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November 3, 2015

Coach, Kate And Kors – Handbags Are Not The Only Thing On Sale

by Jharonne Martis.

Luxury retailers Kate Spade & Co. (KATE.N), Michael Kors Holdings Ltd. (KORS.N) and Coach Inc. (COH.N) are all experiencing weak stock price momentum. Coach reported earnings last week. KATE and KORS are expected to report Q3 2015 earnings this week. Let’s look at expectations.

Looking at the StarMine models, it is evident that all three retailers have the lowest possible Price Momentum Model (Exhibit 1) – which places them in the bottom decile and suggests that their stock price outlook is not in their favor.

Exhibit 1: COH, KATE, KORS – StarMine Scores
c1
Source: StarMine

KORS

Analysts polled by Thomson Reuters also suggest that Kate is ahead of the game in terms of freshness and fashion. Some argue that Kors lacks newness and their fashion profile has remained stale. Looking at Kors’ inventory days, this is the most inventory it has had on its shelf in the past eight quarters. The handbags are not flying off the shelves as in the past.

Exhibit 2: KORS Inventory Days
c2
Source: Eikon

What’s more, 90 days ago, KORS had zero sell stock recommendations vs. two today. The bulk of analysts polled by Thomson Reuters still recommend the stock as a hold.

Exhibit 3 –Recommendations & Target Price
c3
Source: Eikon

Sales breakout

In general, Q3 sales were muted for most retailers, including the handbag and accessories sector. More than half of our three companies’ revenue is generated in the U.S. (exhibit 4). All three are hurting from the strong dollar, in terms of foreign sales and weak tourist sales conversions in North America. What’s more, foreign exchange differences are hurting the luxury market overall (yen weakness).

Exhibit 4 – U.S. Revenue
c4
         Source: StarMine

KATE

Our StarMine Intrinsic Valuation (IV) model accounts for the systematic biases that our quantitative research team found in sell-side estimates. Thus, the faster the expected growth rate, the more optimism bias. And more-distant estimates are more optimistically biased than nearer ones.

For KATE, after adjusting long term growth (LTG) estimates for optimism bias, the StarMine IV model places fair value at $11.55 per share. In contrast, the market price is higher at $18.30 per share. Plugging in today’s price and solving for growth suggests that investors are optimistic. KATE market expectations are strong with an implied 5-yr compound annual growth rate (CAGR) of 39.7%.

However, looking at the StarMine scores, it is evident that the company has a low Earnings Quality score (8) – which places it in the bottom decile, and suggests that earnings are not coming from sustainable sources. It has poor cash flows and margins.

Kate Spade is a favorite during Black Friday, sporting huge lines out the door. These shoppers wait for steep discounts. Selling at discounted prices means that profit margins are more likely to be hit. As a result, we look at KATE operating profit margin. On trailing four quarter margins, KATE’s operating profit margin has remained somewhat stable over the past two years, but below market average. Currently, it is 2.7%, significantly below the industry average of 9.6%.

Exhibit 5 – KATE Operating Profit Margin
c5
Source: Eikon

COH

Coach embarked on a major facelift that included revamping its stores and logo. This cost the company eight straight quarters of negative earnings growth. However, for the first time, it looks like Coach could be coming out of this negative streak starting in 2016 (Exhibit 6).

Exhibit 6 – COH YoY% EPS Growth: Actual and 2016 Estimates
c6
Source: Eikon

What’s more, COH had 10 buy stock recommendations 90 days ago vs. 15 today. It also had five sell stock recommendations 90 days ago vs. four today. This suggests that analyst sentiment polled by Thomson Reuters is turning slightly more optimistic. Also, the StarMine Smart Holdings Model gives Coach a high score of 96 out of 100 — which suggests that its fundamentals are aligned with what institutional investors and the market care about.

Exhibit 7 –Recommendations & Target Price
c7
Source: Eikon

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