This Luxury Goods Company Is Poised For A Comeback

#-ad_banner-#When investing in out-of-favor companies, timing is crucial. Get in too soon and you could fall victim to a failed turnaround. Procrastinate and you could miss out on big gains when word about a successful comeback gets out.

The key is finding the sweet spot, where the odds favor a successful turnaround, but the herd hasn’t taken much notice yet. The beleaguered luxury goods retailer Coach Inc. (NYSE: COH) is finally approaching such a sweet spot three years after hitting a rough patch.

Based on a recent share price of about $33, Coach’s stock is down by more than 50% from its peak in March 2012. Back then, the company was at the top of its game, thanks to the popularity of its lines of designer handbags and accessories such as scarves, fragrances and jewelry.

But soon after, it began to wobble in the face of stiffer competition from Kate Spade & Co. (NYSE: KATE), Michael Kors Holdings Ltd. (NYSE: KORS) and others. Management fought back by opening more discount outlets and increasing promotions, but these measures only ended up hurting the business further by encouraging customers to wait for lower prices.

The resulting toll on performance: annual revenue has slipped to $4.3 billion from $4.8 billion in fiscal (June) 2012. Earnings per share are down by more than half to $1.68 during the same period.

Management’s latest quarterly report, delivered on April 28, included a 15% year-over-year decline in revenue to $929 million. As has been the case in recent years, business was weakest in North America, where revenue plunged 23% from the year-ago quarter.

Despite Coach’s many skeptics, the company retains crucial advantages that it displayed in better times. These include a substantial base of customers who remain loyal to its core offerings, premium handbags and accessories. In the latest quarter, for example, handbags retailing for $400 or more accounted for 30% of handbag sales, compared with 20% in the year-ago quarter.

Also, profitability metrics are still among the best around. While relatively low by Coach’s standards, operating and net margins of 16% and 11%, respectively, compare favorably with the industry averages of 13% and 9%. The firm has a solid edge in returns on assets and equity, too, which is another clear sign of management’s ability to deploy capital profitably.

Such data also reflect the positive influence of Stuart Vevers, who took over as creative director two years ago. Management brought in Vevers because of his extensive accessories experience with Spanish luxury fashion retailer Loewe. Vevers‘ resume also includes stints with other high-end fashion outlets such as Givenchy, Louis Vuitton and Bottega Veneta.

At Coach, he’s helping to re-establish a premium image with new, higher-end product lines that emphasize core offerings, while extending the company’s reach with complementary fare. Recent initiatives include additional forays into menswear, a $700-million segment that’s projected to expand beyond $1 billion in annual sales in two or three years.

The latest menswear collection includes leather bags ranging from $450-to-$895, outerwear from $695-to-$2,500 and footwear from $200-to-$400, reflecting Coach’s strategy of appealing mainly to wealthier consumers. Vevers took a similar approach with the three lines of womenswear he designed since being hired by Coach.

To complement creative efforts, Coach recently closed 70 of its 350 North American stores. These were mostly discount outlets, but also included a few of the traditional department stores that were underperforming.

The firm is also cutting back greatly on promotions. In the latest quarter, for example, it reduced flash-sale (deal-of-the-day) events by a third to just two per month. There was just one invitation-only customer event, which took place in mid-March.

Coach recently acquired high-end shoemaker Stuart Weitzman Holdings LLC expecting to enhance its financial performance and rebranding. Stuart Weitzman with annual revenue of $300 million has a robust presence in 70 countries and is growing by 10% a year. Operations include a strong presence in the United States, which is important since the country has been such a sore spot for Coach. Potential synergies include cross-sales of Coach handbags and accessories, as well as increased attention for Coach’s own footwear lines.

In Europe, where Coach is still a newcomer — with projected 2015 revenue of $90 million — Stuart Weitzman could help facilitate expansion for the brand, which recently achieved double-digit growth on a constant-currency basis.

“In Europe, the brand equity of Stuart Weitzman is substantial,” Oppenheimer & Co.. analyst Anna Andreeva recently told Bloomberg.

Another key international market for Coach is China, which currently accounts for 11% of the company’s revenue. “Coach increased its China business to more than $100 million in 2010 and to approximately $550 million in fiscal 2014,” Morningstar analyst Paul Swinand recently wrote. ”Coach should also see higher operating margins in China as it expands because of lower operating costs and higher gross margins.”

Risks To Consider: As I said earlier, Coach is nearing a sweet spot, but its probably not there yet. Investors who buy now may be getting in too soon.

Action To Take –> A couple of years into its turnaround, Coach is on a logical path that should ultimately lead to solid growth. But it’s not quite time to buy as financial results and Coach’s stock are apt to deteriorate further before the benefits of the strategy are realized. Thus, investors should watch the stock for a few more quarters before establishing a position. If management and analysts are correct in predicting that Coach will resume top- and bottom-line growth in fiscal 2016, it may not be all that much longer until its stock begins moving sharply higher.

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