Can China Save Coach?

China is a bright spot in Coach’s otherwise dismal results.

Jul 29, 2014 at 10:16AM
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Source: Coach.

I am not a fan of Coach (NYSE:COH), either as an investment or for its products. Although I continue to be bearish and critical of the company as I've been for some time now, as Fools it's never a bad idea to take a look at the opposite side of our stance in case we are missing something or in case the fundamental picture changes in a way that makes us rethink our position. With that in mind, I'm taking a look at one of the main bullish arguments for the stock: Coach is doing amazingly well in China.

A tale of two regions
Coach sells its products all over the world, but its North American sales seem to get all the negative attention. Last quarter Coach reported a slide in North American sales of 18%, a drop in same-store sales of 18%, and a plunge in net income of 20%. During a recent analyst/investor day, the company warned that you can basically expect more of the same over the next year.

Meanwhile, Coach products in China are selling like hotcakes and sales are growing. CEO Victor Luis stated, "China results remained resilient with total sales growing [more than] 25% and comparable-store sales rising at a double-digit rate." While over 60% of Coach's sales are still in North America, the growth rate in China is moving positively.

More growth expected
While Coach has been closing stores in North America and announced during its analyst/investor day that it will be closing 70 more stores or about 13% of its store base there, in China it is adding stores. It added five net new stores last quarter, bringing the total up to 147; it now has locations within 52 cities there. During the most recent earnings conference call, Luis stated: "We are very pleased by the continued development of this market, which bodes well for our global travel retail business, where the mainland Chinese tourist plays an increasingly important role."

He then went on to say that in China the Coach brand is recognized as "a dual gender and lifestyle brand," which implies there is opportunity to grow sales among men at perhaps a greater acceptance rate than in the United States.

Luis noted that Coach plans to open 30 net new stores in China over the next fiscal year. These stores will be what he describes as "dual gender" stores and will be around 25% bigger in terms of square footage. Coach expects China to contribute more than $540 million in sales over the fiscal year compared to $430 million last year.  It's still a minority of sales, but it's a relatively large and growing minority.

Wallpaper

Source: Coach.

Not the first time China was mentioned
Rewind to the January conference call, and Luis was only calling for $530 million in sales for China. The extra $10 million isn't exactly a game changer for Coach, but it's always nice to see guidance raised in any area, even if just a little. He reminded everybody then that Coach remains quite a young brand in China, so the possibilities of growing much larger are there. Who knows, in a few years it could be bigger than the U.S. market ever was.

At a conference back in November, it was pointed out, and reiterated more recently, that in China Coach doesn't have the stigma of being a handbag-only company that it tends to have in the United States. The result is that around one-third of sales there are actually in men's and other lifestyle categories.

Foolish takeaway
While it's obvious investors will want to follow the North American results for hints of a brand revival, it's possible that such a revival won't even be necessary if Coach continues to have its way in China. The growing middle class is also a positive tailwind that makes Coach's products affordable for the first time for millions of people in China. It's worth keeping an eye on the situation over the next few quarters and years. In the meantime, Coach's overall growth is disappointing, but the company is still quite profitable and well capitalized, so if the company starts growing again, it may make for a compelling investment opportunity.

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Nickey Friedman has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Coach. 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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