Buy a Designer Handbag Now (but Sell the Designer Bag Maker)

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Kate Spade New York - Presentation - Mercedes-Benz Fashion Week Fall 2014
Cindy Ord/Getty Images
It may be back-to-school shopping season, but this doesn't mean that moms -- or other well-to-do fashionistas -- can't snap up a seasonal bargain. There may never be a better time to buy designer totes, satchels or shoulder bags.

This is the time of year when Coach (COH), Michael Kors (KORS) and Kate Spade (KATE) usually discount some of their dated product lines ahead of new fall arrivals. But the markdowns may be even juicier this summer.

Gross margins are contracting, and inventory is starting to build up. This is bad news for handbag makers and investors, but it should be good news for folks looking to buy a luxury purse.

Let's Fly Coach

Coach is the largest of the three luxury handbag makers, but that's about to change. After yielding market share to Michael Kors and to a lesser extent Kate Spade in recent years, analysts see Michael Kors overtaking Coach this upcoming holiday shopping season.

Coach isn't doing very well. Sales and adjusted earnings are fell 7 percent and 35 percent, respectively, in its latest quarter. However, investors were braced for an even sloppier showing. Strong international sales, particularly in China, helped offset some but clearly not all of the domestic shortfalls (Coach suffered a 16 percent decline in North American sales).

Coach was the only one of the three publicly traded luxury handbag makers to see its stock climb the trading day after announcing results. The other two are growing, but there are problematic signs for investors across all three players.

Calling a Spade a Spade

Kate Spade is the smallest of the three, and it was the last of the three to report. After unloading its Juicy Couture apparel and Lucky Brand premium denim lines, Kate Spade has been able to focus on its booming premium handbag and accessories business.

Kate Spade's sales soared 49 percent in its latest quarter, and it was able to turn a year-ago deficit into an adjusted profit this time around. The stock still took a 25 percent hit on the news as Kate Spade scared the market with weak gross margins. Kate Spade blames the contraction on having to discount the Kate Spade Saturday brand. Investors dumped the stock despite Kate Spade boosting some of its outlook metrics for all of 2014.

Crash Kors

Michael Kors reported after Coach but before Kate Spade. It experienced a 43 percent spike in sales, and earnings climbed 50 percent. The stock still moved lower on the news. Kors disappointed investors by warning that margins will contract in the current quarter.

It also posted a 65 percent increase in inventory. Seasoned investors know that it's not a good sign when inventory is growing faster than sales. It usually suggests that the company has more unsold merchandise around, and that's often a precursor to margin-gnawing clearance sales.

The markdowns are already happening. Kate Spade, Michael Kors and Coach all posted lower gross margins this time around than they did last year. We can't blame this on seasonal blips since we're comparing one early summer quarter to the same period the year before.

Making things even more interesting is that Coach hired a creative executive late last year. This may indicate that Coach will be in more of a discounting mood than usual as it emphasizes new handbag lines. Either way, the message is clear: Go out and get a great deal on a designer handbag now, but wait until the rubble settles before buying the actual premium handbag designers.

Motley Fool contributor Rick Munarriz has no position in any stocks mentioned. The Motley Fool recommends Coach and Michael Kors Holdings. The Motley Fool owns shares of Coach and Michael Kors Holdings. Try any of our newsletter services free for 30 days.

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