Wedgewood Partners comment on Coach Inc (NYSE:COH)’s mistakes and shortcomings in their current brand and marketing strategy as they attended the company’s Investor Day.
Dear Clients of Wedgewood Partners:
We attended Coach Inc (NYSE:COH)’s Investor Day last week in New York. Over the course of the Company’s four hour presentation we found ourselves nodding our head in agreement as the Company addressed mistakes and shortcomings in their current brand and marketing strategy. We agree too that the Company’s comprehensive remedies are welcome news for frustrated shareholders. However, as we sat throughout the detailed presentations from all of the Company’s top executives it became quite clear that the “fix” at Coach will be very expensive, inducing a sharp decline in the Company’s earnings power over the next 12-18 months – and the projected brand and earnings renewal won’t be quick. In fact, the fix will take a few years to fully complete in order for the Company to reclaim their once vaunted industry leading profitability.
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The significance of the new Coach Inc (NYSE:COH) news – and Wall Street’s swift reaction – was such that we did not want to wait until the next quarterly Client Letter to share our current thoughts on Coach.
Benched by the Coach
Our journey in our ownership in Coach thus far since July 2012 has been long…and wrong.
Were did we go wrong on our initial timing?
The first mistake in 2012 was our view that Company’s lackluster North American sales slump was largely due to a pause in creative new product. Thus, our initial investment in these shares came far too early in the Company’s efforts to reinvigorate their iconic brand.
Our second mistake by 2014 was not recognizing the severity of the underinvestment in the brand. Competitors Michael Kors, Kate Spade and Tory Burch have all successfully copied key aspects of the high return on capital Coach Inc (NYSE:COH) playbook, and now the original progenitor of “accessible luxury” now finds itself at the crossroads of not only redefining and rebuilding its own brand, but fighting off it’s well entrenched progeny.
Why do you still own it?
We still think Coach Inc (NYSE:COH) has a sustainable competitive advantage, and we do not think that the competitive inroads of Coach’s peer group are sustainable over the next 3 to 5 years.
First, we think competitors have expanded too quickly and will soon reach a point of saturation. For instance, Michael Kors Holdings Ltd (NYSE:KORS) reported roughly $400m in sales for its fiscal 2009; the Company recently guided to just above $4bn in sales for the period ending June 2015 – a roughly ten-fold increase in just six years. For perspective, we look at well-known peers: Burberry – an iconic affordable luxury brand that is over 100 years old – eclipsed $400m in sales 2001. According to IBES estimates, the Company will surpass $4bn in March 2017. In other words, it has taken Burberry Group plc (LON:BRBY), roughly 16 years to go from $400m to $4bn in sales. But that’s actually about normal: Ralph Lauren Corp (NYSE:RL) took at least 15 years. Coach Inc (NYSE:COH): 16 years. Hermes: 22 years, and Tiffany & Co. (NYSE:TIF): 25 years.
All told, we think the exclusivity of the Michael Kors Holdings Ltd (NYSE:KORS) value proposition is at risk, and therefore not sustainable.
Second, several months ago, Coach Inc (NYSE:COH) embarked on an aggressive plan to reinvest in the brand and buttress its competitive positioning in North America. We think this is very necessary after years of underinvestment. This reinvestment plan has included the hiring of a new head of creative, and repositioning the brand by curtailing dilutive impressions, particularly by closing underperforming stores and online “flash-sales” as well as elevating flagship full-price stores to dictate Coach’s value proposition of modern luxury. While these investments have hurt sales growth over the past 6 months and will continue to do so for the next 12 months, we think it will lead to a healthier brand impression and a much higher, sustainable level of earnings power in 3 to 5 years.
Third, the Company’s competitive positioning remains relatively unassailed in its international markets – especially in faster growing markets, such as Greater China. As the North American business remains challenged, we expect international will come to represent 40% or more of revenues.