Shoppers Are Leaving Coach on the Bench; Should Investors?

Alamy Shares of every-woman’s-got-one leather accessories maker Coach (COH) are down 8 percent since it released a mediocre earnings report earlier this week.

The latest quarterly report revealed that sales in North America (both in-store and direct) were down 1 percent compared to the same period last year. Worse, same-store-sales collapsed 6.8 percent year over year. International sales were basically flat.

All retailers are pinched right now, but this luxury brand has the most to lose.

Buy, Sell, or Hold the Handbag Maker?

With a slew of poor earnings reports for retailers this year, conference calls everywhere are featuring executives frantically listing all of the ways they are going to improve business.

Coach did that too. But, to its credit, Coach didn’t promise blue skies and candy floss.

CEO Lew Frankfort said on the call, “We are not going to forecast an improvement in our trend rates here within North America. So we’re actually waiting for that to occur. And when it occurs, you will know about it.”

Honest? You bet. Good for you as an investor? Not so much.

Think of Coach, despite its international growth, as a mature business like Microsoft (MSFT). Both are spending to try to grow, but have so much cash left over that they pay you a dividend and buy back mountains of shares. Those buybacks help dividend-paying companies and investors who love dividends. Every time a company buys a share, it eliminates its obligation to pay a lifetime of dividends on that share. That saves money, making it more likely that its remaining happy dividend collectors will see increases. It’s a virtuous cycle.

But in the end, it’s only virtuous so long as there is growth.

Dividends and buybacks are fine, but they’re no substitute for increased sales, earnings, and stock gains. And those three won’t be arriving any time soon. As CEO Frankfort said: “And when it occurs, you will know about it.”

Staging Coach’s Future

Coach does have a road map. The company knew years ago that it couldn’t flourish by simply selling every woman a closetful of expensive handbags. Not that there’s anything wrong with that.

So now the company has set its sights on moving more firmly into footwear and men’s items, and to being more of a “lifestyle company.”

It’s not an easy transition for any company to go beyond the market where it made its name. Abercrombie & Fitch (ANF), Aeropostale (ARO), Gap (GPS) – they all have tried to leverage their initial brands and stumbled.

Coach isn’t in that league yet by any means, but its sales confirm what we’re seeing all over the retail map. Their executives are far from alone when on the earnings call they noted “heightened promotional levers” which are “largely related to clearance, especially during the holiday season.”

In plain English, that means “We’re facing a brutal holiday quarter. Markdowns are coming.”

Coach sells itself as a luxury brand, and markdowns don’t exactly send that message, but you’ve gotta move the merchandise. This means a great holiday shopping season for us. But it’s not good for anyone who owns Coach stock.

With their first fiscal quarter anemic and the company all but waving the red flag for the holiday season, Coach is a sell. Today it’s definitely wearing flats on the sidewalk, not high heels on the runway.

Tom Jacobs is Lead Advisor for Motley Fool Special Ops, a premium investment service concentrating on special situations such as spinoffs. He is also the author, with The Motley Fool’s John Del Vecchio, of What’s Behind the Numbers? A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio (McGraw-Hill). Follow him @TomJacobsInvest. Tom has no position in any stocks mentioned. The Motley Fool recommends Coach. The Motley Fool owns shares of Coach and Microsoft.

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