Is Coach Inc.’s Stock Price Decline Justified?

After a rally in the first half of 2016, Coach‘s (NYSE:COH) stock price has witnessed a decline, to levels seen at the beginning of the year. The company’s closing price rose to a high of $43.46 on August 1, but has seen a steady decline thereafter, with fears of a poor year-end performance. While Coach isn’t alone in being out of favor in the retail industry, however, given its recent performance, the decline in its share price may not be warranted. According to Trefis estimates, Coach’s stock price has an intrinsic value of $44.02, implying a 24% upside potential. Below we have highlighted some factors which we feel justify this price point.

See our complete analysis for Coach here

1. Department Store Pullback

During its fourth quarter and financial year 2016 (ended June), Coach announced its decision to pull the company’s handbags and leather goods out of 25% of department stores, or by over 250 locations, a move which is specifically designed to move away from the discounting that has hurt its luxury brand image. Furthermore, the company intends to reduce the markdown allowances to the channel, citing a highly promotional environment embraced by such stores. The heavy discounts offered in this channel makes it harder for consumers to spend more on a similar bag at the company’s own stores or at its e-commerce websites.

Coach is the latest label to be cracking down on the heavy discounting associated with its brand. Others include Ralph Lauren and Michael Kors. The latter generates an estimated 40% of its revenues from such stores, and is also cutting down on the amount of merchandise it sells through the channel. Kate Spade, which is still building out its wholesale network as it is a much smaller brand, is also taking a careful and cautious approach. Since outlet stores are usually located in tourist locations, they’ve been hit particularly hard, as a strong dollar has hit the tourist inflow into the US.

While this strategic decision negatively impacted sales by 150 basis points in the first quarter of 2017 (ended September 2016), it is expected to have significant long-term gains. These steps are being taken to elevate the brand positioning, which was reflected in the above-$400 price bracket rising in penetration to over 50% of the handbag sales. This further drove the handbag AURs (Average Unit Retail) to over $300. While these efforts have resulted in slow growth, with an overall growth of 1% for the company, it has resulted in a better bottom line performance and a healthy inventory position. The company was able to reduce the inventory from $575 million in the year ago period, to $547 million at the end of the September quarter, putting it in a better position heading into the holiday selling season.

2. Turnaround Of Coach’s North American Business

One of the highlights of Coach’s third quarter (ended March 2016) was the turnaround of the company’s business in its most important region – the United States. Same store sales at the retail stores there remained unchanged, after several quarters of negative comps. This represented the fourth consecutive quarter of improvement for the company in the country. While store and mall traffic remained soft, the average value spent by the consumer was higher than a year prior; the handbag AUR (average unit retail) rose to over $300 in the quarter, a figure reached for the first time since FY 2009. The renovated luxury store concept of the company proved to be a hit, with positive comps seen in such stores. Furthermore, the sales of premium bags increased when compared to six months before, with higher penetration of the above $400 price bracket. This segment formed 40% of the handbag sales, versus 30% in the previous year.

The North American segment of the Coach brand continued its positive comparable sales growth in the first quarter of FY 2017 (ended September 2016), even though sales fell 3% in the quarter. The decline was a direct result of a deliberate department store pullback and a reduction in reliance on e-commerce promotions.

3. FY 2017 Guidance

Coach has reaffirmed the FY 2017 guidance in the first quarter earnings conference call, wherein it expects a low-to-mid single digit growth in revenue, and a double-digit growth in both net income and earnings per diluted share. The operating margin is expected to be between 18.5% and 19% for the year, which incorporates the negative impact of Stuart Weitzman and the strategic decision to elevate the Coach brand’s positioning in the North American wholesale channel, including a reduction in promotional events and a closure of about 25% of doors. These efforts will drive the positive momentum in North America, especially as the company was heading into its most important quarter of the year.

4. Growth Of The Chinese Market

While many fashion brands are looking to North America as they feel the effects of a slowdown in China’s luxury market, accessible luxury brand Coach is seeing the opposite phenomenon. Coach has been an aggressive early mover and a pioneer in the affordable luxury segment in China, profiting in this region despite many other International luxury brands taking measures, such as dropping prices, to spur their sales. Coach acquired the domestic retail businesses from its distributors in Hong Kong, Macau, and mainland China (Greater China) in Fiscal 2009. Coach has since gone from strength to strength, expanding aggressively in the region, and being rewarded by the achievement of strong growth. The company has been relatively immune to the anti-corruption crackdown that has hurt other Western brands, due to its comparatively less expensive products. Coach has also been adept at the use of its digital marketing, building strong connections with Chinese consumers, and keeping them updated with the new store openings and latest collections. According to The Digital IQ Index: Luxury China 2016, Coach has the third best digital strategy in China. Moreover, the launch timing of its new Disney collection could not be any better, with the opening of the Shanghai Disneyland on June 16th. The company’s seven stores in Shanghai can be expected to get added attention as a result of this.

Have more questions on Coach? See the links below:

• Instead Of Just Its Bags, Could The Kate Spade Company Be Up For Sale?
• It’s Raining Promotions This Holiday Season In The Handbag Industry
• Coach Continues With Its Positive Momentum In North America
• Can Coach Continue Its Positive Earnings Surprise Streak?
• Is A Coach-Burberry Merger In The Cards?
• Why Has Coach’s Stock Price Risen 30% In One Year?
• What Is Coach’s Plan With Regards To Its Store Footprint?
• Coach Q4 And FY 2016 Earnings: A Return To Growth In North America
• Why Do We Feel Coach Has A 17% Upside Potential?
• How Will Coach Close Out Its Financial Year?
• What Will Be Coach’s Revenue And EBITDA Breakdown In 2016?
• How Will Coach Perform In 2016?
• What Will Be The Impact of Coach’s Collaboration With Disney?
• How Has Coach’s Revenue Per Square Foot Changed Over The Years?
• What Percentage Of Coach’s Stock Price Can Be Attributed To Growth?
• What Has Resulted In A Decline In North American Net Sales And A Rise in International Sales For Coach So Far In FY 2016?
• Coach’s Strong Presence In China To Help The Company In The Future
• How Did the Different Segments Of Coach Perform In Q3 2016?
• How Has The Transformation Plan Affected Coach’s North American Retail Store Count?
• Coach Q3 2016 Earnings And Revenue Beats Expectations
• What To Expect From Coach In Q3 FY 2016?
• Is Coach’s Transformation Plan Working?
• Coach: Year 2015 In Review
• Is The Men’s Segment Becoming Big Business For Coach?
• How Will Coach’s Revenue And EBITDA Change In The Next 3 Years?
• What Is Coach’s Fundamental Value Based On Expected 2016 Results?

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