Why Has Coach Inc.’s Stock Price Increased Over 15% Since The Beginning Of The Year?

Affordable luxury brand Coach (NYSE:COH) has been making a very persuasive argument that it has turned around its fortunes. A breakdown by Market Watch noted that, among the S&P 500 companies, only two retailers, namely Coach Inc. and O’Reilly Automotive, reported positive comparable sales in the December quarter, a gross margin of at least 50%, and a net income of at least 10% of sales. This reflects the long way the company has come since its rough patch that started in 2012.

The positive performance has been reflected in the stock price. Below we have highlighted some factors which we feel have resulted in the company’s stock price appreciation.

1. Improved Performance

In its fourth quarter of FY 2016 (ended June 2016) the company noted a return to positive comparable sales in its North American segment. The positive metric was reported for the first time since the third quarter of 2013, representing the seventh sequential improvement since a transformation plan was implemented by the company. The growth was driven by an increase in the direct business, and actions implemented to elevate the brand positioning and streamline the distribution, given the highly promotional nature of its department store channel. Since then, the company has continued to perform well in the two following quarters. In the latest period, the company delivered top line growth in each of its segments, highlighted by positive comparable sales in North America, and overall gross margin expansion.

The second quarter (ended December 2016) marked the third consecutive quarter of positive comps in North America. Coach brand sales in the region increased 2% on both a reported and constant currency basis, despite the negative impact of a department store pullback. Direct sales increased 5% and the brick and mortar store comps rose approximately 4%, driven by ticket and conversion, with traffic down modestly.

In the International space, the Coach brand sales increased 3% on a reported basis, and 1% on a constant currency basis, driven higher by a positive performance in China and Europe. Greater China sales were flat when compared to the prior year in dollar terms, but rose 6% on a constant currency basis. Strong results in the mainland were coupled with improved performance in Hong Kong and Macau to spur the sales growth. European sales grew at a double-digit pace, positively impacted by new distribution and positive double digit comps.

2. Brand Elevation

Coach has been working hard to transform its brand in recent years, in the wake of market share loss to Michael Kors and other rivals, who also employed Coach’s strategy of selling luxury products at affordable prices. The company hired a new designer, Stuart Vevers, who introduced higher end products and undertook to remodel the stores. The retailer has also recruited Selena Gomez to be their new face, in order to appeal to the younger shoppers.

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 make it harder for consumers to spend more on a similar bag at the company’s own stores or its e-commerce websites. In the fall, the company closed 120 such locations, and the number of days of sale in the department stores were reduced by about 40%. While this strategic move will bring long term benefits, it will negatively impact the sales growth in the short term.

Coach is also continuing to establish its modern luxury concept globally, renovating and opening 46 locations in the second quarter, including four in the directly operated North American business, taking the total up to 540 globally. This is in line with the retailer’s target to end the year with over 700 stores in the new format, representing a vast majority of the traffic the company receives. This will also be a boost to the earnings, as the comps in such stores exceed those in the balance of the fleet. All these steps undertaken have helped to drive brand elevation. This is reflected in the penetration of the above-$400 price bracket products, which increased to 50% of the handbag sales, a massive rise from the 30% seen last year.

3. Lone Wolf In A Bear Market

The number of US retailers trading at the most-distressed level of credit rating spectrum has more than tripled since the recession of 2008-2009, and is heading towards record levels in the next five years, according to Moody’s Investors Service. The rating agency noted it has 19 names in its retail and apparel portfolio, or 14% of the total, that are ranked as Caa/Ca. This is close to the 16% level seen in 2008-2009. This trend is mainly as a result of a shift in retail from brick-and-mortar stores to online shopping, forcing a number of companies to spend heavily on their e-commerce operations. While concentrating on the online channel makes sense, an inherent problem associated with this strategy is the increased pressure on margins. Undertaking investment to develop the e-commerce capabilities, as well as for improving the online experience, just means higher costs. Furthermore, in order to compete with companies, such as Amazon, retailers will also need to cut down the prices of products sold online. This results in a higher promotional environment, which does not do the margins any favor. Hence, while an increase in comparable sales reflects a good performance, if the margins are declining a possible reason for this could be a rise in promotional activity.

According to Market Watch analysis, of the 34 S&P 500 retailers, excluding Amazon, 17 companies noted an increase in comparable sales, while only 11 of those reported an improvement in the gross profit margins in the latest quarter. These companies have been listed below:

Coach is one of the few retailers which reported a rise in both comparable sales and margins, which is even more impressive once the department store pullback is taken into consideration. While sales growth slowed as a result of this, the company emerged out of the quarter with expanding margins.

See our complete analysis for Coach here

Have more questions on Coach? See the links below:

• Could Coach Inc. Be A Takeover Target?
• Why Does A Deal Between Kate Spade And Coach Inc. Make Sense?
• Coach And Michael Kors Still In The Hunt For Kate Spade
• Coach Inc.’s Revenue Rises Despite Department Store Pullback

See our complete analysis for Coach