Is There Light at the End of Coach's Tunnel?

Shares of Coach sunk after the company warned investors that sales in North America would fall faster than anticipated. Could the bad news possibly be priced in?

Jun 25, 2014 at 6:00PM

It's been an awful year for Coach (NYSE:COH) to say the least. Shares of the handbag and accessories maker have collapsed 40% over the past year. The fashion space is fiercely competitive, and consumer preferences can change quickly. After a punishing year in which shoppers have flocked to rivals like Michael Kors Holdings (NYSE:KORS), Coach investors were clearly hoping that a turnaround was in the near future.

Unfortunately, that's not going to happen. Coach management presented at its analyst and investor day and didn't give listeners what they were hoping for. The company expects results to deteriorate this year. It's clear that the competitive landscape has intensified. In response, management resorted to discounting to try and lure customers back to its brand. That didn't work, and now the pressure is on for management to figure it out.

Shares of Coach fell nearly 10% after the company provided its financial guidance. Add that on top of its poor performance over the past year, and it's reasonable to feel bleak about Coach's prospects. It's worth noting, though, that Coach is still profitable and pays investors a significant dividend. At this point, there's some value to be found in Coach, but you've got to have nerves of steel to buy the stock.

Can strength in China make up for weakness in North America?
Coach's position in North America is a mess. North American comparable-store sales, which measure sales at locations open at least one year, are expected to decline in the "mid-to-high teens" in percentage terms this fiscal year. This may come as a surprise since Coach didn't do poorly in recent periods. Total net sales actually rose 6% last year.

But beneath the surface, there's a big difference across Coach's results in terms of geography. Coach's North American sales were basically flat last year and quickly turned south this year. For example, sales in North America fell 18% last quarter.

By contrast, Coach is doing very well in emerging markets, which is where the company's best hope for its turnaround resides. Even though it struggled mightily in North America last quarter, sales in China soared by more than 25% and comparable sales there increased by double-digits.

Therefore, it's clear that the growth going forward will need to come from international sales. As far as domestic operations are concerned, Coach's strategy is to try and stabilize its performance as much as it can.

Better late than never
To be fair, Coach is doing the right things about its languishing sales in North America. It's going to close 70 underperforming stores. In addition, management is going to "de-emphasize" discounting. Taken together, these are two definitive steps in the right direction.

Coach is known as an upscale brand. By resorting to promotions and discounting to try and boost sales, Coach accomplished little other than diluting its brand. Clearly the strategy didn't work as anticipated, as North American sales have fallen off a cliff this year, and competitors are hitting Coach where it hurts.

Michael Kors recently wrapped up a huge year. In fiscal 2014, sales and earnings per share skyrocketed 51% and 63%, respectively. Management expects another good year in fiscal 2015. This year, the company estimates revenue to clock in at $4 billion, which would represent a 21% increase.

Michael Kors and Coach appear to be going in opposite directions. But Coach management is reversing course and acknowledged it was on the wrong track. At this point, Coach shares have been beaten down so badly that there appears to be some value here. Coach now trades for just 10 times trailing earnings per share and 12 times forward EPS, which are much lower valuations than the broader market.

Coach also offers a 3.8% dividend yield and a strong balance sheet. Coach holds $774 million in cash and equivalents on the books with no long-term debt. As a result, while Coach is currently going through a very difficult period, this could be a tempting time to buy if the company's turnaround efforts work out.

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Bob Ciura 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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