Handbags: Who’s hot and who’s not. KATE & KORS Earnings Preview

5/12/2014

Coach Inc. (COH) - $42.12 Kate Spade & Co. (KATE) - $34.04 Michael Kors Holdings. (KORS) - $91.82

Why Read?

Luxury goods and handbags in particular have remained a resilient and growing subsector of retail. With luxury spending on the rise, investors have rewarded high growth high margin companies like Kate Spade (KATE) and Michael Kors (KORS) with equally high valuations. Companies who have failed to protect their brand equity and popularity like Coach (COH) have been punished, as we have observed in the -9.3% drop following -21.4% North American comparable store sales results for Coach in 3Q14. There is a lot to say about each of these names but this note will focus on top-line prospects.

_________________________________________________________________________________________________________  § Sales Trends: From May 9th to May 10th we called 52 Nordstrom stores across the nation to survey the

current trends in handbag sales. We chose to exclusively survey Nordstrom because they are one of the few retailers to sell all three brands (Coach, Kate Spade, and Michael Kors) and generally give approximately the same floor space to each. Of the stores surveyed, 54% said Kate Spade was their hottest trending brand, 29% Michael Kors, 15% Tory Burch, 2% Marc Jacobs and 0% Coach. 49% of stores said Michael Kors was their second hottest brand, 32% Kate Spade, 11% Tory Burch, and 9% Marc Jacobs, and 0% Coach. We believe Kate Spade sales will continue to impress, as the brand becomes the new “hot thing” in women’s handbags. We also believe Michael Kors will still continue to post strong topline results, although we have concerns regarding market saturation, and believe they have reached their peak in popularity. Remember, once everyone has what’s “cool” all of a sudden its not so cool anymore. Coach remains dead in the water, although we received positive comments regarding older customers, and some associates remain optimistic about the direction of Coach’s design trends.

§ Estimates: COH: We expect Coach to generate revenue of $1.05bn vs. consensus of $1.10bn in 4Q14E. For 4Q14E we expect Coach to earn $0.48 vs. consensus of $0.54. For FY14E we expect Coach to generate $4.54bn in sales vs. a consensus of $4.65bn. For FY14E we expect Coach to earn $2.67 vs. a consensus of $2.78. KATE: We expect KATE to post +25% comps for 1Q14E. We expect Kate Spade to generate revenue of $215mn vs. consensus of $201mn in 1Q14E. For 1Q14E we expect Kate Spade to earn $(0.02) vs. consensus of $(0.04). For FY14E we expect Kate Spade to generate $1.09bn in sales vs. a consensus of $1.02bn. For FY14E we expect Kate Spade to earn $0.33 vs. a consensus of $0.25. KORS: We expect KORS to post +24% comps for 4Q13E. We expect Michael Kors to generate revenue of $861mn vs. consensus of $816mn in 4Q13E. For 4Q13E we expect Michael Kors to earn $0.73 vs. consensus of $0.68. For FY14E we expect Michael Kors to generate $4.3bn in sales vs. a consensus of $4.06bn. For FY14E we expect Michael Kors to earn $4.00 vs. a consensus of $3.85.

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Sales Trends:

Michael Kors and Kate Spade have continued to eat Coach’s lunch, this is what happens when a brand obtains “has been” status. What we find most telling is the acceleration in Kate Spade’s comparable store sales starting in 4Q12 through 3Q13, and the trend reversal in Michael Kors’ comparable store sales in 3Q13. We believe that some of Michael Kors’ 4Q13 comparable store sales acceleration was from capturing market share from weaker brands like Coach from once a year holiday shoppers.

-­‐25.0%  

-­‐5.0%  

15.0%  

35.0%  

55.0%  

Q1  2012   Q2  2012   Q3  2012   Q4  2012   Q1  2013   Q2  2013   Q3  2013   Q4  2013   Q1  2014E  

1  Year  Comparable  Store  Sales  

KORS   KATE   COH  (North  America)  

-­‐25.0%  

-­‐5.0%  

15.0%  

35.0%  

55.0%  

75.0%  

Q1  2013   Q2  2013   Q3  2013   Q4  2013   Q1  2014E  

2  Year  Comparable  Store  Sales  Stack  

KORS   KATE   COH  (North  America)  

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From May 9th to May 10th we called 52 Nordstrom stores across the nation to survey the current trends in handbag sales. We chose to exclusively survey Nordstrom because they are one of the few retailers to sell all three brands (Coach, Kate Spade, and Michael Kors) and generally give approximately the same floor space to each. Of the stores surveyed, 54% said Kate Spade was their hottest trending brand, 29% Michael Kors, 15% Tory Burch, 2% Marc Jacobs and 0% Coach. 49% of stores said Michael Kors was their second hottest brand, 32% Kate Spade, 11% Tory Burch, and 9% Marc Jacobs, and 0% Coach. Kate Spade led popularity by the greatest margin in the West and Northeast, followed by the Midwest. Michael Kors still leads in popularity in the South. Handbag popularity runs in cycles. First a brand becomes popular in major cosmopolitan cities, selling at full price, and creates aspirational status. After this status has been created, brand sales surge in outlets and begin to saturate 2nd tier cities. But let’s have the sales associate tell it as it is:

“When I worked in Houston, Michael Kors was all the rage 2-3 years ago, now its not as popular there but has really caught on here in San Antonio. People take longer to catch on here.” – Sales Associate, San Antonio

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We expect both Kate Spade and Michael Kors will still continue to report strong top line growth, although the runway for Michael Kors’ popularity is much shorter than Kate Spade’s and Michael Kors is in a later inning. Michael Kors has begun to saturate the market with their more traditional bags and is relying more on fashion and edgier styles to drive sales. We observed strong sell through in their new pink Hamilton bags, tri-color bags, and Selma bags. Michael Kors recently changed the leather on their Hamilton bags and darkened the trim to create newness.

“We got 3 pink Hamilton bags in yesterday afternoon, down to my last one today.” – Sales Associate, Frisco TX

What was most resounding was sales associates’ forwardness in recommending AGAINST buying Coach bags. When asked if buying a Coach bag was a good idea sales associates responded with:

“Meh, not so much.” – Sales Associate, Coral Gables, FL

“Don’t get her Coach, I wouldn’t do that.” – Sales Associate, Novi MI

“Coach is still recovering from the monogram disaster of 2010” –Chicago IL

“Coach is trying to come back, but they’re dead to me” –Indianapolis IN And regarding Michael Kors oversaturating the market and becoming the next Coach:

“Michael Kors is the next Coach” – Sales Associate, Menlo Park, NJ “Michael Kors is getting too gaudy because of the giant emblems and logos” – Sales Associate “Everyone has Michael now, its not as cool as it used to be.” - Sales Associate

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Wrap-up: We are very excited now that Kate Spade has transformed into a pure play luxury/handbag company and sold Lucky & Juicy Couture. Based upon our phone survey and channel checks, we believe Kate Spade has the greatest runway for growth and will continue to best top-line estimates. That said, don’t write off Michael Kors yet. We expect their growth to shift from core U.S. cities to International and outlet as the brand moves through the natural cycle of popularity. We expect that customers who shop at Nordstrom are a bit “ahead” of the trend in the U.S. so we believe Michael Kors still has another few quarters to a year to run before the story is over. Coach remains dead in the water and will likely remain so. Based upon our survey, we think there is an opportunity for Coach to regain some brand share amongst older women and in the high-end space, especially with the feedback regarding their new styles. We are most enthusiastic about KATE going into earnings on Wednesday (May 14th) as we see the greatest upside in the name amongst the 3 handbag companies. Although we still believe KORS will still post strong results for their 4Q earnings (May 28th), we believe the stock is currently priced to perfection and will take extraordinary results to move significantly higher. COH remains on our “do not touch” or short list for more aggressive folks. We believe results will continue to disappoint but stress the importance of performing new due diligence on the name as we move to the back half of the year. Any good news surrounding their new lines, or even less bad news, could see the stock move higher after taking a beating for so long.

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