Despite Coach (COH
)'s weak revenue results reported for the holiday quarter, the Company managed to maintain its core profitability profile, which we think is a particularly rare attribute in retailing, and is a testament to the strength of the Coach brand. As more apparel-‐focused retailers enter the handbag market, Coach is countering by expanding into more "lifestyle" based products, including ready-‐to-‐ wear, footwear, fragrance and watches (to name a few). While much of consensus is concerned that the Company's profitability will be hampered by these new categories, we think the bulk of any incremental costs, particularly distribution, are already "sunk" in the Coach-‐owned and operated, world-‐wide distribution footprint -‐ which includes over 900 branded full-‐price stores and outlets. In fact, almost 90% of Coach's sales are derived from its stores and website, so we believe that allocating incremental store space to lifestyle will require minimal incremental investment. For instance, the Company can give employees portable point-‐of-‐sales units and convert checkout counter space into product floor space. This is in stark contrast to branded competitors that typically rely on wholesale distribution channels. These brands have a very limited amount of space to utilize so it is very difficult to roll out incremental products without displacing an established competitor, which would probably require larger up-‐front pricing concessions to the wholesaler. Of course, a company can certainly do well by expanding via this route, but wholesale distribution is extremely competitive (Coach management drily refers to the floor of a wholesaler as "the wilderness"). Without having to rely on wholesale, Coach is less susceptible to the same competitive pressures that many of its peers would face attempting this sort of product expansion.
Although Coach's near-‐term growth trajectory has disappointed markets, we are confident that the Company has robust enough prospects for double-‐digit growth -‐ particularly in markets where there is an expanding middle class, such as tier-‐2 and tier-‐3 cities in China. For Coach, these markets offer higher margins and growth prospects compared to developed markets, since traditional competitors, including boutique designers as well as high-‐end brands, are sparse. As the stock continues to trade towards a historically low earnings multiple, we continue to believe that Coach's substantial competitive edge and growth prospects are not being recognized by the market and we, in turn, will look to add to positions on pullbacks.
From Wedgewood Partners’ first quarter 2013 investor letter