Why Coach Is Not a Good Investment Anymore

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As competition heats up within the luxury retail space, customers have more options at their disposal than ever before. Now that consumers can switch brands more easily than ever, this reflects in the same-store sales and revenue of various retail players as some benefit and some lose.

Coach has been one such loser as its recent first-quarter results revealed. This is in stark contrast with Michael Kors and Fifth & Pacific's Kate Spade. Both companies have been consistently recording revenue gains.

COH Chart

COH data by YCharts

Losing its base
The North American market makes up roughly 68% of Coach's revenues. The most worrisome factor in this region in the previous quarter was the sharp same-store sales decline of 6.8%. This is the first such decline since the company's September 2009 quarter. According to analysts, the reason behind this significant drop is clear: target customers are switching over to competitors like Michael Kors, Kate Spade and other newcomers in the lifestyle luxury market space.

Coach is overly-dependent on the North American market for all its business, as well as factory sales, where products are sold at discounted prices. Coach started opening more factory stores in North America in order to gain new customers. When North America comps declined 6.6% in fiscal 2012, management rolled out an even more aggressive strategy -- an online factory store site.

The net impact was that Coach started relying heavily on outlet stores and that, in some way, damaged its "luxury brand" image . According to Cowen & Co. analyst Faye Landes, Coach's North American outlet business has grown to 60% of its retail sales in the region from about 30% six years ago. Who in their right mind would buy a full-price bag when there are items available at a 50% discount?

Coach posted quarterly revenue of $1.15 billion, which was short of analyst estimates by about $40 million. Weakness in the North American market was the main reason behind the underperformance . Another worrying factor for investors is the inventory growth of 6.5%. With sales declining, this means that Coach, at some stage, will have to resort to discounts to move unsold inventory.

Some relief
As per Bain & Company , the worldwide luxury goods market continues to see double-digit annual growth, and it is currently valued at over $260 billion. It is estimated that the worldwide luxury goods market will grow about 50% faster than world GDP, with 4% to 5% average annual growth through 2015. It is not surprising to find that international sales came to the rescue of Coach, or else the results would have been far worse.

The international market might continue to remain the major growth driver behind Coach's performance going forward. International sales fell 1% in dollar terms due to the weaker yen. However, in constant currency terms, they increased 9%. China was the star performer, where sales jumped by a whopping 35%, driven by increased distribution and double-digit comparable-store sales growth. Coach expects this metric to grow 20% in fiscal 2014. Coach's sales in the other Asian markets such as Korea, Taiwan, Malaysia, and Singapore also continued to grow at strong rates.

Gaining at Coach's expense
North American sales growth at Michael Kors have grown 50% in every quarter since its December 2011 IPO. Analysts believe that Kors now controls 13% of the North American market, while Kate Spade controls 4%. Young shoppers are leaving Coach and switching over to Michael Kors, Kate Spade, and other newcomers in the luxury market space. The following chart is the proof.

COH Revenue (Quarterly YoY Growth) Chart

COH Revenue (Quarterly YoY Growth) data by YCharts

Michael Kors is looking to expand in China, which currently seems to be Coach's stronghold . China's clothing industry is projected to become the world's second-largest by 2020, and it will account for approximately 30% of the global fashion market's growth over the next five years . China will become the next battleground for luxury retailers like Coach and Michael Kors.

In the previous quarter, Michael Kors reported that same-store sales improved 27% and revenue was $640.9 million. This was 54.5% more than the same quarter last year and it exceeded Street expectations of $572 million. Gross profit increased 58.3% to $397.3 million. The company posted earnings of $0.61 per share, which beat consensus estimates by 24.5 %.

Fifth & Pacific's handbag brand Kate Spade witnessed an increase of 27% in its direct-to-consumer (e-commerce) sales, while overall sales from the brand jumped 65% in its latest quarter. Fifth & Pacific is looking to increase its sales further by enhancing its stores, improving pricing, merchandising, and inventory management, as well as refreshing the designs of its merchandise .

The bottom line
These moves by Coach's rivals will lead to more intense competition in the luxury retail space. Coach is clearly struggling, and it looks like its strategies to increase sales and gain more customers are backfiring. In the meantime, Michael Kors and Fifth & Pacific have seen their top lines improve at good paces.

Hence, investors looking for a play in luxury retail should stay away from Coach and instead look at other options that have been doing well, such as Kors and Fifth & Pacific.

Can Coach rule retail?
The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.

The article Why Coach Is Not a Good Investment Anymore originally appeared on Fool.com.

Amal Singh has no position in any stocks mentioned. The Motley Fool recommends Coach. The Motley Fool owns shares of Coach. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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