Coach Wants to Be Michael Kors, Will Consumers Buy It?

Coach (COH) has plunged 27% this year after dropping 12% last week. Still, Wedbush’s Corinna Freedman thinks now is a perfect time to downgrade the beaten-down luxury retailers shares. The reason: It’s going to get worse before it gets better for Coach. She explains:

Bloomberg News

Following the comprehensive Analyst meeting held last week in New York City (COH's first in seven years,) we are downgrading our rating on share of COH to UNDERPERFORM from NEUTRAL as we have incremental concerns about the company's turnaround plans and while we do find some incremental positives and while we continue to hold out hope that marketing plans will be compelling, we believe the shares are likely to remain under pressure for the balance of the year. We believe it remains to be seen whether COH will be successful in changing brand perception and although its strategic initiatives touching product, marketing and stores are dramatic and bold, we are concerned about the lack of testing and ultimately customer acceptance in the near-term. We believe a more conservative stance for beyond fiscal 2015 (relative to management's long-term goals) is warranted and as such, we believe valuation is likely to further compress. Though some may argue that the guidance is 'kitchen sinked,' and somewhat de-risked, we believe that beating very conservative guidance by any magnitude, still indicates a brand in decline as the difference between guidance of a -27 – 29% North American retail comp and reporting a -20% comp may not ultimately be relevant given the continued hemorrhaging of market share. Though the timeline has been drastically extended and tangible results of the turnaround may not be evident until 2H15, a flat dividend (we do not expect any increase in FY15 or FY16) and declining in free cash flow may not be enough to satisfy longer-term holders.

Changing perception of Coach certainly won’t be cheap. Freedman notes that Coach recently switched ad agencies, hiring Michael Kors’ (KORS) Baron & Baron to head up its new campaign. Coach plans to spend about 3.4% of sales on advertising, Freedman notes, well above the 2% of sales Michael Kors spent in 2013.

Shares of Coach have dropped 2% to $34.02 at 1:41 p.m. today, while Michael Kors has dipped 0.2% to $88.43.