Sizing Up Coach's Downside

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Coach ( COH ) is a leading American marketer of luxury lifestyle handbags and other fashion accessories for both men and women. It is one of the most well-known accessories brands in the U.S. and also maintains a presence in select international markets. Coach competes with other premium apparel and accessories players like Polo Ralph Lauren ( RL ), Liz Claiborne ( LIZ ), and AnnTaylor ( ANN ), as well as high-end brands like Louis Vuitton, Hermes, Gucci and Prada.

We have previously discussed the potential upside to Coach from expansion in China and the increasing popularity of its "affordable luxury" brand image. (see Could Coach Replicate its Japanese Market Success in China? ) However, Coach's shares sold off post earnings even as Coach beat expectations, largely because gross margin remained flat and failed to meet expectations. It seems that the market is not ready to pay more for Coach right now.

We maintain a $57.04 price estimate for Coach , in line with market price, but identify a few factors below that could be giving investors second thoughts.

See our full analysis and $57.04 price estimate for Coach

1. Commodity Costs on the Rise

Coach is planning to shift production outside of China to places like Vietnam and India as production costs in China increase due to a rise in labor costs. The move indicates Coach's concerns over erosion to profit margins.

While shifting production to new regions might help Coach cut down on production costs going forward, the initial expenditure required to set-up production capabilities or establish ties with manufactures could pose a near-term headwind to profit margins.

The firm plans to have half of its handbags and accessories made outside of China in the next 4 -5 years and this could mean a significant increase in the firm's capital expenditures in the years ahead. We estimate a 1% increase in Coach's capital expenditure as a percent of revenues in 2011 could result in a 3% downside to the company's stock value.

2. Targeting a Wider Consumer Base Could Cause Brand Deterioration

Coach has been pushing into emerging markets and aiming to appeal to a wider audience by marketing itself as an "affordable luxury" brand. The firm even lowered the company's average handbag price by about 10% to boost demand during the economic downturn. While this has contributed to Coach's popularity and helped lift the firm's revenue during times of economic uncertainty, the prolonged effect could be less exclusivity and, consequently, lower branding power in the future. The consumer markets in which Coach operates are heavily influenced by the concepts of style and exclusivity.

The result could drive high-end consumers to look elsewhere for exclusivity, hurting Coach's sales and reducing its profit margins.

The interactive charts above showcase the affect of various EBITDA margin and capital expenditure scenarios on Coach's stock value.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: ANN , COH , LIZ , RL

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