Narrow-Moat Tapestry Overcoming Economic Challenges Due to Its Luxury Focus and Coach’s Brand Power

Senior Equity Analyst

David Swartz

Revenue segments as reported by the company.

Coach

Kate Spade

Stuart Weitzman

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We think Tapestry has successfully restructured Coach (74% of fiscal 2022 revenue) but needs to prove the value of Kate Spade and Stuart Weitzman. All three of Tapestry’s brands suffered sales and operating profit declines during the pandemic, but results have been improving rapidly as it implements its Acceleration Program strategy to cut costs and improve margins and as handbag pricing has risen.

Coach shares many of the qualities of other luxury brands per the Morningstar Luxury Brand Power Framework and, therefore, has the brand strength and pricing power to continue to provide a narrow moat for Tapestry. Coach had some difficult years, but we think Tapestry has turned it around through store closures, restrictions on discounting, and increased e-commerce, which took off during the pandemic. Further, we expect growth in complementary categories like footwear and fashion. We anticipate China to be a key growth region for Coach as, according to Bain & Company, Chinese consumers will compose 38%-40% of the worldwide luxury goods spending in 2030, up from 33% in 2019. We forecast Coach’s greater China sales to reach $1.26 billion in fiscal 2032 (20% of sales), up from $892 million in fiscal 2022 (18% of sales). 

We do not believe the acquisitions of Kate Spade and Stuart Weitzman contribute to Tapestry’s moat. Kate Spade was a natural fit for Coach as both generate most of their sales from handbags. However, Kate Spade merchandise is priced lower than Coach and lacks its international reach. Still, there are signs that the brand is back on a growth trajectory. Tapestry has a stated goal of $2 billion in Kate Spade revenue, which we forecast will be achieved by the end of this decade. As for Stuart Weitzman, while its women’s shoes achieve luxury prices, we view it as a niche brand (just over $300 million in fiscal 2022 sales) with fashion risk. It is struggling so much that Tapestry wrote off all the goodwill and intangibles related to its purchase (about 90% of the price) and has closed stores.

Business Strategy & Outlook

We assign a narrow moat rating to Tapestry due to the strength of its intangible brand asset. Although Tapestry owns three brands, Coach, Kate Spade New York, and Stuart Weitzman, our moat rating is based solely on Coach. We forecast this brand will account for 74% of Tapestry’s revenue and 92% of its segment operating income in fiscal 2023. We believe Coach is a market leader in women’s handbags and other leather goods in North America and Asia. Coach products are primarily sold through more than 900 company-owned stores and its own e-commerce. It also has a wholesale operation, but Coach implemented a plan in 2014 to improve pricing and restrict distribution. Among other changes, the company pulled Coach products from at least 250 U.S. department stores. While this plan contributed to a decline in the brand’s total sales, we believe it enhanced Coach’s competitive position. In fiscal 2022, wholesale channels only accounted for 10% of its sales. As evidence of Tapestry’s competitive edge, its adjusted ROIC including goodwill was above our estimated WACC for the company of 9.5% in nine of the past 10 years, with virus-affected fiscal 2020 the only exception. We forecast an average adjusted ROIC for Tapestry of 24% over the next decade.

We believe the strength of the Coach brand has made it one of the largest luxury handbag companies in the world in terms of units and revenue. Euromonitor estimates Coach was the sixth-largest brand in terms of retail sales in this $44 billion market in 2022. Coach manufactures and licenses thousands of individual products, but women’s handbags are its largest individual category (52% of its fiscal 2022 sales). We estimate the average unit retail price of a Coach handbag at more than $300. While there are countless firms that manufacture handbags, we view Coach as the category leader in the mass premium $300-$400 handbag market in North America and other markets. We believe women see Coach as a prestige brand and are willing to pay more for its bags despite the widespread availability of competing products. Morningstar’s Luxury Brand Power Framework identifies five key attributes of luxury companies: overall brand strength, pricing power, conspicuousness of consumption, control over distribution, and supply discipline. As compared with other luxury brands, we rate Coach’s control over distribution as high and the others as moderate. While Coach’s supply discipline has been poor in the past, we believe it has improved. We believe it is one of a small number of American brands viewed as a leader in the luxury space, supporting our view that its parent has a narrow moat based on its intangible brand asset.

Coach achieves very high gross margins. Leather handbags are widely available at price points ranging from less than $50 to more than $5,000. We believe Coach bags achieve prices above those of comparable bags in the affordable luxury part of the market because the Coach brand is stronger than most other competing brands. The Coach segment of Tapestry achieved a 71% average gross margin over the past five years, and we forecast it will average 72.5% over the next decade. For comparison, Capri reported an adjusted gross margin of 66% in fiscal 2022. Coach’s gross margins are like those of narrow-moat Burberry (71% in fiscal 2022), narrow-moat Ralph Lauren (67% in fiscal 2022), and wide-moat LVMH (68% in 2022). Coach’s gross margins have held up well despite significant turmoil in the business. Between fiscal years 2013 and 2015, Coach’s sales dropped by $1 billion in just two years due to an intentional reduction in retail distribution and aggressive competition from Michael Kors and others. Coach had become too dependent on outlets, flash sales, and discount-heavy department stores to drive sales and move excess inventory. Since fiscal 2014, Coach has reduced wholesale distribution and closed stores to support the value of the brand. Although this restructuring, known as the Transformation Plan, was difficult, it stabilized the brand’s gross margins. We believe the company has increased control over distribution and pricing, allowing for reduced discounting. We believe Coach attains high gross margins in an extremely crowded category because consumers view its products as being of high quality and fashionable and are willing to pay extra for its products. Thus, we think Coach’s gross margins reflect a brand intangible asset.

We think the high prices of some Coach products support our view that it has a narrow moat based on its intangible brand asset. While Coach sells products at many price points, some of its products sell for prices usually reserved for luxury brands. While we do not expect Coach’s bags will ever attain the prices of LVMH’s Louis Vuitton bags, they are comparable to the prices of LVMH’s Marc Jacobs bags. Most Coach handbags retail for $300-$400, and many styles are priced between $500 and $1,000. While these prices are below those of high-end handbag brands, they are above those of other broad premium market brands. Other Coach products also command high prices, such as men’s and women’s jackets and coats that may retail for more than $1,000. We believe Coach has pricing power in many categories because of its status as a premier American leather goods brand.

We view Coach’s high segment operating margins as evidence of a brand intangible asset-based moat. Coach’s operating margins declined during its period of excess inventory and restructuring but have generally improved under its turnaround plans. We forecast Coach’s segment operating margins at around 30% over the next decade due to strong pricing and cost cuts. Consequently, we estimate Tapestry's overall operating margins at about 18%-19%, an improvement from prepandemic midteens levels. To bolster the brand's relevance, we think Tapestry will continue to invest heavily in marketing to support Coach. The firm spent about 8% of sales on advertising in fiscal 2022 ($552 million), a significant increase from years past (4%-5% of sales). Apart from direct advertising, Tapestry has invested heavily in remodeling company-owned stores and improved e-commerce, part of its $1.6 billion in capital expenditures over the past seven fiscal years. We believe competition in the women’s handbag market has intensified over the past decade, requiring Tapestry to attract customers and maintain premium pricing. Overall, we think Coach’s brand and improving profitability support our view that Tapestry has a narrow moat.

We believe the popularity of Coach outside North America contributes to its brand intangible asset. Coach products are sold in about 55 countries. International sales (outside North America) for the brand grew to 37% of sales in fiscal 2022 from 28% in fiscal 2011 on the strength of organic growth, store openings, distributor acquisitions, and lower sales in North America. At the end of fiscal 2022, 64% of Coach’s stores were outside North America. The brand has limited history in Europe, having opened its first European flagship store in London in 2011. In Asia, though, Coach produced $1.9 billion in fiscal 2022 revenue. For comparison, Michael Kors produced sales of about $490 million in Asia in its fiscal 2022. Asian territories with large numbers of Coach stores include mainland China, Japan, South Korea, Hong Kong, and Taiwan. Much of Coach’s recent international growth has come from China, where its products have been sold for more than 20 years. Coach acquired its Chinese distributor in 2008 and increased annual sales in greater China from about $30 million at that time to nearly $900 million in fiscal 2022. We forecast annual Coach sales in greater China will exceed $1.2 billion in 10 years. We view Coach’s brand strength outside North America as part of its economic moat.

We do not view the Kate Spade brand (acquired in July 2017) as a contributor to our narrow-moat rating on Tapestry. Kate Spade (founded in 1993) does not have the proven long-term popularity of Coach (founded in 1941). While Kate Spade is a popular and well-known brand ($1.4 billion in fiscal 2022 sales), we do not believe it has the pricing power of Coach. Kate Spade, like Coach, is largely dependent on women’s handbags (57% of fiscal 2022 sales). Kate Spade, though, has greater exposure to the competitive $150-$300 per bag price category than Coach. Moreover, Kate Spade bags are commonly marked down to prices below $150 at department stores. Further, although progress is being made in this area, we think Kate Spade’s previous management damaged the brand through frequent online flash sales, heavy discounting, and expansions of relatively low-priced products. We think the relative lack of pricing power is reflected in the margins of Kate Spade as compared with Coach. In fiscal 2022, Kate Spade achieved a gross margin of 63% versus 72% for Coach. Tapestry is implementing a turnaround plan to better control the distribution of Kate Spade products and reduce discounting. It is closing underperforming Kate Spade stores and taking control of distribution (it acquired control of distribution in China in fiscal 2018). However, we do not expect Kate Spade to achieve the pricing power of Coach in the foreseeable future and, therefore, do not view it as part of Tapestry’s economic moat.

Further, we do not view the Stuart Weitzman brand as a contributor to our narrow-moat rating on Tapestry. The label accounted for only 5% of Tapestry’s fiscal 2022 sales and is not diversified. Moreover, its results have deteriorated so much that Tapestry wrote off the goodwill and intangibles associated with its purchase. Stuart Weitzman is almost completely dependent on footwear and is highly exposed to a small number of shoe and boot styles. Thus, it has significant fashion risk and has struggled when certain styles have fallen out of fashion. While full-price Stuart Weitzman footwear carries high price tags (with many styles of boots priced between $500 and $1,000 at retail), the brand achieves the lowest gross margins in Tapestry’s portfolio due to its limited scale and the relatively high cost of producing its shoes in limited quantities in small factories in Spain. Much of Tapestry’s other merchandise is mass produced in large factories in Asia. Also, lower-priced Stuart Weitzman shoes are available at some discount stores. The segment achieved an adjusted gross margin of 58% in fiscal 2022, the lowest of Tapestry’s three brands. We think the company will need to show more progress in its reform efforts at Stuart Weitzman before we consider it as part of our narrow-moat rating on the company. 

We do not think Tapestry has a moat based on any factors other than its intangible brand asset. We believe the company’s gross margins of around 70% are based on good pricing rather than low production costs. Tapestry, like many competing firms, outsources its production to factories in Vietnam, China, the Philippines, and other countries and, therefore, has no production cost advantage over others. Coach uses a lot of high-quality leather that is available from a limited number of suppliers, suggesting that it does not have any scale advantage in sourcing. There are no switching costs in Tapestry’s key categories of women’s handbags, accessories, and shoes, and no network effect.

Narrow

Economic Moat

Tapestry

Tapestry, Inc. engages in the provision of luxury accessories and lifestyle brands. It operates through the following segments: Coach, Kate Spade and Stuart Weitzman. The Coach segment consists of global sales of coach brand products to customers through coach operated stores, including the internet and concession shop-in-shops, and sales to wholesale customers, and through independent third party distributors. The Kate Spade segment focuses on Kate Spade New York brand products to customers through Kate Spade operated stores, including the Internet, sales to wholesale customers, through concession shop-in-shops and through independent third party distributors. The Stuart Weitzman segment comprises Stuart Weitzman brand products primarily through Stuart Weitzman operated stores. The company was founded by Dawn Hughes in 1941 and is headquartered in New York, NY.

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