Fashion is a notoriously fickle and hard-to-predict business. A company can fly high for a length of time, only to crash back down if consumer sentiment shifts. That happens more frequently in the luxury apparel space than in other areas, which means the task for investors is to capture the companies whose products are in their heyday.
Value investors might think Coach (NYSE:TPR) is worthy of consideration, because on the surface it seems like an ideal candidate for bottom-picking. Coach has seen its share price plunge over the past year. But there's a very good reason for Coach's collapsing share price. Its business has deteriorated, as consumers have flocked to other brands such as Michael Kors Holdings (NYSE:KORS). And Coach's strategic initiatives undertaken to reverse its poor performance have not gained traction.
Investors therefore have a clear reason to stay away from Coach.
Coach's self-inflicted wounds
Over the past year, Coach has adopted a strategy of sales promotions and discounts to lure back shoppers in light of stagnating sales. The rationale was that with lower price points, Coach could bring in more customers, but the strategy completely backfired. All Coach accomplished was to erode its own brand. This is evident in Coach's deteriorating margins. Last quarter, Coach's operating income margin stood at 20.9%, down a whopping seven full percentage points from the same quarter last year.
Coach had been universally known as a luxury, high-end brand. High pricing goes right along with that, and consumers demonstrated a willingness to pay up for premium brand quality. What Coach unwittingly did was essentially push out customers expecting a top-line brand and exchange those shoppers for lower-end customers who are buying at lower price points.
Sales in North America fell an astonishing 19% last quarter. Coach is even underperforming in the lucrative emerging markets, where millions of shoppers who are new to the middle class are proving to be a gold mine for fashion retailers. Coach's sales in China rose 10% last quarter, which sounds good, except that it represents the slowest rate of growth in two years. Sales in Japan, meanwhile, declined for the eighth straight quarter.
Going forward, Coach is counting on its new Stuart Vevers line to rejuvenate sales. The inaugural collection was launched in September, and Coach has high hopes for this line. Whether this is enough to stop the massive decline in sales is questionable at best. Coach is still resorting to discounting and sales promotions to bring in traffic, which will keep pressuring margins.
Coach is losing ground to rivals
The higher-end shoppers have instead flocked to other fashion retailers that have maintained their luxury image. Affluent consumers are still spending on luxury apparel, they're just spending it elsewhere. A few of Coach's rivals are still putting up solid growth. One of which is Michael Kors, which produced 42% revenue growth and 40% earnings growth last quarter, year over year.
Put simply, shoppers are buying. Unfortunately for Coach, high-end shoppers don't need discounts, and in fact, they're more inclined to shop elsewhere because Coach's sales promotions are seen as a step down in quality. Coach's pain is Michael Kors' gain.
On the surface, Coach seems like a compelling value stock to buy. That's because the stock trades at 14 times earnings. This is a significant discount to the broader market, which makes Coach seem relatively cheap. Plus, Coach offers a 4% dividend yield, which could be attractive to income investors. However, Coach's value proposition will likely prove to be a mirage if sales and earnings keep falling. If Coach's fundamentals continue to deteriorate, its valuation multiples will in fact expand due to lower EPS.
Because of this, Coach has all the makings of a value trap.
Bob Ciura owns shares of Michael Kors Holdings. The Motley Fool recommends BMW, Coach, Michael Kors Holdings, and Nike and owns shares of Coach, Michael Kors Holdings, and Nike. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.