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Michael Kors and Coach swap places in middle-tier fashion

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Fashion is a notoriously fickle business. One season you are in, the next you are out. Take the luxury goods companies Michael Kors and Coach. They are "aspirational" rather than super-high-end brands. Both target customers that want a cut above the chain stores, but fashionistas know they are not luxury.

Growth at Coach, the older and more mature of the two brands, began to fade at the end of last year. Its cloth logo bags have fallen out of style, replaced by sleeker studded purses made by the likes of Michael Kors and others. For the last four quarters, sales in Coach's core North American market have risen by less than 1 per cent on average. Michael Kors, by contrast, has seen revenues in the region grow by 46 per cent over the 12 months to June this year.

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In the equity market, companies also go in and out of fashion – growth stocks one day, value stocks the next. Investors in Michael Kors have watched their investment rise 65 per cent over the past year. The shares now trade on 25 times forward earnings. Coach shares, on the other hand, have lost 2 per cent over the same period and have a price to earnings multiple of 14 times. Given the two companies' diverging fortunes, the differing valuations seem fair.

Coach is cracking the whip in an attempt to stay relevant. It is trying to reinvent itself as a lifestyle brand, selling a complete range of products versus mostly handbags and accessories. The management team is also turning over, including the chief executive, the head of North America and the creative director. Stuart Vevers, formerly of brands including Louis Vuitton, Mulberry and Loewe, will take over Coach's creative direction.

Investors in Coach therefore have to believe that it can return to growth by broadening its products, including the Men's business, as well as expanding internationally. Helpfully, China has remained strong. And Coach's balance sheet is still robust enough that growth can be bought – it has about $1-billion (U.S.) of net cash. Finally, management turnover could end up being a blessing in disguise.

Meanwhile at Michael Kors, already a lifestyle brand, the story is much simpler. Investors are simply buying its explosive growth, both in the U.S. and abroad. Risks involve anything that would derail that growth, chief among them that the brand becomes so popular that it stops being cool. A potentially nice and terrifying problem to have.

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