COH | Absolutely Uninvestable

Takeaway: COH could be a TRADE to the upside as negative leverage swings in its favor. People will look to $2.50+ EPS power. But real number is $1.50.

Coach might be a good TRADE at any given point it time based on its business trending at varying degrees of ‘terrible’. But for anyone that has a duration of anything more than a year, we think that the name is absolutely positively uninvestable. Can COH earn $2.00 this year? Perhaps. It’s definitely on a ‘really bad’ as opposed to ‘horrible’ earnings trajectory – with sales ex Weitzman down 9% and EBIT down 31% as opposed to sales -15% and EBIT -50% three months ago. So yes, $2.00 in EPS is possible as we see operational leverage swing the other way.  But that would be the last time annual earnings start with a 2-handle again – at least until someone takes the company private at a lower price than where it is today, incubates it, and finds the right market (and new investor base) for another IPO.

 

There are so many things we could point to that are problematic here, and most of them don’t represent any unique thought. A $32 stock knows about the following; a) Coach’s exodus of talent, b) that the brand simply does not resonate outside the US like other brands such as Kors, Kate Spade, and European higher-end luxury brands like Gucci and LV, c) that man-purses are not the answer, and d) what it means that the company had to resort to an acquisition in accessories (Stuart Weitzman footwear) – because unlike other brands it could not do it on its own.

 

[Two quickies on the SW deal: 1) buying a company like SW is a huge admission that the Core can no longer grow at the desired margin structure, and 2) one of the Cardinal rules of Retail is “Never Buy a Business from Jones Apparel Group”. JNY finalized its purchase of SW in 2012 for $430mm. Then as Sycamore Partners carved up JNY after the buyout, it sold SW to Coach for $574mm. JNY was the undisputed king of buying companies and stripping them of growth capital in order to improve margins. Coach is likely going to pony-up some deferred capex and SG&A on that one (upwards of $100mm).]  

 

Ultimately, the problem is what most people know at some level – the brand simply does not resonate anymore with the consumer it needs to drive $1-$2bn in sales at an industry leading margin. The reality is that there’s nothing in the company’s strategy that we think allows it to shed its fate as a Department Store/Outlet brand for a style-conscious, but aging consumer.  The slide below – which compares the KATE, KORS, and COH consumer -- says it all. Only 12% of KATE’s customers shop COH – that’s 9% for KORS. COH skews older (than the brand admits) and less affluent. KATE skews younger and wealthier. KORS is somewhere in between – but skews toward KATE. 

 

The key point is that last year Coach sold about 25mm handbags to 16mm people (our math) – them’s big numbers. The best marketer in the world can’t just snap her fingers and change-up the underlying consumer group for a Brand. If Coach wants to accelerate growth, it probably has to fire some older, less affluent customers first. If it wants to drive margin, it should stop talking about the top line.  Some brands/companies can have both. But that ship has long sailed for Coach. Unfortunately the company does not know it.

 

Bottom Line: The real earnings power for Coach – the one that allows it to sustain a low-single digit revenue growth rate over the long term, is about $1.50. That’s where we are 1 and 2-years out. But over the next two quarters, we think that the bounce in the sales/margin trajectory will make people believe in a much higher number. Unfortunately, COH management set expectations for a positive comp in 4Q – which is bold to say the least. We’ll look to get aggressive on the short side on the big green days.

 

COH  |  Absolutely Uninvestable - COH   Kate Slide 10 27

 

A Quick Point On The Category – We’re Still Buying KATE

Category growth – in the North American premium and women’s men’s market was estimated to be in the LSD range during the quarter in line with what the company reported during it’s 4th quarter call back in August and off the high-single digit pace in 1H15 and mid-single digit pace in 3Q15. That’s not alarming to us given that two of the biggest competitors in the space, COH and KORS with market share collectively in excess of 40%, (using the $13bil market COH has cited) have been comping negative in North America at a negative HSD to LDD clip. KATE on the other hand has ~5% share in that market place and a lot of runway for growth. If COH’s numbers are right and the category is still growing at a LSD in spite of that, the dollars have to be going somewhere and we think that’s KATE.


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