Why You Shouldn't Bag Coach Just Yet

Why You Shouldn't Bag Coach Just Yet

So far this year, Coach had been doing fairly well in terms of earnings. The apparel giant beat in the first quarter and the third quarter of the fiscal year, although shares haven't appreciated meaningfully over the last twelve months. However, its most recent report was somewhat worrying. Earnings per share met expectations. Hover, sales slowed down and analysts say this is a result of increased competition. Still, the firm trades at quite a steep discount to the industry. This leads me to believe that it isn't time to dump Coach shares just yet.

Some color
First quarter EPS came in at $0.77 which beat analyst expectations by $0.01. However, revenue declined 0.9% year-over-year to $1.15 billion which missed the $1.19 billion consensus. Perhaps more worryingly, North American same-store sales dropped 6.8%. Direct sales in the region declined 1% for the quarter. International sales did considerably better, up 9% on a currency-neutral basis. China led the way with total sales surging 35 %. However, taking currency effects into account, international sales were also down.

The stable EPS combined with the top-line slowdown shows that in any case, the company's cost cutting efforts are paying off. However, the company's EPS picture was also brightened a little through share buybacks, which totaled around 3.3 million shares in the first quarter . Investors were not amused. Shares were down around 7.7% at the time of writing.

Coach has been working on transforming itself from a maker of luxury handbags into a global lifestyle brand that offers a wider range of products. So far, these efforts have failed to translate into top-line growth, as North America especially remains challenging . Coach's CEO was quoted as saying he was disappointed with the performance of women's handbags and accessories in the region, which is still suffering from a sluggish consumer spending environment .

Fierce competition
According to some analysts, these results indicate that the company is losing market share to some of its faster growing competitors, notably Michael Kors . The upstart luxury retailer has been delivering some fairly impressive numbers over the last few quarters, and seems to be eating away at least some of Coach's business. Michael Kors, for its part, delivered total revenue growth of 54.5% in the first quarter with comp store sales up a formidable 27.3%. The company's luxury lifestyle products have been rapidly gaining popularity in recent times and growth has been especially quick in Asia.

Coach may also be losing market share to the Kate Spade brand, which is owned by Fifth & Pacific . While the brand currently has a market share of only around 4%, it seems to be growing and it is viewed as a threat to Coach's dominant position . Fifth & Pacific announced a 27% increase in direct-to-consumer comp sales for handbag maker Kate Spade in its most recent quarterly report, while net sales were up a staggering 65%.

Valuations and Metrics
After its plunge following the report, Coach is now an even cheaper stock which trades at only 13.89 times trailing earnings. Competitors Michael Kors and F&P trade at 34.38 and a negative multiple respectively, according to Yahoo Finance. Coach's gross margin of around 71% is pretty good compared to the apparel industry average. The 47% return on equity is very good indeed. Finally, the company has a total debt to equity ratio around zero. These are some fairly good metrics.

The bottom line
Coach's most recent earnings report largely disappointed investors. While EPS was more or less in line with expectations, the company whiffed on comps and revenue. As a result, the stock tanked. Yet, the company still has a dominant market position, albeit on the decline, and trades at a very reasonable valuation compared to the industry. In my opinion, it's not time to bail on Coach yet.

The article Why You Shouldn't Bag Coach Just Yet originally appeared on Fool.com.

Daniel James 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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Originally published