This Fashion Designer Is Cheap, But Should You Jump In?

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

After years of growing in popularity, it seems that Coach (NYSE: COH) has pretty much maximized its main product lines in the United States. However, the company continues to evolve in two very big ways (more on that in a bit). With the company set to report its earnings on Monday, July 29, now seems like a great time to take a closer look at Coach, as their shares tend to be highly reactive to earnings announcements. On the chart below, the company’s fiscal 2nd quarter earnings caused the giant drop in late January and a good 3rd quarter caused the equally impressive pop in April. With shares relatively steady since then, how should investors play Coach pre-earnings?

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Coach’s current state

Coach is most famous for its line of women’s handbags and accessories, and the company operates 833 “direct” stores, which include retail stores, factory stores, and shops-in-shops. They also sell through about 1,200 indirect locations, such as department stores and duty-free shops, but most (89%) of the sales come from the direct channels. The company’s total sales were almost $4.8 billion last year, and are expected to top the $5 billion mark for the first time this year. 

As I mentioned in the first line of this article, I believe that the explosive sales growth of the women’s handbag business is mostly done. While sales of $100+ handbags grew by 10% last year, I think this is mostly a function of the improving U.S. economy and not a rise in the “awareness” of Coach. While there is unlikely to be dynamic same-store sales growth in women’s handbags, the company certainly has a few things cooking to ensure years of double-digit growth ahead.

Strategy 1: Physical expansion

The first strategy that Coach is using to grow is by physically expanding its presence, both in the U.S. and abroad. During the current year, the company had intended to expand its North American square footage by 10%, so this is definitely one thing to pay attention to in the earnings call. The company also planned to open 35 new stores in China and 13 in Japan, which would increase Coach’s physical presence in those countries by 35% and 10%, respectively.

Strategy 2: New product lines

While the increased presence in Asia will certainly help Coach’s sales numbers, the largest growth source may very well be from the efforts the company is making to expand its men’s product lines. Coach doubled their men’s sales to about $400 million in 2012, which still only represents a small percentage (8.3%) of the total. Of the new stores mentioned above, 10 of the new U.S. stores will be stand-alone men’s factory stores, and plans are in place to expand about 20 current stores to offer men’s products. 

The numbers

If Coach can meet the high expectations the market has for the future, it could indeed be a great bargain at the current share price. Coach trades for 15.9 times 2013’s consensus earnings of $3.73 per share, and there are plenty of reasons to like the stock. First, Coach has roughly $1 billion in cash and virtually no long-term debt. Second, at 2.3% annually, Coach pays one of the highest yields of its peer group. Finally, the consensus calls for earnings of $4.12 and $4.69 in 2014 and 2015, respectively, which represents annual earnings growth of 10.5% and 13.8%, which more than justifies the P/E, especially given the great financial shape of the company.

Alternatives: Ralph Lauren and Michael Kors

There are several alternatives to Coach, and they represent a wide range of growth and stability.

Ralph Lauren (NYSE: RL) is on the “stability” end of the spectrum. The company offers a complete product line, and has its largest growth opportunity in international markets, with just 37% of the company’s sales coming from outside of the U.S. currently. Ralph Lauren has stated that their long-term goal is to increase its European and Asian business to the point where each contributes one-third of the company’s total sales. This is ambitious to say the least, and Ralph Lauren seems to be content to grow their business slowly and steadily.

Michael Kors (NYSE: KORS), on the other hand, is definitely a growth story. The company’s sales have more than quintupled in the last 5 years, and grew by 67% in the last year alone. Products made by the company, particularly their watches, have become a major fashion trend over the past several years. Unlike Coach, Kors’ products have not come close to maxing out their growth potential yet, so shares are priced based on what the company could become, not what it is now. With shares trading for 31.8 times TTM earnings, this is certainly the biggest gamble of the group.

Final thoughts

I believe that Coach is a great combination of stability and growth and is more than fairly valued at the current share price. Having said that, my attitude towards Coach’s earnings announcements is to wait and see what happens. Who knows, a relatively significant earnings miss could easily create an even better entry point for us!

Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Coach. The Motley Fool owns shares of Coach. 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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