A Luxury Stock You Can Afford

Declan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The Consumer Discretionary sector continues to fly high as one of the lead performers in the current rally.  For the last three months, the sector SPDR (NYSE: XLY) has gained just over 9%, and is up almost 24% for the last 12 months.  Gains haven't just come at the low end of the scale, but have been enjoyed by luxury brands too.  However, this may be about to change as recent holiday sales disappointed some of the top tier brands, and this will likely filter down through the retail market.

The most recent hit to the sector was delivered by Coach (NYSE: COH).  The stock dropped 16% on a combination of bad earnings, and a strategy switch to selling shoes.   The company was "clearly disappointed in our North American performance notably in women's where results were below expectations."  Lew Frankfort, CEO, blamed the fiscal cliff and a slow recovery from Hurricane Sandy as factors for the drop, but they were also forced into "heightened promotional activity" (but not price drops) in their core business of women's bags and accessories, effectively 70% of their business.  The underperformance was not the result of natural disaster or politics, but was instead the result of market share losses to Michael Kors (NYSE: KORS) amongst others. 

Digging a little deeper,  weakness was not the fault of sales of high price items, such as $400+ leather handbags (which remained strong), but instead came from the lower end mixed material and logo products.  Michael Tucci, President of Coach North America Group did suggest a macro shift towards leather goods and away from the traditional logo business, but this in itself doesn't explain the strong performance from its competitors.  For example,   Coach's same store sales fell 2%, while Michael Kors rose 30%; Coach EPS was up 5%, Michael Kors did 96% year-on-year; Coach net sales rose 4% , Kors retail sales grew 82%.  Coach's reaction to launch into footwear has a 'two wrongs don't make a right' ring to it.  Not only is it a venture for which Coach has no history, but it also places itself deeper in competition with the very same companies stealing market share from it.  

However, it wasn't all bad news for Coach.  Internet sales "remained strong", but actual figures were lacking.  International sales were robust, up 12% for Q2 and accounted for one third of total sales.  Chinese growth was up 40% from the prior year, with 13 new stores coming on line over the quarter.  Men's sales jumped over 50% for the year, to $600 million, providing an alternative avenue which the company can work.

The earnings miss by Coach was greeted with a downgrade to Neutral from Buy by ISI Group.  The miss also swept up Tiffany and Co (NYSE: TIF) as it experienced a similar downgrade.  This time for missing consensus expectation for four consecutive quarters, although the last miss was most egregious.   Tiffany has yet to release its holiday sales figures, but given Coach's earnings and its own history, it's probably not going in with much optimism.

Tiffany's Expectations are for an EPS of $1.43 for Q4, some $0.04 above last year's reported Q4.  The company experienced a 30% decline in earnings for Q3, squeezed by tightening margins.  This factor will just compound troubles generated by a drop in sales.  Europe was the only bright spot in sales growth.  Interestingly, both Coach and Tiffany attributed their respective sales drops to 'cheaper' items, in Tiffany's case, to jewellery priced below $500.  Tiffany reported increased sales volume in all other, higher product price points.  One of the few highlights from Q3 was the 5% rise in sales from its New York flagship, despite Hurricane Sandy, but impacts from the hurricane are likely to continue into Q4.  Unlike Coach, Tiffany's internet sales were reported as "modest", although the Tiffany 'experience' isn't really suited to the online space.

Despite the damage to Coach's share price, Tiffany and Co's share price has remained firm.  Earnings aren't due until the end of March, so it's possible investors have adopted a wait-and-see approach. 

A stock which has also bucked weakness in the luxury sector is Movado Group (NYSE: MOV).  It supplies watches to a number of luxury brands, in addition to a retail arm of its own.  Its wholesale business accounts for 42% of its revenues, providing insulation from the vagaries of individual brand performance.   It serves the luxury sector, which at the high end (as most watches are) appears more resilient based on comments from Tiffany and Coach.  The company's inventory metrics also suggest increased demand on the horizon.  Of the mentioned stocks, Movado has enjoyed the greatest buying activity.  The push to $37 (a new all-time high) was achieved on three times typical trading volume.  Even Michael Kors has traded within norms these past few days.

Movado Group's P/E of 15.8 is more competitive than Tiffany & Co.'s 19.4 and Michael Kors at 44.8, but is slightly worse off that Coach's 14.4.  Forward projections are less competitive than its rivals at 20.30, but given the optimism at Michael Kors it's easier to understand how positive price momentum can quickly push P/E ratios out.   Certainly the top end of the luxury market looks in good shape, and this is unlikely to change as lesser mortals turn their backs, or at least their wallets, away. 

fallond has no position in any stocks mentioned. The Motley Fool recommends Coach. The Motley Fool owns shares of Coach, Movado Group, and Tiffany & Co.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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