Why Are We Bullish On Coach Inc.?

Shares in Coach ( COH ) took a nosedive once the company released its fourth quarter and full year (year ended June 2017) earnings. Mixed fourth quarter results, coupled with a disappointing FY 2018 guidance can be said to be the cause for the stock declining 15%. In a bid to boost its luxury image, the company has pulled back its level of merchandise from department stores and cut back on its discounting. This factor pressured the sales of the company, but improved comparable sales and increased e-commerce revenues in the US helped to offset it. However, excluding the additional week in Q4 2016, the revenues for the company would have actually increased by 6% as reported, and 7% at constant currency. Below we'll highlight some factors that we feel provide an upside to Coach Inc.

Acquisition Of Kate Spade

The acquisition of Kate Spade is expected to give a nice bump to Coach's revenues in FY 2018, with a modest organic growth of low single digits to be boosted by $1.2 billion of revenues from the newly acquired company. Kate Spade has had great success with the millennial customers, who have been the driving force behind the high growth rates the company has achieved. Approximately 60% of Kate Spade's clientele are millennials, compared to just over 30% for Coach. Hence, this acquisition would give Coach access to a younger clientele.

Furthermore, the brand has significant potential to grow internationally, where it does not have much of a presence. One key market identified has been Japan, where the brand is present currently but is underpenetrated. Growth opportunities also exist in markets such as China and Europe, and consequently, Coach expects 20 to 25 net openings for Kate Spade in FY 2018. Coach will be curtailing the number of surprise sales and pulling back on its wholesale channel for the Kate Spade brand, similar to the steps it has taken for its eponymous brand. However, this good news is accompanied by the fact that operating margins of Coach are expected to be pressured as the company carries on with the integration in the short term. Looking ahead, the acquisition of this brand should be accretive to Coach's earnings.

Coach 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 into a new luxury format, ending the year with just over 720 store renovations. The retailer has also recruited Selena Gomez to be their new face, in order to appeal to younger shoppers.

Coach's decision to pull the company's handbags and leather goods out of 25% of department stores, or by over 250 locations, has also been a positive step, as the heavy discounting in this channel 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 its e-commerce websites. 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 45% of the handbag sales in the June quarter, up from about 40% in the prior year period.

Growth Opportunities For Coach

Despite the sluggish macroeconomic environment affecting the handbag industry and consumer spending in general, Coach has delivered positive sales growth in North America. Looking ahead, however, we expect a bulk of the growth for the company to come through its international operations. One of the positive highlights of the fourth quarter (ended July 2017) was the solid international sales, particularly in China and Europe. Greater China sales increased 3% versus the prior year in dollars and 7% in constant currency on a 13-week basis, driven by double-digit growth and positive comparable store sales on the Mainland. This was offset, in part, by softness in Hong Kong and Macau. Europe was also very strong on a 13-week basis, driven by double-digit growth in the directly operated channels and benefiting from the planned shift in wholesale shipment timing.

Another avenue of growth for Coach is its men's line, which in FY 2016 and FY 2017 (year ended June) grew at a faster rate than the women's in North America. In the fourth quarter of FY 2017, the men's segment accounted for almost one-fifth of the Coach brand sales, and for the full year, the sales from this segment reached $840 million at POS (point of sale). Given this impressive growth trend, the company believes the men's segment is an over $1 billion opportunity for the Coach brand. Seeing the strong momentum in the men's segment, Coach intends to continue its expansion across all categories. Furthermore, with the addition of Kate Spade's men's line, Jack Spade, there can be an additional boost to the company's sales.

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

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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