The sales picture at Coach has been darkening after it decided it wanted to go even further upmarket.
Coach (TPR 1.50%) reported fiscal third-quarter earnings last month that missed consensus estimates, causing its stock to drop 6%. But that doesn't mean the handbag maker can't fall further.
Coach is in the midst of a risky, high-profile realignment of its business and image, which could create a hazard for its operations. The company does pay a dividend that currently yields 3.5% annually, giving investors some solace as they wait to see if the revamp works -- and a big pullback in a stock is always a great time to consider an opportunistic purchase.
All the same, here are three reasons why Coach's stock may not have hit bottom yet.
1. The plebes can't afford you, and the bourgeoisie don't want you
The biggest change Coach is making to its business model is going even further upscale, becoming a "modern luxury" handbag designer and pricing itself accordingly. When some 30% of your handbags are selling for $400 or more -- up from mid-teen levels just two years ago -- you're going to be pricing yourself above a significant portion of the market.
The "upwardly mobile woman" sustained Coach for decades, but now the handbag maker is kicking her to the curb. Thanks to pushing prices higher and limiting discounting -- whether through sales events or in designing product for the outlets themselves -- Coach is hemorrhaging customers.
Revenue tumbled 15% year over year last quarter. Meanwhile, comparable-store sales (a metric that strips out the effects of growth achieved from opening new locations) plunged 23%, marking eight straight quarters of customer loss. Compared to rivals like Kate Spade and Michael Kors, which both posted high single-digit comp growth in their most recent quarters, Coach is trailing by roughly 3,000 basis points.
Coach's problem seems twofold: Its traditional customers can't afford the new higher-priced handbags, while the wealthier customers it's targeting still look down their noses at the brand. Selling nearly $1 billion worth of merchandise in the quarter shows that there's still a market for what it makes, but Coach may find its world shrinking.
2. Profit is still getting squeezed even with margin expansion
Also shrinking is Coach's net profit, which was more than halved this past quarter. While Coach's gross margin improved by about 50 basis points, its operating margin remained particularly pressured, dropping from 23.9% last year to 15.8% in the third quarter.
The numbers provide further proof that the problems affecting Coach are more specific to the reimaging than they are to some broad rejection of upscale goods. Hermes, after all, had a very good quarter, and Cartier-owner Richemont was only blindsided on profit last quarter because of currency exchange rates; otherwise, it's doing quite well.
Product specially designed for its off-price outlet educated consumers that they didn't need to pay full freight for a Coach handbag.
As Coach keeps discounts to a minimum and shrinks its outlet footprint, its gross margin should rise going forward. However, this underscores the higher-price path the handbag maker is on, which likely means its total profit will be lower.
Minimizing discounts is actually a good strategy for Coach, because previously, discounts were just cannibalizing its sales. Had it pursued that strategy alone, it probably wouldn't be in the straits it finds itself in now.
3. China doesn't bode well for luxury products
The continuing crackdown on luxury goods by Chinese officials, along with the economic slowdown there, is taking a toll on Coach's growth in the country. Last quarter, sales there rose 10%, or 8% in dollars, with positive comparable-store sales. But a year earlier, Coach was still boasting 25% sales growth in China with double-digit increases in comps.
The deceleration under way in China, coupled with weak performance in Japan -- sales were down 11% in constant currency, 23% in dollars -- make the international story for Coach another tough one. The numbers might have been better than what management had projected, but the Asia-Pacific region is no longer the growth engine it once was.
With so much invested in the region -- and with growth overseas propping up the rest of the business in recent years -- weakness in China may cause the underpinnings of Coach's operations to fall apart.
What it means for investors
Coach stock had been on a rebound until last month's earnings report, even if it was trading well below the highs it hit just two years ago. The sudden change in direction for the handbag maker has thrown it off balance, and consumers apparently aren't sure if they like what they see.
The dividend may serve as a salve for investors stung by the collapse in Coach's share value. But until Coach proves that its new strategy is resonating with consumers, they just might want to prepare themselves for lower stock prices ahead.
