Coach: A First-Class Ticket to Nowhere

by Dan Burrows | January 23, 2013 1:22 pm

Has Coach (NYSE:COH[1]) lost its caché?

Shoppers in the U.S. failed to open their purses for the company’s luxury handbags over the holiday season, causing profits, revenues and same-store sales to miss Wall Street’s fiscal second-quarter estimates.

The stunning stall-out in growth amid much tougher competition led investors to dump Coach en masse Wednesday. COH shares were among the most actively traded on the New York Stock Exchange, tumbling as much as 17% to $50.47 soon after the opening bell.

My, how times have changed. It used to be that purveyors of luxury and aspirational items like Coach and Tiffany (NYSE:TIF[2]) were almost immune to tough economic times.

If you were rich enough to afford such goods, then high unemployment, higher taxes or even a falling stock market couldn’t keep you away from such comparatively reasonable indulgences. Because, hey, it’s not like a $300 leather handbag is going to set you back like a Mercedes CL-Class sedan.

But, apparently, luxury shopping ain’t what it used to be — and there’s more competition than ever, thanks largely to Polo Ralph Lauren (NYSE:RL[3]) and Michael Kors (NYSE:KORS[4]). Not only is there seemingly less total demand for such wares, but the demand that does exist has more options — often at more attractive prices.

As Chairman and CEO Lew Frankfort said in Coach’s earnings release:

“We were disappointed by our performance in North America, where the holiday season proved challenging. Most broadly, the consumer was impacted by a muted macroeconomic environment, while in the Women’s handbag category competition intensified and promotional activity increased. Importantly, we maintained our pricing strategies despite the retail climate, protecting our brand proposition.”

Note that point at the end: Coach refused to budge on slashing prices for its goods over the holiday shopping period.

Seems crazy, but in a way, Coach had little choice. The company has to protect its brand position as a high-end, luxury purchase. Deep discounts, after all, look shabby. Furthermore, once you train shoppers to wait for sales, it’s notoriously tough getting them back to paying full price.

Still, Coach certainly has plenty of wiggle room when it comes to creative discounting. Gross margin — or the difference between sales and cost of good sold (essentially, the initial mark-up) — was not only unchanged during the most recent quarter, but it remained insanely, enviably high at 72.2%.

To put that figure in perspective, it’s so wide that it crushes margins in the remarkably profitable tech industry. Apple (NASDAQ:AAPL[5]), for example, has a gross margin of 40%. Google (NASDAQ:GOOG[6]) boasts a 54% gross margin. Even Intel (NASDAQ:INTC[7]), a famously high-margin enterprise, has a gross margin of “only” 63%.

Maybe Coach can’t pull back on prices, but it sure has to do something something to get its catwalk back. Competition in a soft marketplace is intense, and its pricing policy and fashion choices have Coach’s market share shrinking at an accelerating rate.

The stock was already off more than 5% during the past 52 weeks before Wednesday’s big selloff. COH now is down about 19% in the past year, versus more than a 13% gain for the broader market.

At some point, Coach will become a buy, but we’re probably not there yet. The last two times the market freaked out about Coach’s prospects — back in the summers of 2012 and 2011 — it sent shares below $50 and $46, respectively.

Here’s betting we reach lower levels once again. Coach might not be willing or able to cut prices on its handbags, but investors should likely wait for some deeper discounts on its stock.

As of this writing, Dan Burrows did not hold positions in any of the aforementioned securities.

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