Coach Flies Coach
Board: Value Hounds
September can’t come fast enough for Coach unless it comes and the new Vevers lines fail to ignite sales. Then it’s back to the drawing board (in a very real sense for Stuart.
Third quarter growth
The third quarter was everything we expected and more. Comps continued to slide down, store growth slowed and revenue steepened its decline. There was not much to like. Victor Luis remains excited about vibrant international sales, increasing men’s sales and footwear, but even these failed to drag Coach out of its yearlong slump. There is no doubt they have lost their way for now.
[See Post for Tables]
North American sales decreased 18% to $648 million from $792 million last year. North American revenue is now 59% of total revenue down from 65% for 2013. Same store sales in North America were a chilling (21)%.
International sales increased 14% to $441 million and sales in China increased 25%. Dollar amounts are never given but we can guess. In 2014 they are looking for $549 million from China alone as discussed in the conference call. That’s up 25% from last year so 2013 China revenue was around $450 million. Total international was $1541 million last year so China makes up 30% of international revenue but only 8% of total revenue. This tells us that North America is key to Coach’s success at present and it’s going to take a lot of expansion in China to get them moving forward if North America continues to flail.
In Japan, sales increased 10%. Japan was 22% of revenue in 2013 for the year. It’s growing slowly.
I half expected to hear Luis admit that the brand has been cheapened by having a strong factory outlet presence and anticipated a change of strategy. While you can find Michael Kors factory outlet online, most are frauds and Michael Kors has no sanctioned discount outlets less sluggish inventory to blow out at bargain prices. Coach is determined to persist in the strategy and even increase the number of stores.
From the conference call—Victor Luis
As it comes to the factory channel, there are some who believe that there is may be a magic formula to full price doors to a factory door or 3:1 or 4:1 whatever it maybe, I haven't seen that play in our own analytics.
Certainly there is a fine balance and it really comes down to consumer perceptions across the channel.
Luis knows consumer perceptions of factory outlet brands are negative. Factory outlet sales imply non-exclusivity and a brand anyone can own because it’s cheap. That’s not the same consumer aspirational luxury brings in the door to consummate a sale. The Kors/Coach customer may not be able to afford Louis Vuitton but they can buy Kors and the MK logo is meaningful admitting them to the club. Coach has a military style dog tag on a chain and an embossed stamp and both read COACH, but if these same symbols of near-wealth are also available at 205 factory outlet stores, handbags bought at full retail become a less meaningful badge of wealth and good taste. Coach retail sales reflect consumer disinterest.
Victor Luis is shooting Coach through its aspirational heart. Coach is now all about confusion and contradiction. Are they Kors-worthy competitors or deep discounters? Results would suggest that the Filene’s and Kors combined consciousness model can’t live together under the single Coach corporate image. The (21)% North American comps are proof that Coach is losing its cachet as a must have accessory. They do what they have always done through their history—make beautiful leather goods. That may not be enough to keep them in the running converting high-end shoppers into retail sales.
Randy Konik - Jefferies
….can you kind of talk to us about on one hand it sounds like you are trying to elevate the brand which is kind of and you spoke about the penetration with the increase of higher price points, but yet you are continuing to expand the outlet channel distribution. How are we supposed to think about that balancing act or what's the vision long-term for how the outlet sits in this business model, the price point sit in the business model and then how the logo sits in this business model? Thanks.
Victor Luis – CEO
…as you suggested, [maintaining growth in outlets] is a really important balancing act, I would just say that this is not a change in our business model. The word elevation is not about transforming Coach into what we perceive or what may be perceived as a traditional luxury brand. Indeed, while some may believe that affordable and luxury are two words that don't go together, this brand has been created and has as its purpose affordable luxury as its positioning, and that’s what we will do moving forward.
Indeed, we are really excited as I mentioned earlier about providing extreme value to the consumers at really great price points. Quality, great design, great materials, craftsmanship are all a part of what has made Coach great and what differentiates us from many of our traditional competitors and especially the new accessible luxury competitors that have arisen in the market space. and that's part of our mantra and what we are going to reclaim.
As it comes to the factory channel, there are some who believe that there is may be a magic formula to full price doors to a factory door or 3:1 or 4:1 whatever it maybe, I haven't seen that play in our own analytics. Certainly, there is a fine balance and it really comes down to consumer perceptions across the channel.
They comment that Stuart Vevers will be rolling out designs for the factory channel. If Vevers is Coach’s ticket back into competitive aspirational luxury, this is the wrong way to proceed. Vever’s lines need to be completely exclusive and full retail.
We expect that Stuart's focus on the factory channel will lead to rollout a product in that channel from spring summer with some initial products coming in December in a small way.
In two years factory outlets have grown from 162 stores to 205 last quarter and are now 38% of the North American store base. In japan there are 151 retail stores and 48 factory outlets – 32%. That’s a lot of second tier product moving through Coach.
Margins and inventory
Inventory increased year-over-year even as revenue decreased. Ideally, inventory increases shadow revenue increases and don’t diverge like this. It’s a sign of weak sales and wrong/excessive inventory on the shelves. Factory outlet sales were also down in Q3 and that didn’t help inventory levels that continue to pile up.
When a retailer discounts margins decline.
Check March 2014 margins all the way down compared to March 2013. The numbers speak for themselves. Coach is a company having trouble selling aspirational luxury at retail prices.
Why is Q3 so awful? It’s the dog ate my homework excuse. In Q2, Luis referred to sector wide slow mall traffic. Kors shrugged it off and did great. Go figure.
As was the case industry-wide, in-store traffic continue to decline with the ShopperTrack retail traffic index which includes also lifestyle and outlets malls down 16% for the quarter, impacted by weather as well as the Easter shift to April.
It’s not all bad. Men’s is doing well and should hit $700 million in sales up 20% year over year and China is still growing at 25% with double-digit comps. Cash flow is tremendous and share buybacks and dividends are returning some cash to shareholders.
Coach has a proven and brand-worthy designer on board and his collection has the potential to do well.
Wrap up and guidance
Guidance isn’t good and forecasts continuing declines in sales and comps. That’s no doubt one negative overhang keeping shares from recovering. Sales will deliver mid-single-digit declines in constant currency and a high single digit decreases in dollars for the full year. The fourth quarter sale drop will be in the neighborhood of 10% with our North America comps still in the negative 20% range. This is not the neighborhood Coach wants or needs to be in.
Gross margin will be around 70% for the year including a fourth quarter margin of about 69%. Investors may be longing for the good old days remembering 77% gross margins in 2007 before aspirational luxury branding became a way of life for a large contingent of shoppers and changed their focus and performance. Operating margins will range between 25% to 26% for the year (30% in 2013).
As far as knowing when Coach has turned the corner, not even Victor Luis is claiming to have a clue. He says he will know it when he sees it—whatever it is. He does give us a hint and it won’t be traffic (which I would have taken for a sign of better things to come).
… as we look to this transformation taking place which lever are you most encouraged about going forward on a long-term basis which would be kind of the leading inflection point in terms of which comp lever would we monitor?
Victor Luis – CEO
… traffic is a lagging indicator. We would expect conversion to be the first sign of transformation taking hold and, of course, moving forward as well potentially from slight increases in AUR as we continue to shift our assortment.
Since traffic is not the first indication that Coach is in recovery mode, then according to Luis, we should focus on conversion. Average unit volume will be the first sign of Coach reversing its slide. Coach doesn’t report AUR and we have to find it for ourselves. It’s not hard if you have the information and we don’t. In many ways Coach’s reporting template leaves a lot of gaps that can’t be filled in and AUR is one of them.
Theoretically, if we have total retail square feet and divide retail revenue by that we get revenue per square foot. Tracked over time, the revenue per square foot for retail would show an increase if consumers were spending more on a per square foot basis. This is a great metric for comparing retail businesses and for tracking a businesses progress over time.
We can almost get there with Coach’s reported numbers. Coach reports square feet for retail and outlet in North America, but doesn’t separate revenue for retail and outlet. All we get is total North American retail. I don’t care what the outlets are doing in the recovery. I want to see retail’s progress. But will have to settle for combined AUR. Not ideal but workable. The worst aspect is there is no way to collect the data quarterly in the 10Q or reliably covered in the conference call. Yearly monitoring isn’t going to help.
I contacted IR complaining about this lack of coverage for what Luis considers to be a key indication we should monitor. Sometimes I hate Coach. The analyst that raised the question didn’t ask for the actual numbers--
Here are the yearly numbers and they did drop in 2013. Can’t tell about 2014 yet.