Coach reports on-target earnings, fooling no one

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Coach reports on-target earnings, fooling no one

Julian Close 11/04/2013

Earnings season is well underway on Wall Street, and will continue for about another week before beginning to trail off. When keeping track of so many earnings reports (during peak season there are frequently more than 300 per day) it becomes necessary for market watchers to categorize broadly, at least at first, and the simplest possible differentiation is between companies that hit and companies that miss . To hit, in this case, is to earn exactly as much, or any amount more , than the consensus estimate, whereas to earn less than the consensus estimate, even by one cent, is a miss. It is axiomatic and, for the most part, true, that companies are always punished for missing earnings targets, though companies are not necessarily rewarded merely for hitting them. If a company reports an earnings hit that is very close to the line, sharp eyed analysts know to look deeper in the report to see if the apparent earnings hit is concealing weakness. If it is, the company might still be punished, just as if it had reported a miss.

This go-round, one such company is Coach ( COH ), a designer and marketer of accessories for women and men. Coach is best known as a designer of women's handbags, which bring in 58% of the company's revenue. Coach has demonstrated solid growth over the past ten years, with revenue having risen from $1.3 billion in 2004 to $5.1 billion in 2013. Earnings have kept pace as well, rising nearly 500% over that time. It sells products through a combination of its own stores, store-within-stores, and display within other stores.

Still, things have been far less rosy in the past two years, as competitors such as Michal Kors ( KORS ) have robbed the company of some of its chic as well as cutting into its revenue growth. Coach has been diversifying in recent years, attempting to become a "lifestyle" brand, such as Michael Kors and Ralph Lauren. This means breaking into such markets as footwear, glasses, watches and outerwear, where the Coach name doesn't carry the same weight that it does in women's handbags. Many analysts believe Coach waited too long before beginning these efforts, though I think the actual mistake was a more basic one: the mere fact that some companies sell both handbags and, for example, wallets, does not mean that customers put additional value on a wallet that carries the name of a company they are familiar with only as a maker of handbags.

Declining market-share, which Coach definitely faces, can be a self-exacerbating problem in this space, as consumers desire those brands that seem to be on the rise. Coach needs to stop the bleeding quickly, but it appears that the company's ability to do so may be impaired by the loss of key executives. Coach's long-time president, Reed Krakoff, left the company in June, purchasing from Coach the standalone brand that bears his name on the way out the door, and the company's CEO, Lew Frankfurt, will be leaving in January, meaning that Coach's executive team will be far less experienced, even as its competitors move in for the kill.

When Coach reported its earnings hit on October 22, it revealed some troubling things as well; revenue, in particular, was lower than the consensus estimate. Also, Coach opened 4 new stores in North America during the quarter to try to keep revenue high, but comparable-store sales fell by 6.8%. Investors were spooked and COH gapped downward from $54.18 to $48.55, though a small bounce at the end of the week pushed the stock back above $50.

Given the deterioration of Coach's core handbag business, its failure to transition rapidly enough into a lifestyle brand and the recent disintegration of the executive team that drove the company's success for many years, the chance of any significant near-term rise in the price of COH stock appears remote.

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I seek to capitalize on Coach's weakness with a bear-call credit spread. Look at the January '14 55/57.5 bear-call spread for at least a $0.20 credit. Use limit orders. This trade has a target return of 8.7% over 75 days, which is an annualized return of 42.3%, (for comparison purposes only). The stock has to rise 9.5% to cause a problem. Be aware that this is an aggressive trade, best undertaken by investors with diverse portfolios and high tolerance for risk.

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

Originally published on

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

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