More Does Not Mean Better for this Leading Handbag Brand

There is this misconception that diversifying into new products and becoming more vertically integrated will result in better financial performance. Vera Bradley , a leading designer and marketer of women's handbags and accessories, seems to have subscribed to this erroneous view, which is why I am negative on its future prospects.

Diworsification
While Vera Bradley is an iconic brand known for its handbags and related accessories, it has taken its brand extension efforts way too far. Vera Bradley's portfolio of products now includes prescription eye-wear, office stationery and baby clothes, among other products. I believe that Vera Bradley will find it hard to gain a foothold in these new markets, given the lack of synergies between them and Vera Bradley's core handbags and accessories products.

Vera Bradley built its initial success on selling its products through independent retailers, but it has recently gone with a multi-channel distribution strategy. It opened its first retail store in 2007 and added its 65th retail store and 11th outlet store in 2012. In particular, Vera Bradley expanded aggressively in direct sales in the past year, opening 20 retail stores and four outlet stores.

Unfortunately, by pushing aggressively into retail, Vera Bradley runs the risk of alienating its channel partners. Retailers have no incentive to promote 'non-exclusive' products. They also have to compete on price with a brand owner that has a lower cost base.

In addition, vertical integration naturally leads to a larger asset base and increased risks with higher operating leverage. Coca-Cola spun off its bottling business in 1986, because that is the most capital-intensive and least profitable segment of the entire value chain.

Last but not least, there is the issue of core competency. Vera Bradley might design the most beautiful handbags in the world, but operating retail stores is a different kettle of fish altogether. Successful companies stick to what they do best. This is the reason why Iconix Brand, the second-largest licensor globally (behind only Disney), chose to remain a brand management and marketing company without either manufacturing facilities or retail stores.

Future outlook
Vera Bradley delivered a lackluster set of results for the second quarter of fiscal 2014. Its top line increased by a mere 1.9% to $125.4 million, with a 3.7% drop in same store sales and a 12.2% decrease in indirect revenues. In light of this, Vera Bradley revised the lower end of its full year revenue forecasts downward from $570 million to $535 million.

To compound matters further, there have been key management departures this year. Mr Jeffrey Blade, its Chief Financial and Administrative Officer, resigned in January; and Mr Michael Ray, the Chief Executive Officer, announced his plans for retirement in June.

Peer comparison
Vera Bradley's peers include Coach and Michael Kors

While Vera Bradley is seeking new talent to fill the shoes of those who have left or are leaving, Coach announced the appointment of Mr Stuart Vevers as Executive Creative Director in June. Stuart was previously the Creative Director at Loewe and Mulberry, and was named the British Fashion Council's Accessory Designer of the Year in 2006. I am positive that his experience will be helpful to Coach in its brand-building efforts.

Coach reported a decent 9% increase in revenues on a constant currency basis for the fourth quarter of fiscal 2013, with its Chinese performance particularly impressive. Revenues from China grew 35% year-over-year, driven by strong double-digit same store sales growth. China currently accounts for less than 10% of Coach's total sales, with significant room to grow on the back of a rising middle class.

Michael Kors delivered an excellent set of results for the first quarter of fiscal 2014, with quarterly revenues and diluted earnings per share increasing by 54.5% and 79.4%, respectively. This is especially impressive considering its strong outperformance across all of its different business segments and geographies, and the fact that its peers have suffered from weak store traffic.

Michael Kors' focus on the high-growth accessories market and its retail store strategy of locating stores in high-traffic and high income demographic areas have paid off. However, the market has factored that into Michael Kors' share price, and it trades at a forward P/E of 22. In comparison, both Vera Bradley and Coach trade at 13 times their forward P/E ratios.

I do not like Vera Bradley's diversification into new, unrelated products and its focus on its stores' expansion at the expense of its channel partners. In addition, the uncertainty over company leadership adds to the risk profile of the stock. I do not consider the stock a good investment candidate, even at its current valuation.

These aren't the only retailers shaking up the industry
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 More Does Not Mean Better for this Leading Handbag Brand originally appeared on Fool.com.

Mark Lin 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.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.