Coach Is in the Bargain Bin: Buying Opportunity or Damaged Merchandise?

Shares of Coach can´t seem to find a bottom due to falling sales in the U.S. and increased competition from Michael Kors and Kate Spade. However, there are also some reasons for hope in the long term. Is Coach a buying opportunity for investors?

Jun 20, 2014 at 4:10PM

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Source: Coach.

Handbag and accessories retailer Coach (NYSE:COH) is going through a remarkably challenging period, hurt by declining sales and increased market-share competition from Michael Kors (NYSE:KORS) and Kate Spade (NYSE:KATE). After falling more than 35% year to date, the stock is in the bargain bin. Is Coach a buying opportunity for smart shoppers, or should you stay away from this damaged merchandise?

On sale
Adding to Coach's challenges, the stock fell by almost 9% on Thursday after management announced in a meeting with analysts that it would close 70 underperforming stores over the next year. Coach expects revenue to fall by low double digits during the fiscal year ending in June 2015, while comparable sales in the U.S. are forecast to decline by the high teens.

Coach does not expect any quick turnaround in performance, and this is understandably a reason for concern among investors. On the other hand, management is doing the right thing in trying to set expectations at achievable levels. For a company in this situation, it's far better to underpromise and overdeliver than to create unwarranted hope among analysts.

Besides, not everything is bad news for Coach lately. The company is performing remarkably well in international markets, where sales increased 14% to $441 million during the first quarter of the year. Sales in China increased by a strong 25% during the quarter, and management estimates the business is on track to generate more than $540 million in sales in the country during 2014.

Coach is making a big bet on its renewed collection from Creative Director Stuart Vevers, which is due to reach stores in September. During the earnings call, CEO Victor Luis said, "The collection got a significant attention and the global press was uniformly positive bringing Coach into the fashion conversation."

The situation could materially change if Coach can position itself as a trendy and desirable brand once again. Even if it takes some time for an improved merchandising strategy to be reflected in better financial performance, winning customers back with a successful new collection could be the first step to leaving the company's problems in the past.

Competitive pressure: Coach vs. Michael Kors and Kate Spade
Michael Kors' success has been explosive in the last few years as the company has positioned itself as one of the most demanded brands in the industry, and recent financial reports suggest there is no slowdown in sight.

Kors announced a 53.6% increase in revenue during the first quarter of 2014, reaching $917.5 million. Sales were strong across different segments and geographies: retail sales grew 49.7% to $408.4 million, wholesale sales jumped 55.5% to $473.7 million, and licensing revenue increased 79.1% to $35.4 million.

Sales in North America grew 43% versus the prior year, on the back of a 20.6% increase in comparable-store revenue. Europe was an even stronger market for Michael Kors, with a 125% increase in revenue during the quarter and an increase of 62.7% in comparable-store sales.

Kate Spade is materially smaller than both Coach and Michael Kors, but the company has gone through an impressive transformation, disposing of other brands so it can better focus on its leading Kate Spade name. 

Total sales from continuing operations reached $328 million during the first quarter of 2014, an increase of 33.5% versus the same period in the prior year. Kate Spade brand revenue increased 54% to $217 million during the quarter, so both Coach and Michael Kors will probably be facing increased competition from Kate Spade over the medium term.

Foolish takeaway
Falling sales in the U.S. and competitive pressure from Michael Kors and Kate Spade are serious headwinds for Coach. But there are also some reasons for hope. Nobody expects a quick turnaround at this stage, but the business is still performing soundly in international markets and management is optimistic about the company's renewed fall collection.

The smart thing to do is to see how the company's new collection resonates among customers before making an investment decision, as this could be a major inflection point for Coach in the medium term.

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Andrés Cardenal owns shares of Coach and Michael Kors Holdings. The Motley Fool recommends and 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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