The brand transformation at Coach announced by Victor Luis on June 19, 2014 is gaining traction. We are six quarters into its new modern luxury positioning, replete with new full price and outlet store formats, new accessories and lifestyle product, extensive PR and social media, as well as limited-edition capsule collections at world renowned fashion specialty stores including Barneys New York and Colette (Paris, France). And good news, the consumer is responding. Positive consumer response will likely continue building in tandem with marketing efforts supporting Coach’s 75th anniversary. Simultaneously, new heritage-inspired products, with a modern twist, arrive in stores with the launch of a new line, Coach 1941. Later this fall, a new flagship, a “Coach House” will open at 685 Fifth Avenue, New York; a 20,000 square foot monument to all that is Coach modern luxury.

Executive designer Stuart Vevers is bringing vitality and playfulness to Coach’s modern luxury and has imbued the brand with personality, an intangible that supports an emotional connection to Coach. This was missing in the final years of Reed Krakoff’s reign as Coach’s designer. The product may have been impeccable, but in retrospect, it was too formulaic, lacking inspiration and personality. These two features are necessary for a brand to live in the consumer’s mind as a building block to a relationship, aspirational ownership, and ultimately drive the purchase of a covetable and must-have product.

Turnaround Is Fair Play

A turnaround or brand repositioning in the midst of a weak domestic economic recovery, a slowdown among many of the world’s emerging luxury shoppers (China, Russia, and Latin America), and the increasingly promotional retail environment, especially in the handbag category, is quite a feat. Yet, Coach remains on track. Management reiterated its expectation that comps (same store sales comparisons) would turn positive in the final quarter of the current fiscal year ending June 2016.

We see progress on all of the key brand objectives and strategies Luis articulated nearly two years ago. By consistently communicating the brand’s story across all touchpoints with emotional and aspirational messaging, Coach is leveraging its global opportunity and deliberate European and Asian expansion is underway. They have redefined their modern luxury positioning so much that Michael Kors, the consummate copycat, employed the same messaging (Michael Kors Gets Modern) in Women’s Wear Daily’s February 3rd edition including derivative product! Coach is reinforcing a more premium international brand positioning, and thus “owns” modern luxury. Finally, with multiple international fashion shows that have received favorable editorial comment, Coach has worked to establish fashion credibility. By showcasing accessories within the context of a full seasonal fashion look, Coach has transitioned from an accessories brand to a lifestyle brand. This multi-pronged and multi-layered strategy is taking root, allowing for the next phase to start, continued brand building and profitable growth.

Against Trend

According to Luis, the North American premium women’s handbag and accessories market was essentially flat in the 2015 December quarter. Against this backdrop, Coach’s sales of women’s bags and accessories, while still negative, improved in North America led by retail stores and business in Coach Factory Stores. Men’s, about 17 percent of Coach’s global sales, is projected to grow at a mid-single digit rate in FY 2016 and remains a billion-dollar opportunity.

The turnaround included a radical reduction in e-outlet sales and flash sales, reduced promotional activity in the outlet channel, and closing underperforming full price stores as well as an incremental $50 million in marketing expenses to support the new modern luxury positioning. The transformation proceeds at the store level with 65 renovations and openings during the most recent quarter, for about 250 across all channels worldwide. To date, 26 outlet renovations have been completed, including 12 in the first half of fiscal year 2016. Five Coach Factory Stores have been opened in the new format. Coach is on target to end the year with 40 percent of its doors in the new format. These renovations are driving significant inflections from previous trends and comps, and exceed the balance of the fleet in the vast majority of stores around the world. The success of these remodels is testament to the brand’s resurgence.

By Design

We see a new enthusiasm for Coach with Stuart Vevers’ designs, which is reinvigorating old customers and attracting new ones. Brand integrity is being restored, assortments that elevate the symbols Coach is known for: leather, the horse and carriage, and the turn-lock closure. Better performing concept stores and flagships reinforce heritage and luxury positioning. For instance, the Hong Kong, Parisian, and TimeWarner flagships all have dedicated monogram workshops. At the Coach Parisian flagship on Rue Saint-Honoré, iconic products spanning Coach’s 75-year history are displayed, reinforcing brand heritage.

Too Many Outlets Still an Issue

Coach still remains over-exposed in the North American outlet channel, where an estimated 70 percent of profits are derived. Traffic has been softer at outlets with fewer international travelers and Coach is challenged by unstoppable bargains at department stores, specialty stores, and online. Not surprisingly, the competitive backdrop escalated during the past holiday period and Coach responded with a higher level of promotions than planned, resulting in an enthusiastic reception to Vevers’ designs at outlet and reduced logo product.

Coach showed Coach 1941 during New York Fashion Week in February, 2016. Outerwear remained a focus, where plush shearling oversized jackets were paired with short metallic booties,and Vevers offered a new twist on the perennial basketball jacket. Both Vogue and Women’s Wear Daily had positive comments on the show. The live video was posted on Coach’s website at www.coach.com/shop/womens-fall-2016. The fashion dialogue continues, and kudos to Vevers and team for making Coach a part of the fashion conversation. The launch of a heritage line during its 75th anniversary when the zeitgeist is increasingly one of nostalgia is serendipitous for Coach. We think it will propel improved growth and productivity metrics going forward. Time will tell. For now, enjoy the ongoing show!

We believe Coach has stemmed the market share losses of the past few years and that its business is stabilizing, positioning itself for profitable growth in fiscal 2017. Its share of the North American handbag market is approximately 17 percent, second to Michael Kors’ estimated 20 percent. Further growth in the North American region will reflect new categories including footwear and offerings for men. International growth is considerably more promising, offering double digit expansion over a long-term planning horizon. We do not envision a return to the heady 30 percent+ EBIT margins of the 2010-2014 period, but healthy margins approaching 20 percent. Coach will likely continue to face severe competition from growing U.S. luxury brands such as Michael Kors, Tory Burch, and Kate Spade, new entrants, such as Rebecca Minkoff, who is capturing the eye of young fashionistas, and the entry price point offerings of international luxury labels such as Burberry, Louis Vuitton, and Mulberry.

Coach’s EBIT (earnings before interest and taxes) margin was 31.1 percent or better in each of the four years leading up to the fiscal 2014, when the EBIT margin contracted 510 basis points (5.1 percentage points) to 26 percent of sales. In fiscal 2015, Coach’s EBIT margin lost another 740 basis points (7.4 percentage points), to 18.6 percent of sales. The trailing twelve months ended December 26, 2015, and another 150 basis points were clipped from Coach’s EBIT margin, resulting in a 17.1 percent EBIT margin.

At Michael Kors, margin erosion has not been as severe; EBIT margin peaked in the fiscal year ended March 29, 2014 at 30.5 percent of sales, and has declined 460 basis points to 25.9 percent of sales for the trailing twelve months through December 26, 2015. Importantly, analysts estimate 17.1 percent as the EBIT margin nadir for Coach, and estimate EBIT margin expansion for fiscal year 2017, up 110 basis points, to 18.2 percent of sales, while the trajectory for Michael Kors is for further erosion—another 220 basis points through fiscal year 2017, to 23.7 percent of sales. John Idol, CEO at Michael Kors, has guided the company to sustainable operating margins in the 24 percent to 25 percent area. In the most recent December quarter, Michael Kors’ operating margin erosion in its retail segment was twice the erosion in its wholesale business (360 basis points versus 180 basis points) and the Michael Kors North American business is slowing as it bumps up against an estimated 20 percent market share. Michael Kors is more developed than Coach in Europe, while Coach has the head start in mainland China and Japan.