What's Driving High-End Retail Sales Now?

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

Coach (NYSE: COH) is making more money at its discount outlets than its full price stores, according to The Wall Street Journal. LVMH Moet Hennessy Louis Vuitton (NASDAQOTH: LVMUY) is seeing a similar trend. Ulta Salon, Cosmetics & Fragrance (NASDAQ: ULTA) is going to benefit more than that pair from this shift.

Too much money

The wealthy have fared better than the less affluent since the 2007 to 2009 recession. That's allowed high-end retailers to perform reasonably well compared to those who serve the middle class. This year, however, there's been something of a shift. Some high-end retailers have begun to see sales slow down. But they haven't fallen off of a cliff because aspirational purchases have helped prop up their businesses. Coach is a good example.

The leather goods and accessories company sells its products at full-price and at a discount through outlet malls. According The Wall Street Journal, the outlet business has grown from 30% of sales before the recession to 60% now. That's a huge shift hidden under solid overall growth.

The difference between the two store types is important. Coach bags are expensive, but at the discount stores they turn into aspirational purchases. These stores allow customers to have a name brand bag at a reasonable price. These types of purchases are driving Coach's business today.

The risk, of course, is that the company tarnishes its brand. Protecting its high-end image and bringing new and desirable products to market is a key aspect of the company's growth plan. While overseas expansion is also important to watch, that segment only represented about a third of the company's sales in fiscal 2012. Thus, maintaining its core U.S. business is vital to growth.

Coach has grown its top line about 20% on average over the past decade. Earnings dipped in 2009, but have otherwise been on a similarly steady upward climb, averaging about 30% growth per year over the period. The shares yield around 2.5% and the dividend has been increased each year since it was introduced in 2009.

The stock's price to earnings ratio of about 15 is a little below its five year average. Although the shares appear reasonably valued, the shifting sales mix should be closely watched by those seeking a mixture of growth and income.

If the company shifts too far toward the discount side of the business, it could lead high-end customers to avoid the brand. That, in turn, would hinder the company's long-term growth prospects. If it can find a good balance, and adjust to market conditions without alienating one or the other customer base, Coach should be able to maintain its solid top and bottom line advances. 

Other aspirations

High-end retail giant LVMH is seeing a similar shift. Its leather goods and fashion division has seen sales go from 14% growth last year to low single digit growth this year. However, its Sephora brand has continued to grow strongly. The difference is that Sephora sells products that are expensive, but not exorbitantly so. A $50 lipstick is an affordable luxury.

While LVMH has been aggressively expanding its hot makeup retailer across the world to capitalize on the aspirational purchase trend, it has also been looking to shore up its core, high-end niche. For example, it just bought Italian cashmere company Loro Piana for a little over $2.5 billion. Clearly, management sees the problem at the high end and is trying to do something about it.

The company trades with a PE of about 21 versus its five year average of around 18. Thus, it's a little expansive. That said, LVMH has an enviable collection of high-end brands and owns one of the fastest growing makeup retailers. For investors seeking a broadly diversified high-end retailer, this is still a good company to consider. And, there's little risk that Sephora's success will end up tarnishing LVMH's other brands. The company has found a way to let aspriational products to co-exist with high end products. 

Picking out the best

Investors who wish they could just buy into Sephora should take a look at Ulta Beauty. The company has 550 makeup stores in 45 states and is basically a copycat of fast-growing Sephora. Ulta, for its part, has seen its top line expand at about 20% a year over the last decade. 

The bottom line fell slightly in 2009, but picked right back up the next year. In fact, earnings are now double their pre-recession levels. That's been backed by a more than doubling of the company's profit margin. Ulta is an impressive growth story.

A PE of 37, however, means that this growth has been recognized by Wall Street. The shares seem fairly valued, however, assuming growth keeps up. And it should;  the company's goal is to open 1,200 stores. Thus, it's less than half way through its growth plan. Moreover, the company has increased its store base by an average of 15% a year over the past five years. While that rate may slow as the store count rises, new stores are clearly on tap and will continue to be the driving force going forward.

Don't underestimate aspirations

The value of offering aspirational purchases may seem trivial when times are good. However, it's an important trend that's taking center stage today. It should become even more prominent as the world's baby boomers start to retire and no longer have as much disposable income.

Coach is benefiting from aspirational buying, but there's a risk that its shifting product mix could tarnish its brand. Still, growth has historically been robust and the shares appear reasonably valued today. If it can balance aspirational versus high-end purchases, there's no reason to believe it won't be able to keep the top and bottom lines heading higher. LVMH, meanwhile, is playing the high-end and the aspirational trend via is Sephora brand. The shares are a little expensive, but Sephora's growth and acquisitions may justify the price. Ulta, meanwhile, is a fast growing clone of Sephora, appropriate for growth investors who don't care for LVMH's higher-end offerings.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Coach and Ulta Salon, Cosmetics & Fragrance. The Motley Fool owns shares of Coach and Ulta Salon, Cosmetics & Fragrance. 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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