Coach and the American Consumer

The high-end purse maker is seeing strong demand for its products, thanks to upbeat consumers. But is inflation lurking around the corner?

One look at the financial results of Coach (COH) provides a pretty clear indication that at least some people have been shopping. On Oct. 24, the company best known for its stylish and pricey handbags reported a 23% surge in sales for its first fiscal quarter, to $554 million. Meantime, net income hit $126 million for the period, up 34% compared with the same quarter a year earlier. "Congratulations on the great quarter," said analyst Margaret Major of Goldman Sachs (GS) during the company's earnings call.

So $800 suede handbags are flying off the shelves. What does that say about the mindset of the American consumer? It may say more than most people think. Coach has been broadening its reach in recent years, expanding its offerings of sub-$100 products and also opening stores far from major urban centers. In the conference call with investors and analysts, Chief Executive Lew Frankfort pointed out that the retailer opened 12 stores in the most recent quarter, including ones in Evansville, Ind.; Greenville, S.C.; South Bend, Ind.; and El Paso. "Thus far, the performance of these full-price, new stores are averaging (sales of) $2.5 million on an annualized basis well ahead of our plan," says Frankfort.

Investors are certainly cheering. Coach's stock rose 8% during regular trading hours on Oct. 24, to close at $39.21. Share are up about 20% over the past year.

Healthy Labor Market

Clearly, shoppers are feeling pretty good. Consumer confidence is at its highest level in a year, nudged up by more than 10 consecutive weeks of falling gas prices. The University of Michigan reported that its consumer sentiment index jumped to 92.3 in October, from 85.4 in September. It was the highest reading since July, 2005.

At the same time the labor market is showing healthy signs. The unemployment rate fell to 4.6% last month, matching a five-year low, and workers' average hourly earnings rose 4% from September, 2005, matching the biggest gain in five years, according to the Labor Dept. With all the good economic news, expectations are high for the holiday season. "With gas prices coming down and consumer sentiment on the rise, shoppers want to celebrate the holidays in style," says CEO Tracy Mullin of National Retail Federation, a trade group based in Washington (see, 10/9/06, "U.S.: Consumers Aren't Sweating the Housing Slump Yet").

All this may be brightening the mood at the Federal Reserve. Over the past few months, Chairman Ben Bernanke and his colleagues have been struggling with how to keep the economy on an even keel as housing prices slid and gasoline prices surged. Now, it looks as if consumers have managed to weather the troubles reasonably well, and, with prices at the gas pump on the decline, they're feeling a bit less stretched.

The Fed seems to have managed to dampen the exuberance in the housing market without smothering consumer spending. "The consumer's propensity to spend out of saved fuel bills is quite high," says Brian Bethune, an economist at financial analysis firm Global Insight (see, 10/23/06, "Is Housing Out of the Woods?").

Falling Gas Prices

Tough questions remain. Among the most difficult is whether the Fed has tamped down the economy enough to wipe away inflation fears. The most recent report from the government shows inflation concerns are very much alive. Excluding food and energy, the consumer price index (CPI) rose 0.2% in September, the third straight monthly increase of that size, even though overall CPI declined 0.5%, reflecting the drop in gas prices.

The core CPI rose 2.9% in the 12 months ending in September. That's the highest level since February, 1996, and well above the Federal Reserve's "comfort zone," for core inflation of 1% to 2%. No wonder all eyes and ears are tuned in to what is being discussed at the two-day Federal Reserve meeting that will conclude on Oct. 24. The Fed has left the federal funds rate at 5.25% for two straight meetings and it is expected to do so again this week. What folks are straining to hear is whether that will again be the case at the next meeting.

A further interest-rate increase may indeed be necessary to fight inflation. But it may also have the effect of raining on the American consumer's shopping parade. Would it affect all those Coach shoppers, who have been swarming into the company's stores? The executives at Coach don't seem worried. CEO Frankfort says the company is looking to add 300 new stores in the next three years, starting with 30 new U.S. stores in the current fiscal 2007.

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