January, the company specifically said on its conference call that Michael Kors had taken market share, which likely led to the decline in comparable sales and margins. Yet, obviously, Kors didn't feel the same pressure.

Looking ahead
Today, Coach is finding it harder to make excuses for its poor performance; but it's worth noting that its 540 basis point decline in gross margin and 21% fall in comparable sales shows an acceleration of loss over the holiday season. It's also worth noting that while retail hasn't been particularly strong in 2014, it has shown a 2.5% increase over last year. Hence, retail is not that bad.

With that said, Vera Bradley is very much in the same boat as Coach. If we use the holiday season as a guide, and agree that Michael Kors is playing its own game, then the latter might have stolen even more market share in this last quarter. Therefore, in knowing that retail sales aren't declining, and that neither Coach nor Vera Bradley are leading the way within this space, Michael Kors might be a good investment opportunity.

Final thoughts
Currently, Michael Kors is trading about 10% off its 52-week highs, and much of this loss has occurred in a broad market pullback. However, at 23.5 times forward earnings, Michael Kors is not expensive, especially when you consider its top-line growth. In many ways, the future is still bright for this company.

Unlike Coach, Michael Kors has kept the bulk of its business in North America. But in recent quarters and in future plans, the company is expanding internationally at a rapid rate. Essentially, this is only going to drive growth and add to a North American market that is thriving -- or at least for Kors. Hence, Michael Kors is clicking on all cylinders; and judging by Coach's latest quarterly flop, it appears that performance is here to stay.

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Brian Nichols owns shares of Michael Kors Holdings. 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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