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Coach Chasing Python Pump Lovers Risks 73% Profit Margin

Coach Inc. (COH) has fought for relevance in recent years by introducing bling-laden products to attract younger shoppers and then bringing back more classic lines for its long-time customers. Yet the company remained true to its roots: finely crafted leather bags.

Now, in a defensive move as upstarts such as Michael Kors Holdings Ltd. (KORS) and Tory Burch LLC challenge its dominance of that market, New York-based Coach is trying to become a full lifestyle brand that outfits customers from head to toe.

It’s starting with shoes, a business that is more competitive and growing more slowly than handbags, while also presenting challenges Coach hasn’t faced much before. Where bags will always fit over a woman’s arm, Coach runs the risk of having too many or too few shoe sizes in stock. Shoes also don’t lend themselves to the gallery-like presentation of Coach’s bags. Analysts say the whole idea could put the company’s legendary profitability at risk.

“Coach’s shoe strategy is an uphill battle,” Brian Pitera, a Chicago-based principal at the consulting firm A.T. Kearney, said in an interview.

In an e-mail response to questions, Andrea Resnick, a Coach spokeswoman, said footwear is “a significant opportunity.”

Source: Coach, Inc. via Bloomberg

Where bags will always fit over a woman’s arm, Coach, Inc. runs the risk of having too many or too few shoe sizes in stock. Close

Where bags will always fit over a woman’s arm, Coach, Inc. runs the risk of having too... Read More

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Source: Coach, Inc. via Bloomberg

Where bags will always fit over a woman’s arm, Coach, Inc. runs the risk of having too many or too few shoe sizes in stock.

“We are in the early stages,” Resnick said. “We will move purposefully.”

While Coach isn’t the first company to try to extend its brand into new areas, it is trying to do so from a position of weakness, said Robert Burke, founder of a namesake luxury research firm in New York. Companies typically expand this way when they’ve grown so strong in their initial market that customers demand the brand on other items, Burke said.

Designer Halo

Successful lifestyle brands usually start in apparel and enjoy the halo that comes from a celebrity designer sending fashion down runways, Burke said. Ralph Lauren began selling men’s ties four decades ago and diligently built his English country life and American West brand imagery, methodically applying it to more and more categories from men’s to women’s to kids’ to home goods, layering in labels in different price ranges. Tory Burch started out in 2004 with apparel.

Accessories-driven brands such as Prada SpA (1913) have turned themselves into successful lifestyle brands by moving quickly to stage fashion shows and add categories, Burke said.

In recent years, Michael Kors, Ralph Lauren Corp. (RL), Tory Burch, and Fifth & Pacific Cos.’ (FNP) Kate Spade brand moved more aggressively into Coach’s territory, chasing handbags’ lucrative margins. Coach for the first time lost North American handbag market share in the quarter ended in December. In January, Coach responded by saying it would work harder to become more of a lifestyle brand after spending years content to dominate the handbag market.

Faux Python

Coach has offered some shoes before, such as $98 casual “C” logo sneakers. Its new line, introduced in more than 170 North American stores in March, is larger, more fashionable and higher-priced, with styles including “Nala” faux python pumps for $248 and “Dalia” ballet flats at $138. The company has installed shoe salons in some flagship locations and made shoes the feature of its windows in more than 75 locations.

The shoes will be added globally in the second half of this year, and Coach also plans to work on boosting sales at the department stores that carry its wares. The retailer will consider developing men’s shoes in the quarters ahead and may add footwear to its factory outlets, executives have said.

“We see ourselves growing a very substantial footwear business,” Victor Luis, who becomes chief executive officer next year, said at an investors conference last month.

The new shoes are being produced by Jimlar Corp., the Great Neck, New York-based company Coach has had a licensing deal with since 1999.

Footwear Sales

Coach said footwear sales at retail would be about $250 million in the fiscal year ending in June, while declining to provide the previous year’s footwear sales or provide targets. In the previous year, Coach got about 7 percent of its revenue, or about $333.4 million, from products other than accessories and handbags, a category that also includes scarves, jewelry and sunglasses.

Investors and analysts have so far been skeptical of Coach’s plans. The shares rose 4.9 percent this year through yesterday, trailing the 20 percent gain for the Standard & Poor’s 500 Consumer Discretionary Index and Michael Kors’s 25 percent increase. Coach traded at a 22 percent discount to the index on a price-to-earnings basis and a 52 percent discount to Michael Kors yesterday. About 55 percent of the analysts tracking Coach recommend buying the shares, compared with 84 percent for Michael Kors. Coach was little changed at $58.25 at 9:31 a.m. in New York today.

Shoe Market

Part of the caution is due to the business Coach is pushing into. Total U.S. sales of women’s shoes climbed 3.5 percent to $23.5 billion in the 12 months ended in March, slower than the handbag category’s 5 percent advance to $7.24 billion, according to NPD Group Inc., a Port Washington, New York-based market-research firm.

Stores also have to carry lots of sizes, and markdowns to clear inventory could eat into margins, said Faye Landes, an analyst with Cowen & Co., who is based in New York, said in a phone interview.

Coach’s gross margin -- the portion of sales left after subtracting the cost of goods -- was 72.8 percent in its most recent fiscal year. Ralph Lauren posted 59.8 percent while shoe-focused Deckers Outdoor Corp. (DECK)’s was 44.7 percent.

Coach Chairman Lew Frankfort said last month that footwear will help boost sales and profitability and won’t materially affect the company’s overall operating margin.

The early read on the shoe strategy has been positive, Coach said. Shoes as a percentage of sales at the Coach stores where they were reintroduced grew to almost 12 percent in the first five weeks from 3 percent, according to the company.

‘Powerhouse’ Brand

Coach is making “a very good move” because shoes are a hot category and the company has a “powerhouse” brand that can sell a lot of footwear along with its handbags globally, said Mortimer Singer, president of New York retail consulting firm Marvin Traub Associates.

While the early shoe sales results are encouraging, the boost occurred in a limited number of stores and was helped by national ads, Landes said.

The gain also may not last because the shoes look like “a me-too product,” with some being discounted down to $69 a pair Pitera said.

Cowen’s Landes, who rates the shares neutral, the equivalent of hold, sees another reason for caution, the same one that drew Coach to expand beyond handbags.

“There is more competition,” she said. “The competition has greater momentum.”

To contact the reporter on this story: Cotten Timberlake in Washington at ctimberlake@bloomberg.net

To contact the editor responsible for this story: Robin Ajello at rajello@bloomberg.net

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