Canary In A Handbag: Why Coach Hit The Skids

Tyler Durden's picture

Submitted by David Stockman of Contra Corner blog,

For the last two decades Coach (COH) could do no wrong. Its aspirational handbags flew off the shelves at hefty prices, causing its sales to soar from $1.3 billion to $5.1 billion during the 10-years ending in fiscal 2013. Better still, its EPS soared by 6X, representing a 20% earnings growth rate over the same period. Greatest of all, its share price peaked at nearly $80 in 2012 after having opened the 21st century at $3 per share.

Needless to say, the believers and speculators who got on board for the 27X gain in twelve years were fabulously rewarded, as was its founder and largest stockholder, Lew Frankfort, who became a billionaire along the way. So the capitalist dream is still working in America, right?

Not exactly. Last night Coach announced an earnings horror show. Sales were down 21% from year ago levels, the 4th straight quarter of plunging top line results. Worse still, Coach announced that same store sales in its 544 North American stores and outlets, which account for 70% of sales, face even worse prospects in the period ahead. According to the Reuters account,

The clothes, shoes and handbags retailer said it expected North America same-store sales to fall in the “high teens” in percentage terms in the coming year.

Simply stated, a high teens same store sales decline at a luxury retail emporium is a death sentence. Accordingly, COH has now tossed its long standing business model out the window and is marching on the double in the opposite direction.

COH’s 27X share price gain since 2000 depended upon a pell mell path of retail footage expansion by which its opened dozens of new stores every year for nearly two decades and thereby drove its sales steadily upward. But now it will close 70 of its NA stores or 13% of the total. And facing upwards of a 20% decline in same store sales in the coming year that is surely only the beginning of the shrinkage.

Not surprisingly, Coach shares took a 10% hit in the aftermarket, and that’s only the last hurrah for this once high flying canary.The stock has been weakening for two years owing to its recent faltering performance, and now stands at $35/share—–down 56% from its peak and back to the price it first traded at in August 2005.

This can all be dismissed as the unfortunate life-cycle of a high flyer playing out its appointed rounds. And, indeed, the primary force knocking COH off its pedestal was two aggressive competitors in the same market for “aspirational” branded handbags, shoes and apparel goods—–that is, Kate Spade and Michael Kors.Coach Inc. stock displayed the New York Stock Exchange.

Self-evidently, the supply of aspirational buyers at Coach’s nosebleed price points was not nearly as great as the supply of competitive designs, products and merchandizing that its latter day competitors have flooded into the malls. Something had to give, but it wasn’t just old-fashioned capitalist survival of the fittest.

Instead, Coach blew it by playing the bubble finance game on the Wall Street casino—a destructive game which is part and parcel of the Fed’s misguided policy of financial repression and its wealth effects promotion of speculation in risk assets.  In a word, Coach blatantly failed to reinvest in its business in order to preserve its ample head start against its current devastating competitors. Instead, it cycled nearly all of its cash flow into stock-buybacks, thereby levitating its share price by orders of magnitude more than its total earnings, sales and sustainable cash flow.

During the 10-years ending in fiscal 2013, Coach generated about $8.6 billion in operating cash flow—that is, revenue less cash operating expense and change in working capital. But it utilized  $6.2 billion or nearly 75% of the net cash generated during its high flying days to buyback shares. By contrast, it applied only $1.5 billion to net investments in CapEx and some modest acquisitions.

Moreover, that is only half the story. Throughout the last decade COH reliably posted fat EBITDA margins of between 33-35% because that is how the high flyer momentum game is played. Open lots of stores, post fulsome cash flow margins and wait for the sell-side analysts to sharpen their hockey sticks. Next, the momo traders get on board, the CEO appears on Cramer to talk up the home gamers and its off to the races. At it peak in 2012, COH was trading at about 50X forward earnings.

Needless to say, the momo boys and girls never asked how COH could open 544 North American stores and many more abroad on virtually no CapEx. In fact, over the last decade the company’s revenues totaled nearly $32 billion, meaning that CapEx amounted to less than 5% of sales.

And realize, also, that this 5% of sales figure is essentially a low-side benchmark for maintenance CapEx in high end retail where merchandising appeal must be continuously refreshed; it doesn’t even begin to reflect the capital utilization that would be required for the pell mell opening of hundreds of new high-end stores.

The short answer, of course, is that COH didn’t need much CapEx to open stores because they were all financed through operating leases! But there are two giant problems with the rent-a-store approach to company building.

First, the cost of occupancy—which is extremely rich in the so-called in-line section of the mall were the likes of COH are positioned—becomes a fixed cash cost.  So when traffic and sales turn down even modestly, there is no cushion. Instead, there is an immediate hit to margins; and if volumes at “weak stores” fall sharply—-like 20%—-operating cash flow can dry-up completely. Suddenly, a rent-a-store high flyer is in the store closure and lease write-off business—even if this destruction of capital is dismissed as “non-recurring” by the sell side analysts who never figure out that the gig is up.

But there is another more debilitating feature. It is rarely possible to run 35% EBITDA margins in a highly competitive luxury goods market without heavy and continuous reinvestment in design, product, marketing, in-store merchandising and staff support and training. Yet operating leases—because they are a fixed cash charge to the current P&L—inevitably squeeze out discretionary cash investments in the business operations mentioned above when a high flyer is under the gun to meet the rich EBITDA margins that get embedded in analyst hockey sticks. In other words, Coach’s high EBITDA margins were deceptive and unsustainable because they masked a big lump of cash leases.

Why is it so easy to build a 550 store retail emporium on operating leases? The answer is financial repression. Mall owners have enjoyed  “cap rates” on their debt capital (most of their investment) which has been far below market clearing levels every since the Fed launched into monetary central planning and interest rate pegging.

The mall REITs, in turn, collect a generous spread between their rents and their debt carry costs, but they also accord tenants like COH an unwarranted credit rating and therefore an implicit subsidy. The latter is based on the so-called national tenant credit status of fast expanding chains like COH and the demonstrated fact that the Fed will allow no stock market bubble to stay burst. So when push comes to shove, mall owners assume that even injured high flyers, like COH is currently, will be able to obtain enough cheap financing to pay the rent.

So we have a great deformation. High-flying retail rollouts like COH drastically over-invest in stores and square footage on the way up because occupancy costs have been made sub-economic by our clueless monetary politburo. At the same time, genuine entrepreneurs like Lew Frankfort in this case, and serial scam artists more frequently, are encouraged by the momo traders and sell side analysts to drastically under-invest in products, merchandising and service.  There are few more strategic business errors than to underinvest in what’s inside when you are over-invested in fixed leases all around.  Can you say Sears?

Coach may struggle on, but what happens when the current financial bubble ends up as the third stock market crash of this century? Well, what happens is that “demand” for “aspirational leathers” among the top 10% of households will plummet. Then the canaries will be fluttering up and down the mall aisles as Coach, Kate Spade and Michael Kors duke it out for the remnant of customers who will be left.

Needless, to say the momo traders have left the scene months, if not years, ago; and Lew Frankfort has cashed in his billions and retired. What will be left is empty malls, fired staff, closed stores and billions of operating leases written off as dead-weight destruction of capital. That’s how the Fed’s bubble finance works, and how it corrodes and corrupts the vital arteries of capitalism.

Someone should take Janet Yellen to Sears….or even to Coach.

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starman's picture

Hm they should offer discount pricing for Federa Reservel and Central Bank management. That otta fix it.

arby63's picture

Yellen already has slaves in the basement sewing Coach clones. Typical part of the debasement agenda. 

I hear they are making iGadgets next.

old naughty's picture

So, is the [reptile] skin trade coming to a close?

I MISS KUDLOW's picture

i haven't seen a worse chart in a long time its got alot to fall before any kind of support

RaceToTheBottom's picture

Having a business model aimed at the .01% who can afford to worry about new purses, the rest of the serfs are worrying about food....  doesn't seem logical

Stuck on Zero's picture

I've got an idea.  Coach can produce upholstery and matching bags for GM cars.  They can then channel stuff to get their sales up.


californiagirl's picture

Actually, Coach used to produce high quality leather luggage and auto upholstery.  Their main problem now is that the designs are not interesting enough and the quality has deteriorated over the years.  Not that Kors is any better.  Many of his products (clothes, handbags, etc.) are also in a bubble due to his stint on Project Runway and cameos in movies like Devil Wears Prada.  Talk about almost KMART quality with Nordstrom prices! Not to mention that most of the bags are simple, open top (easy pick-pocket and weather-damage targets) and cavernous (lack of organization makes it difficult to find keys and other items), and therefore cheaper to make, something he shares with many Kate Spade bags.  Kate Spade at least has cuter designs. Personally, since I am not sheeple, I prefer something that every 2nd or 3rd person does not have, and quality - more like Chanel, Prada and Feragamo.  And unlike LV, 2/3 of the bags you see are not bad fakes.  Of course, Kors, is definitely designing for the sheeple and successful for it, while his popularity lasts.

I MISS KUDLOW's picture

if you ever have any to throw away i'll take them to use to clean up after my rotty in the yard

californiagirl's picture

Actually, my classic looks-like-new Chanel bag is selling on EBAY for tripple what I purchased it for in 2003 at Saks. good luck tripling an investment on a Coach bag.

CrazyCooter's picture

At the rate things are going, ladies are going need one of these handbags when the go out ...



Georgiabelle's picture

I have never owned a Coach bag, or LV, or any other bag covered with someone else's initials. I buy quality leather purses in classic styles at TJ Maxx or Marshalls at 40-70% off retail. I always look for Tignanello bags because they are very well-made, have full-zip closures, have lots of handy organizer pockets and interior zip pouches, and they look good for years with occassional cleaning with a good leather conditioner. I can't imagine paying more than $100 for a purse, but to each their own I guess. 

kareninca's picture

I once owned five Coach handbags!  But I did not buy them.  My neighbor in Chicago, a nice African American lady, had custody of her teenage granddaughter.  The granddaughter had several part-time jobs, to earn money to buy the status symbol of her set  -  Coach bags.  But she did not care about the bags themselves; just the little leather Coach tags.  She would spend $160 (that was a lot 20 years ago), keep the tag, and give the bag to Grandma.  Grandma had enough of them, so she gave some to me; I gave her various things of course (we were friends).  I kept them a couple of years  -  they were nicely made  -  never actually used them since who needs five handbags??  -  then became vegan and gave them away.  Who wants to carry a chunk of a dead animal?  There are nice fabric purses at Goodwill.

NoPension's picture

Shit..I knew Coach was out 8 months ago, when the Mrs. began to systematically replace her collection with Michael Kors.

Want to see fur fly? Ask why either one is better... Or why they are any better than a gunny sack.
After 31 years, I just put up with most shit. It. Is. Not. Worth. The. Fight.

cynicalskeptic's picture

Quality has been declining which turns off even the serious Coach addicts.  It's worse in the outlets which seem to be selling stuff made specifically made to sell at lower prices.  Coach also went after the teen market big time with overly 'trendy' designs - instead of the older classics - further alienating regulars.

You know it's bad when thestore staff are calling you about 'sales'.  Problem is that the overpriced 'good' bags that ARE in demand never seem to be part of those 'sales'.

Wife has a serious addiction - or I should say 'HAD' a serious addiction.... been a while since she's gotten anything new.    I suspect our son also made her reconsider when she said something about wanting a bag in another color... he said 'why not spray paint the one you have'  Kid is very much an anti-consumer buys only what he really NEEDS type.

Used to be that upscale 'quality' DID have some merit - the 'good' stuff lasted forever.... but too many upscale purveyors got greedy and cut the quality while upping the price. 

mrpxsytin's picture

Greedy? Or just trying desperately to keep the game going for that one second longer as their superiors try to unwind the position onto the back of some pension fund? 

NoDebt's picture

Over-priced crap sold to fickle fashion-fleeting buyers.  Package the company how ever you like.  When the ride's over, it's over.  It's only cool to have it when you're one of the few who has it.  

If Gorge Carlin was around to do a bit on Coach it would problably start something like this:  "It's just LUGGAGE, people.  All you do is carry your STUFF in it.  And who buys this stuff?  YOU DO...."  You could almost imagine the rest.

tarsubil's picture

You miss the point. $200 for a little bag with a zipper and strap is too cheap. It's too middle class (you know, the class that is being annihilated right now). The only growth is with the people at the top. They need to rebrand as $2000 little bags with zippers and a strap.

californiagirl's picture

For $2,000 I would buy a well-made Prada or Chanel, not a cheap piece of crap.  There are a large number of competing designers in the $200 to $500 category right now and most of them are cheap crap that would have cost less than $100 a few years ago and found at the likes of Marshall's and TJ Max.

californiagirl's picture

Oh yes! Terrible me! I work hard, have not been unemployed since the day after my 16th birthday and occasionally buy something nice for myself that is functional, classic and well made and will be beautiful for years as opposed to numerous cheap purchases that that are the flavor of the month and will be falling apart or looking like a truck ran over it in a few months. Yes. I must be truly evil because I don't need or expect a man to buy it for me and can afford it by myself. And surely I practice unspeapkable evil when I purchase good from a business that provides so many jobs to skilled employees with families to support who are not knocking out goods in Chinese sweatshops that employ numerous underaged children working for slave wages. Obviously I am an evil capitalist. Bernanke would certainly not like me because I do not shop like crazy, dread going to malls and find shopping to be more of a chore than a pleasure. I am not interested in practicing massive disposable consumption that rapidly ends up in the landfill or in leveraging the heck out of credit cards. Yup! I am to be despised. Off with my head!

Do you honestly think that if I was a vapid shopaholic only concerned with materialism that I would be reading a website like Zerohedge?

mrpxsytin's picture

The ZH goblins love to pidgeonhole people. Don't take them seriously, they rarely venture beyond their oversimplified stereotypes, racial slurs, and banal expletives. Most of the time they're actually screaming at themselves from the inside of a reflective echo chamber.

californiagirl's picture

I don't mind correcting them now and then, particularly if I can use a little sarcasm. After all, so many men are knowledgeable about women's fashion. Had some time on my hands while waiting at the airport to pick someone up. Time to go now.

what's that smell's picture

somebody in the zhedge basement is gonna get laid tonight......

a purse fetish is no more interesting than a dildo obsession....unless of course a $2000 dildo had better have twinkling LEDs and 52 vibrating modes.


oldmanofthesee's picture

Wow! Sounds like those "down" votes hit a nerve?

boattrash's picture

No down votes from me, just thinking $2000 would be a nice down Pmt. on a .50 Cal. Sorry, I forgot that you can't buy those in Cali.

angryBuddhist's picture

californiagirl - will you marry me?

Buckaroo Banzai's picture

Californiagirl, don't waste time justifying yourself, men simply don't get handbags. You know what the male/female ratio is here.

RaceToTheBottom's picture

Or carrying around the cake.

Actually a bag to carry around your homegrown foodstuffs without advertizing that you have .... real food... might be a useful product.....  In addition to your handgun....

prains's picture

for $2000 i'd buy a cheep old car and try and hit a california girl who thought having a hand bag of any size, cost, design was really that important, but come to think of it i don't think my car would last through the first 4 million women who thought such a thing was even worth a moments notice. Why does your species constantly're a sad lot when really somewhere in you is our salvation...yet you're so easily bought by cheap babbles

mrpxsytin's picture

cheap babbles... cheap baubles too. And the best is when you combine cheap babbles with cheap baubles. 

californiagirl's picture

It appears you get your ideas about all women from Hollywood or perhaps reading Jackie Collins novels. The majority of women I know do not decide on a man based on how many cheap or expensive baubles he buys for them. In fact, most of my friends make more money than their husbands or boyfriends and a couple are even paying alimony to their exes.

mrpxsytin's picture

It was a joke. Everyone knows a good woman doesn't need babbles or baubles. She just needs a strong man to protect her. ;)

californiagirl's picture

Yes. When hard working, successful men purchase a few nice things for themselves, they are contributing to the economy and are to be admired. However, when a woman does it with her own money, she must be run over by a car.

Buckaroo Banzai's picture

Women pay $500 for a handbag that is "cheap crap"??

Son of a bitch. I'm in the wrong business.

bunnyswanson's picture

Like well-made shoes, a well-designed handbag, with strategically-placed metals, stitched to last, will last years.  I have several Doonie Bork (sp?) from 20 years ago and they look new and are classic. Shoes and handbags should compliment each other unless you like poor girl look or a mish mash kinda girl.  Leather is nice.  Paying attention to fine detail is why cost goes up.  Trends but some like me only buy a few of each color and use them a lifetime.  The Great Credit Extension made people think they were rich.  Businesses gave us good pay checks and OT (unlike most now).  It was the roaring 20s.  We got caught up in it, some of us.  This is a ploy and was designed to distract.  Americans are basically good people. 

manofthenorth's picture

Man or woman makes no difference. ANYONE who would trade 100 ounces of Silver for a hand bag is a FUCKING IDIOT !

I too am in the wrong business apparently.


Emergency Ward's picture

500 stores selling $500 bags!  How did I miss that?

limacon's picture

The fundamental problem with democracy .

The Madness of Crowds teaches the wisdom of Crows .

When you think your vote cannot matter , then the Crows will have you .

They will take more than they want , and waste the rest .

valley chick's picture

Just like igadgets its good till something better comes along.  You can now get a coach bag at a yard sale cheap and in great shape.

valley chick's picture

And this weekend could pick up many a coach bag as there is a 100 mile yard sale in NC.  Silly me will instead be on the lookout for more canning supplies for cheap.  :-) 

Caviar Emptor's picture

Without Yuppies, the whole economic model collapses. Capitalism is indeed on the ropes, that is if it still really exists

tarsubil's picture

I said it a long time ago. The US empire is like an addict hopped up on PCP that has just had a bullet through his heart. He's still moving around but he's a dead man walking. The collapse has already happened. But I see more gardens every day. Like flowers blooming out of a corpse.

Seasmoke's picture

Coach round trip to $3. Enjoy your flight.

walküre's picture

Coach stores are empty, Tiffany stores are at capacity.

1% spend more on the high end stuff than 99% would spend on the low end or something like that.

For 40 broke and deadbeat former GM clients, there's one Bentley cash buyer.

The low end is so annoying. They can't afford Coach? Well, let them carry Walmart bags.

Kprime's picture

they take their coach into walmart, fill it with steaks and try to slip out looking classy.

world_debt_slave's picture

couldn't it be knock offs and/or the weather?

kaiserhoff's picture

Yes, but you forgot to BLAME BOOSH!

Chief Wonder Bread's picture

Aspirational? Millenials living in the folks' basement do not do aspirational.