1 Change Would Improve This Company's Growth

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

Many people have realized over the last few years that the retail industry doesn't move together the way they originally believed. In fact, many higher-end retailers have outperformed the overall industry because economic hardships don't effect the wealthy in the way they do everyone else. Investors who understand this dynamic have the advantage and can benefit when the market throws out the baby with the bathwater, so to speak. Coach (NYSE: COH) is one of these high-end retailers that gets thrown in with the rest. The company is doing a lot of things right and offers a good value already, but one move in particular would speed up growth even more.

Coach's Earnings Are Pretty Good:

Before we get to what Coach should do, let's see how they have been doing. Since the company reported earnings not long ago, we get a chance to peek into the company's results. Overall sales were up 11%, and EPS increased by 6%. Normally a disconnect between sales and EPS growth might mean pricing pressure or cost issues, but we will hold off on passing judgement for now. The company operates two divisions, domestic sales and international sales. In North America, sales increased 8%, and comparable store sales were up 5.5%. The company currently runs 354 regular stores and has 174 factory stores in operation. During the last three months Coach opened five new factory stores, and the company plans to continue opening around five stores per quarter. Coach's international division is the growth driver as sales were up 15%, and in particular sales in China increased 40%. The company is expanding its presence in China by opening eight new stores to add to their existing 104 locations. The company is also returning funds to shareholders through both their dividend and share repurchase program. The stock yields over 2.2% and Coach has retired over 2.5% of their outstanding shares over the last year. In addition, the company also authorized a new $1.5 billion new stock repurchase program.

What is the One Change?

While most of Coach's earnings report looks pretty good, the company can do better. The reason I know the company can do better is because of their competition. Coach competes in handbags, accessories, shoes, watches, and many other categories. They face companies such as Fossil (NASDAQ: FOSL), Michael Kors (NYSE: KORS), and Vera Bradley (NASDAQ: VRA). All of these companies offer multiple lines that compete with each part of Coach's offerings. While Fossil and Michael Kors are both known for watches, and Vera Bradley is known for handbags, they each are much more than one trick ponies.

So what is it that each of these companies is doing better than Coach? Each company is reporting superior sales growth. In the last year, Michael Kors grew sales by 62%, Fossil reported an increase of 26.43%, and Vera Bradley showed 25.89% sales growth. Coach on the other hand, grew sales by 17.95% during this same timeframe. While it's true that Coach is a larger company than the rest, I believe something else is working against the company's growth rate.

Normally if you compare companies by operating margin, the company with the highest margin is the most efficient. However, there is a difference between efficiency and pricing issues. I believe one of the reasons Coach isn't growing faster is because of their high prices. Some people would say I'm crazy to suggest that Coach has prices that are too high, but the difference in operating margin between the companies is far too large. In the current quarter, Coach's operating margin was 28.6%.

While this margin was lower than last year, it far exceeds even the company's most efficient competitor. In fact, Michael Kors reported a 19.02% operating margin, and coincidentally both Fossil and Vera Bradley reported margins of 17.72%. Given that all of these brands compete in the same high-end category as Coach, it is likely that Coach is pricing itself out of some sales. The company doesn't need to lower prices dramatically, but bringing its operating margin down closer to its competition would almost surely increase sales and the company's growth in earnings.

Conclusion

When you compare Coach to its competition, the stock is a decent value already. Analysts expect earnings growth of about 13.5%, and with a dividend of about 2.2%, investors could expect a total return of nearly 16%. However, Vera Bradley sells for a similar P/E ratio and is expected to grow earnings by nearly 17%. While Michael Kors is priced at a significant premium to its growth, the company is outpacing its competition by a large margin. In the next few years, Michael Kors is expected to report 27.6% EPS growth. Fossil seems like the best value of the group based on analysts' expectations. Fossil sells for nearly the same P/E ratio as Coach, and analysts expect over 18.3% growth. However, if Coach were to improve its pricing structure, it's possible that sales would increase, and this would drive EPS gains as well. Coach has an impressive brand name, but lower growth at higher prices isn't what investors deserve.


MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Coach and Fossil. Motley Fool newsletter services recommend Coach and Fossil. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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