Luxury goods maker Coach beat the Street this quarter, but it has a lot to prove before investors can believe a real turnaround is underway. Photo: The Motley Fool
It's a good thing analysts set the bar so low for Coach (COH 2.18%) because it was able to leap over the hurdle rather effortlessly, despite the sharp drop in revenues and earnings. The handbag maker is still in the middle of its transformation into a luxury lifestyle company, and all the moving parts have yet to come together into a cohesive whole.
But management remains as effervescent as ever on the potential for the change, though investors may want to be more circumspect until there's some actual proof it's working. Still, Coach's stock is up 5% since the report, and there are five things management wants you to keep in mind.
1. Our store remodels are helping push sales up
Coach is renovating its stores to good effect. It's renovated 84 stores globally so far, bringing the total to 108 for the year. But more importantly, they're outperforming the stores that have yet to be upgraded, with sales, traffic, and conversion all benefiting from the face-lift.
CEO Victor Luis say that those stores that got the "modern luxury" redo "generated positive comps in aggregate in the fourth quarter, representing a significant inflection in trends post renovation and outperformance versus the balance of retail stores."
Coach is counting on store makeovers to bring in customers looking for the luxury lifestyle. Photo: The Motley Fool
2. No, really, higher comps are coming ... eventually
A combination of store conversions and new product introductions is expected to drive Coach's recovery. As noted, it's seeing improvements based on store remodels already, but it's in 2016 where the real gains will be made. There is a big lineup of events occurring that will push comparable sales higher, particularly in the second quarter, and by the end of the year they should finally be positive.
CFO Jane Nielsen said Coach "would expect comp to improve throughout the year, with the most significant inflection occurring in 2Q, driven by product innovation, renovated modern luxury stores, and our 75th anniversary marketing initiatives. We expect to reach positive comps in the fourth quarter."
That's a tall order, though, since they were down in the fourth quarter some 20%, hardly better than the 24% decline they experienced in the third. Expecting a raft of new handbags to suddenly galvanize consumers into action may be wishful thinking because trends are weakening.
3. Luxury goods have slowed down significantly
According to CEO Luis, a good part of Coach's business is simply "an overhang in the luxury market that is being driven by the macro issues and the extreme exchange rate volatility that we've discussed that is obviously impacting tourist flows." All the customer needs and is waiting on is greater innovation.
Fortunately, it's not just Coach experiencing the slowdown, but Michael Kors and Kate Spade have also been hit hard by it, too. Which is why Coach looks at this as an opportunity.
By providing "relevant brand experience" once again as it used to, Coach believes the customer will respond.
4. But the Chinese market is decelerating, too
It's actually a bit of a mixed bag in China, where Hong Kong and Macau continue to suffer from declining traffic, but the mainland is experiencing growth. It's for that reason Coach is investing more money in opening stores on the mainland than in the tourist destinations of Hong Kong and Macau.
And though revenues in China hit nearly $600 million, Coach's business has declined and it anticipates that trend continuing for the foreseeable future. But like with other aspects of its business that have hit headwinds, CEO Luis remains upbeat: "Despite some macro slowdown, we remain optimistic on the prospects of this market over time as the long-term drivers we've consistently mentioned remain intact."
By expanding the Stuart Weitzman brand into other areas, Coach intends to increase its contribution to the company. Photo: bargainmoose
5. Stuart Weitzman is boosting our sales but dragging down our margins
The acquisition of shoemaker Stuart Weitzman was fortuitous because it helped Coach exceed analyst expectations. As has been noted before, those revenues are really just replacing sales the handbag maker lost and it's in a market that is ancillary to its main business.
Worse, it could end up dragging down overall performance. Naturally, Coach sees a chance to grow the business through increased efficiencies and international expansion, but CFO Nielsen cautions "that Stuart Weitzman's gross margin is well below Coach brand, as is the company's operating margin."
What it all means for investors
There has been no real, measurable improvement in Coach's condition despite the earnings beat. Set the bar low enough and you can walk over it. At best, these are green shoots of opportunity, but the broader collapse of similarly situated brands doesn't bode well. If a rising tide lifts all boats, a tide that's running out will drag most back out with it, too.
In recent years, Coach hasn't been such a financially strong outfit that it can swim against the tide, and while you never want to count out a business that has a 75-year track record of growth, the handbag maker still has a lot to prove in the current environment.
