Is This Luxury Brand the Next Turnaround Candidate?

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

Luxury retail is one of the most remarkable sub-sectors in the market today. Forecasters often predict that demand for high-priced goods will fall during times of economic hardship, but current data shows that wealthy consumers will purchase their premium goods during good and bad times.

While this logic may seem counterintuitive, hard evidence confirms its validity. At the moment, the success of luxury retail in London, combined with a national consumer crisis throughout the U.K., serves as a case-in-point. Outside of the British capital, the English consumer remains cautious with unemployment at multi-year highs and the growth of Internet retail harming the economy.

On a broader level, luxury retail is strong in Europe’s largest cities despite the prolonged Eurozone recession. Here in the U.S., a similar story can be told. Sales of luxury goods are the strongest ever as wealthy buyers have benefited from rising home values and stock prices.

What’s the best way to play the long-term trend in luxury retail, and are there any hidden opportunities?

Consider Vera Bradley (NASDAQ: VRA), a functional accessories designer for women that went public in October 2010. The luxury retailer has frustrated long-term investors with its inconsistent quarterly results, management changes, and unclear vision for its premium handbags. As competitors such as Coach unveil the latest trends, retail analysts have criticized Vera Bradley’s marketing team on merchandising decisions and new product development.

On June 5, Vera Bradley provided disappointing Q1 2014 results and weak guidance for fiscal year 2014. The company lowered its 2014 earnings forecast to $1.74–$1.78 vs. the consensus of $1.81. Chief executive Mike Ray also announced that he will retire from the company once a search committee finds a replacement. All in all, Vera Bradley reported a “kitchen sink” quarter -- providing a full plate of negativity to investors in one sitting.

Shares are now down 60% from the post-IPO highs. Yet, despite investor pessimism, a number of long-term positives could propel the stock higher. Here are five reasons why I believe Vera Bradley is an attractive turnaround candidate for the next 12 months:

  • The stock is valued at 11.5x new earnings guidance of $1.74-$1.78, a discounted multiple compared to the industry average of 23x earnings for luxury goods makers. The market is assigning it a low multiple due to perceived uncertainty, but management should meet the new guidance with strong revenues from company-owned stores and online sales.
  • Sales revenue has more than doubled in the last five years from $239 million to $541 million. Net income has nearly tripled, growing from $24 million in fiscal 2009 to $69 million in fiscal 2013.
  • Online sales growth was a strong point in first quarter results with a 22% increase. Direct segment revenues grew 24% as a whole. Company-owned stores continue to perform well, and the 19 full-price and four outlet stores opened in the last 12 months should boost future results.
  • The potential for an upside surprise exists if the board of directors is able to bring in the right leader as CEO. The company’s co-founder, chief financial officer, and chief executive have all retired or resigned in the last year, making Vera Bradley an attractive target for a self-starter exec with leadership capabilities.
  • Wall Street is cautiously optimistic on Vera Bradley following Q1 results and the CEO resignation. Analysts at Sterne Agee upgraded the stock to “neutral” from “underperform” based on valuation. New York-based Jefferies is bullish, and reiterated a buy rating and a $34 price target.

Turnaround in a growing industry

Recent strong results from luxury goods competitors indicate that Vera Bradley’s re-organization is based on company-specific issues and not secular ones. Readers should view this as a positive as it’s easier to hire a new CEO to sell a high-demand product versus a fabulous CEO tasked with a fading brand.

Handbag maker Coach (NYSE: COH) provided a compelling outlook back on April 23, offering guidance of high sales growth, a strong China story, and a dividend raise of 13%. Coach’s market capitalization of $16.5 billion is significantly larger than Vera Bradley’s market cap of less than $1 billion.

The company is expanding beyond luxury handbags into footwear, watches, and clothes. In March, Coach introduced footwear in 170 of its 543 North American stores and 60 stores internationally. Readers should consider Coach in its own right; the stock offers a compelling growth opportunity at lower risk than Vera Bradley.

Internationally acclaimed Tiffany (NYSE: TIF) reported first quarter 2013 results on May 28, with a 9% increase in worldwide net sales. I highlighted the iconic jeweler and maker of the Blue Box going into earnings, stating that results could be boosted by falling gold and silver prices.

The Tiffany report was extremely positive; sales increased in every portion of the globe, including Americas, Asia-Pacific, Japan, Europe, and United Arab Emirates. Following the quarter, Tiffany announced the opening of a Moscow, Russia location in the first quarter of 2014. While shares trade at a premium 25x earnings, if a buy-and-hold forever stock exists, Tiffany fits the bill.

Foolish takeaway 

Luxury goods makers have gathered momentum in 2013, and further gains are likely for long-term investors.

In the case of Vera Bradley, shares are on sale at a time when the brand’s consumer appeal remains strong. I encourage readers to buy Vera Bradley on current weakness, as the stock has limited downside based on management’s revised guidance. Many opportunities exist for the company to right its path going forward, while the number of recent hiccups makes further travails unlikely.

Additional gains are likely in shares of Coach and Tiffany as both companies grow their footprint internationally. Coach is expanding its market presence into footwear and watches; the men’s business should grow 50% this year. Tiffany’s sales grew 15% year-over-year in Asia-Pacific. I'm confident the Blue Box will gain more steam with the opening of 24 new stores worldwide.

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John Macris has no position in any stocks mentioned. The Motley Fool recommends Coach. The Motley Fool owns shares of Coach. 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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