|Shares Out. (in M):||280||P/E||17||16|
|Market Cap (in $M):||10,395||P/FCF||21||16|
|Net Debt (in $M):||-1,244||EBIT||839||943|
|Borrow Cost:||General Collateral|
We are recommending a short of Coach (COH), as we see this as an opportunity to take advantage of short-term thinking investors putting an excessively high valuation on a tainted brand. Coach (COH) is trading at 8.5X peak (2013) earnings (after making a small adjustment for the addition of Stuart Weitzman), a level that we believe the company is highly unlikely to ever achieve again. This limiting factor creates a quasi-free call option for short sellers, which allows an investor to bet against a brand that is clearly declining, but whose short-term performance can be less predictable.
No company has ever fully recovered from overexposure:
Overexposure varies case to case and is tough to define pre-hindsight. It is possible that certain brands needn’t 500 stores to be overexposed and were done at 50. However, in certain extreme cases we believe that overexposure is similar to how the Supreme Court once described porn--we may not be able to define it, but we know it when we see it. We believe that Coach (COH) is a brand that has clearly been overexposed. COH reached a height of roughly 40% of the North American premium handbag market in 2013. This is an amazing and eye popping number, given the number of competitors and the lack of barriers to entry in the industry. COH got there by going down market from a high-end luxury brand to mass market affordable luxury brand. This down-market sell strategy is another sign of overexposure, and while it likely quickened COH’s rise, it also should lead to a quicker and potentially deeper fall.
Thinking about retail--and by retail we are referring to specialty apparel retail brands--we began to ponder if fallen retailers can be truly turned around. Brands can be categorized into two types, those that restrict supply and those that do not. The ones that restrict supply, usually found in luxury goods, can be incredibly durable. The ones with unrestricted supply seem to have a very short half-life. The typical pattern that we see in unrestricted retail is that a brand does well for a while targeting a certain audience. Take for example Dress Barn. For years it targeted predominantly baby boomer women and expanded to fully exploit that opportunity. When its target customer ages, the unrestricted retailer responds by chasing its customer while simultaneously trying to acquire a new generation of customers. This tends not to work with acquiring the new generation, as people do not want to shop at a place with older customers. Simply put, women don’t want to shop where their mothers shop. Overtime the economics of this unrestricted brand deteriorates, though there can be short-term upturns along the gradual decline if the brand hits a trend right. The alternative for unrestricted brands is to fully follow its aging target customer and ignore the trailing aging generation. But as customers age, their taste change. Eventually they do not associate the brands they shopped with their new tastes. In addition, they are likely spending less. Brands will choose this seemingly odd strategy because it’s the least bad alternative. No unrestricted supply apparel business once it starts truly declining seems to turn around.
We set about to look for counter examples to this thesis. We defined a turn-around as a return to peak performance. So we began to search for examples of this, which would seem to run counter to our thesis. Let’s start out with a quote from Warren Buffett. In 2005 Buffett when asked about Sears, he responded in part by saying “Can you think of an example of a retailer that was successfully turned around?” So it appears that Mr. Buffett, has never witnessed this phenomenon. We couldn’t think of an example either.
We next spoke with four industry experts and analysts with a combined approximate 100 years of experience. These experts have not witnessed a turn-around as we defined it. They were able to recall several examples of stabilization after a fall. For examples, Tommy Hilfiger and Lacoste both have viable businesses. They are just the same size as they were at their peaks.
All of the examples so far have been narratives. Looking for something more concrete we stumbled across the Brand Z top 100 most valuable global brands. This is a publication has been valuing brands since 2006. We looked across retail, apparel and luxury categories since 2006 and could not find a brand that had fallen off the list and later got back on. We did see examples such as Gap, Abercrombie, and Espirit that had fallen and not returned. Our look at Brand Z scores did also further illuminate how stable luxury brands are (see exhibit 1 below) and how important limiting supply is to that. The list has largely been the same since 2008, and all of the companies that make the list every year limit supply in some way. Louis Vuitton and Hermes (#1 & 2 since 2008) are notoriously effective at this. Vuitton destroys any unsold product, and there is a multi-year wait for many Hermes products.
Lastly we kept digging up company histories for possible counter-examples. We did find a couple of retailers (Express & Guess) and there are likely more who have had extended periods of ups and downs, but we could not find any who fit our definition of overexposed who did this.
So judging by history, we would expect Coach to never return to its 2013 peak net income. Other factors will also weigh on Coach’s future performance. New forms of shopping are emerging such as Stitch, which sends a trunk full of clothes and accessories to woman on a subscription basis. The expert we spoke with believes that this form could one day be 20% of the market. This form uses their own brands in this trunk, not COH products. This form will appeal to fairly well-off but less fashion obsessed woman, basically a woman who cares how she looks, can afford to dress well, but doesn’t make it her first priority. This description fits the typical COH customer. Additionally, the used and borrowed bag market is growing. Every bag that is resold undercuts demand for a new bag. (We also note that these services usually do not sell Coach products, another reason to say COH is no longer a luxury brand.) We believe these new shopping forms are two factors that could severely downsize the women’s branded handbag market.
We have not talked yet about the current trends going against the handbag market. For years into the mid-2000s the handbag market rode incredible growth as woman made a shift from status spending on shoes to bags. That shift has finally stalled, and apparel spending in general seems to be flattening. A premium handbag is a status symbol. So if women aren’t buying bags for that status, what are they doing? A different accessory? Enter social media, where displaying experiences are status symbols. On Social media one simply can post a photo of a fancy restaurant or a trip to a hip destination and have it seen by an audience. With a bag it’s just whoever sees you that day, but with social media it’s all your friends and more. One could argue the move to getting status from events and social media is far more effective. I am uncertain about this going forward, but it certainly has a logic to it and could be the icing on the cake in our short thesis.
Does the recent Rise in Same Store Sales Counter our Short Thesis?:
Coach has had a few decent quarters recently with a return to low single digit comps. So does this mean that COH is out of the woods and there is a return to growth for the brand? We looked for previous cases of overexposure and decided that Gap in the early 2000s and Abercrombie & Fitch a decade ago are classic examples of overexposure and two (unlike some others) that we could get good data on. Both of these companies are now nowhere near their peaks, but they had some rebounds along the slide down--so the answer is yes!!
Gap’s North American namesake business peaked in 2001 (see Exhibit 2 below), with SSS down 42% since 2000. Along the way, there were three years when same store sales actually rose. So what did those three years of positive comps? There seem to be three contributing factors, easy comparisons, store closures and though we can’t quantify it, being on trend.