Nine trading sessions have passed since Coach reported its 2Q results and nothing from a fundamental perspective has changed in our view. What has changed is Keith's perspective on the shares, which were once again added to the firm's virtual portfolio on the short side.
Here's a recap of our thoughts (questions) following the handbag maker's recent report:
On an absolute basis, Coach’s F2Q was a pretty good quarter. The topline was better than expected (NA comps up 12.6% vs. a whisper of 8-9%) and quarterly EBIT margins of 35.9% by all accounts remain tops across the entire apparel, retail, and luxury sectors. Growth clearly remains the top priority for management with square footage expected to increase by 10% (vs. 8% LY) driven by aggressive expansion in China, new moves into Europe, and modest growth in the US supported by a resurgent men’s initiative. Cash generation is also a strong point as it always has been. The company ended the quarter having repurchased $388 million worth of stock, with $940 million on its balance sheet and no debt.
The “growth” story and the cash are hallmarks of Coach and factors that certainly shouldn’t be ignored. However good this may be, we come away from the quarter with more questions than answers on two fronts. First, is the Street really prepared for extremely challenging gross margin hurdles over the next three quarters after barely printing a gross margin gain of 15bps on an easy LY compare? And secondly, if SG&A growth remains high to support the company’s growth initiatives, will be there be meaningful earnings leverage in the near-term to satisfy those that are accustomed to consistent upside? Couple these unanswered questions with the fact that inventories ended the quarter up 36%, a full 17 points higher than sales growth and we believe there may be more risk than reward in the near term. While the SIGMA chart is not a perfect predictor by any means, this pattern is turning out to be a classic setup for future downside.