Why I'm Standing By Coach

Josh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In what has been a blatantly disappointing holiday sales season, high end retailer Coach (NYSE: COH) has become the latest casualty.  Posting second quarter revenues of $1.5 billion vs. expectations of $1.6 billion and an EPS of $1.23 versus the consensus of $1.28, the company was unable to match on the top or bottom lines.  

To make matters worse, Coach completely whiffed on its same store sales in North America, with same store sales dropping roughly 2% and overall sales up 1%.  I can't help but shudder at the thought of what the market would have done if the company had not been carried by its international sales growth of 12%.  Powered impressively by China, Coach was able to present a glimmer of hope for investors, as the up and coming consumer market posted double digit comps.  

Despite all this excitement, or in my case disappointment, I am still bullish on Coach and will continue to stand by them for the long-term.  Here is why:


The man at the top, CEO Lew Frankfort, has taken a ton of heat, from CNBC and the outspoken Jim Cramer, all the way to general negativity from analysts everywhere tagging $COH on Twitter.  "Coach is a fading company... Coach and Tiffany (NYSE: TIF) are tired products... Coach is losing ground to Michael Kors (NYSE: KORS) and that will take forever to get back... Their just not viral products anymore." 

I read these quotes and watched these clips on tv and couldn't help but feel like they were talking about Best Buy, or Radio Shack.  Yes, Coach faces incredible competition from Michael Kors, among many others.  And yes, its sales in North America were quite disappointing.  But this is a company with tremendous brand which was not put up for sale by Frankfort during these struggles.  By protecting its luxury brand pricing, I believe that the best possible decision was made for the company's long-term potential, which is my true concern.

Margins and Stone Cold Cash

<table> <tbody> <tr> <td><strong>Company</strong></td> <td><strong>Gross Margin</strong></td> <td><strong>Profit Margin</strong></td> <td><strong>Cash King Margin</strong></td> <td><strong>Cash/Debt</strong></td> </tr> <tr> <td><strong>Coach</strong></td> <td>72%</td> <td>23%</td> <td>20.3%</td> <td> 761M/23M</td> </tr> <tr> <td><strong>Michael Kors</strong></td> <td>59%</td> <td>18%</td> <td>6.4%</td> <td> 312M/12M</td> </tr> <tr> <td><strong>Tiffany</strong></td> <td>54%</td> <td>7%</td> <td>1.0%</td> <td> 346M/978M</td> </tr> </tbody> </table>

By maintaining pricing, Coach avoided damaging its margins, like its peers at Tiffany and Deckers, who both relied upon price cuts to catch up on slowing revenue over the holiday season.  As it is clear to see in the chart, Coach and CEO Frankfort are willing to wait through these troubling times in order to maintain strong margins.  Even with its disappointing earnings for the second quarter, the company was able to maintain margins and generate an incredible Cash King Margin, which is pivotal to their expansion plans.

Furthermore, as he was fielding questions from CNBC as to whether or not his company was facing an inflection point with so many people owning Coach products, Frankfort explained "None of our research suggests that we are there." This brings up yet another huge reason I liked to see Coach sticking with their prices, as it helps avoid that inflection point.  If handbags went on a fire-sale, the company would certainly meet this inflection point sooner rather than later.

3 Big Catalysts

First, North America will come back.  Shocking to say, but it will.  With 2012 representing one of the more competitive holiday seasons in recent history, Coach had little defense against everyone's price-cuts and promotions.  However, the company stuck to their guns and will live to sell another day -- and in brighter holiday conditions.  Regardless of this quarter's results, Coach still aims to expand its storefront in North America from its current count of 356 stores to 500 by end game.  Throwing same store growth aside, that would still represent a growth runway of 30% by itself.

Second, had North America posted even modest gains and Coach met its expectations, many analysts would be pounding the table with me over how good China's growth was.  Total sales were up over 40%, and more importantly, comps were up in the double digits.  Throw in overall international growth of 12% and I can't help but dream of an international spin off a la Philip Morris International.  Joking aside, Coach's international growth runway is no joke, and it has only begun its long ride into the future.  

My final catalyst is Coach's often laughed-at men's segment.  Despite the number of eye rolls many analysts have given to it, 50% sales growth yoy is hard to argue with.  Pulling in sales of over $600 million, the men's segment now accounts for 1/8th of company revenues and is a staple in China, where many men's products are bought for various celebrations.  With international sales and the men's segment working hand in hand, quality sales growth is a lock to continue down the road.

A Great Valuation

<table> <tbody> <tr> <td><strong>Company</strong></td> <td><strong>P/E</strong></td> <td><strong>P/CF</strong></td> <td><strong>PEG</strong></td> <td><strong>Dividend %</strong></td> </tr> <tr> <td><strong>Coach</strong></td> <td>14</td> <td>12</td> <td>0.95</td> <td>2.4%</td> </tr> <tr> <td><strong>Michael Kors</strong></td> <td>45</td> <td>53</td> <td>1.20</td> <td>0%</td> </tr> <tr> <td><strong>Tiffany's</strong></td> <td>19</td> <td>28</td> <td>1.80</td> <td>2%</td> </tr> </tbody> </table>

While I haven't yet, I would love to add to my current position in Coach.  With any further decline, I would not hesitate to jump in on Coach's P/E of 14 and P/CF of 12.  Coming at a huge discount to its two major peers, Kors with similar products and Tiffany's and its luxury approach, I find Coach's 0.95 PEG hard to ignore.  Throw in a quality 2.4% dividend and $1.4 billion remaining in the company's share repurchase program, and I still see Coach as one of the premiere luxury stocks.

The Foolish Bottom Line

Due to its recent sell-off, I believe Coach's current price represents an incredible offer for long-term investors everywhere.  While things could have been better, I was happy to see the Coach brand come out healthier than ever, and I see the markets fickle nature as a reloading opportunity for myself.  

North America will come back.  The international market continue to grow.  The men's segment will continue to expand.  Finally, and most importantly, the brand will live on, the dividends will continue to be paid, the shares will continue to be repurchased, and long-term investors will continue to be rewarded.

joryko owns shares of Coach. The Motley Fool recommends Coach. The Motley Fool owns shares of Coach and Tiffany & Co.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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