A new upscale image and tighter pricing policies can halt the decline in Coach's cachet.
The transition to being a modern luxury handbag maker isn't going as smoothly as Coach (TPR 0.03%) would like, but the very things that are holding it back could ultimately enable the company to succeed and cause its stock to rise.
Here are three top reasons why Coach's stock could soon move higher.
Being snobbish can be profitable
There's little doubt Coach is taking a hit from its decision to go upscale. Net sales in its fiscal third quarter fell 15% to $929 million and even missed analysts' generous forecast of $949 million in sales.
With handbags priced at $400 and above now accounting for more than 30% of its handbag sales, up from 18% just two years ago, it appears Coach is clearing out the bottom ranks of customers.
This gives Coach access to a better-quality customer who is much less price-sensitive and more resistant to the vagaries of a volatile market. It will also improve its profitability. Gross margin rose by 50 basis points year over year in the quarter, to 71.6%. While operating and net margins suffered in the period, that was largely due to costs associated with its transformation.
Some $210 million of the $300 million in charges associated with the restructuring have been taken over the past four quarters, and management now expects savings on the plan to be realized sooner than originally anticipated. Coach is forecasting savings of almost $100 million this fiscal year.
When complete, Coach ought to be a better positioned, more profitable retailer.
Limiting the ability of customers to buy pricey new bags at a discount can bolster Coach's luxe image.
Reversing its discount image
Hand in hand with going upscale is putting an end to the practice of Coach cannibalizing its own sales.
Carrying a large part of the responsibility for the collapse in the handbag maker's financial position was the proliferation of outlet stores that received clearance items from its full-price retail outlets, along with merchandise designed specifically for those shops. It didn't take customers long to understand they didn't have to buy some knockoff bag on a street corner to get a Coach bag at a discount price; they could just go to one of its outlet stores to get a lower price.
To staunch the margin compression, Coach put a brake on opening outlet stores, and has closed many of them over the past year, along with a number of underperforming full-price stores.
In addition to closing a fifth of its North American locations, over the past year Coach also scaled back the promotional environment:
- It held only two flash sale events per month compared to three flash sale events per week.
- Had only one invitation-only customer event, in mid-March.
- Had no Coach Days in any North American department store during the quarter, compared to an average of approximately 30 such days a year ago.
- Converted to a semiannual schedule for its doorbuster sales.
This was all done in an effort to maintain Coach's image as a premium product not available to just any mall rat, which should bolster the bottom line in the future.
Footwear to give it a leg up
Women's shoes might not be the most underserved market, and they don't cure Coach's main problem of sagging handbag sales, but luxury footwear designer Stuart Weitzman could give sales a kick-start nonetheless.
The Weitzman brand is Coach's first-ever acquisition. Along with offering certain cachet that the company's own brand of shoes might have lacked, it also introduces Coach into some new markets where it was previously shut out -- for example, Nordstrom, Neiman Marcus, and Saks.
Moreover, they complement Coach's pricier handbags, particularly the line designed by Stuart Vevers. Coach also has plans for a Weitzman brand extension, including its own line of handbags and accessories. Those vaunted synergies we always hear about with mergers and acquisitions could actually come into play here.
What this means for investors
Coach has been under the gun, and though its stock rallied to new 52-week highs earlier this year, the third-quarter earnings report took a lot of the wind out of its sails. Shares now trade where they were over three months ago.
So what does an investor have to pay to own this modern luxury retailer? According to data from Morningstar, Coach shares are valued at almost 18 times next year's estimated earnings, a premium to the average forward earnings multiple of a group of comparable companies that includes Kate Spade, LVMH Moet Hennessy Louis Vuitton, Compagnie Financiere Richemont, and Michael Kors.
Data: Morningstar. Table by author.
However, Coach's enterprise value trades at just 11 times its free cash flow making the stock very cheap, particularly in comparison to its rivals that are valued at two to three times that rate. It's true the business is still in turmoil, but if the three factors listed above play out as well as Coach hopes, the time could be ripe for its stock to rise and may not be a reasonable risk to take.
