A Value Play in the Apparel Industry

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

According to fresh economic data, the unemployment rate in the U.S. came in around 7.9%, staying below the 8% mark for the fourth straight month. This, coupled with rising consumer confidence, suggests that average consumer spending is likely to increase.

This presents a bullish case for premium apparel brands like Ralph Lauren (NYSE: RL), Michael Kors (NYSE: KORS), and Coach (NYSE: COH), which are directly correlated to consumer confidence, liquidity, and disposable income in the economy.

Coach! In for the game

The best thing about Coach is its solid balance sheet. The company operates with little or no debt, and yet it is expanding ambitiously in India and China. With a net margin of 21.3%, and sales nearly $5 billion, the company is an absolute cash cow. Its quarterly net sales rose 4%, with only North America lagging with just 1% increase.

International sales rose 12%, but its operations in China recorded exceptional sales growth (40%). Although the company would be opening 25 new stores in North America, its management feels that growth lies in the emerging world.

To continue its growth momentum, management announced that Coach would be opening 30 new stores in China this year, bringing the total count to 125 (a massive 31.6% increase), and expects its total square footage in China to increase by 35%. The company also plans to open 10 new stores in Japan (193 stores already operational), in order to boost in square footage by 10%. Altogether, Coach seems well poised for a session of exponential growth.

The company also has a share repurchase program worth $1.5 billion underway, which will be carried out by 2015. Since the company is already generating massive chunks of cash, the board will more likely boost its dividend payout by 11%. But that’s only speculation.

At the CMP, its shares yield 2.49% with a modest payout of 30.46%. Analysts expect its EPS to grow by 13.5% for the next 5 years, which means an investment can double in value in just over 5 years. Its shares trade at a forward P/E of 11.6 times and a PEG of 0.98, suggesting that its shares are undervalued. Barclays has an overweight rating for Coach, with a price target of $65 (35% premium).

Peer comparison

Kors also appears to be a solid growth pick. Its comparable same-store-sales in North America surged 41%, while sales in Japan spiked 103%. Its wholesale revenues rose 77.4%, while its retail sales jumped 66.8%. The company was able to record spectacular growth due to its series of expansions.

Kors has an impressive set of financial metrics, some of which have been shown in the table below.

<table> <tbody> <tr> <td> <p>ROE</p> </td> <td> <p>52.35%</p> </td> </tr> <tr> <td> <p>5yr EPS growth estimate</p> </td> <td> <p>32.63%</p> </td> </tr> <tr> <td> <p>Current Ratio</p> </td> <td> <p>4.8%</p> </td> </tr> <tr> <td> <p>Sales past 5 years</p> </td> <td> <p>43.94%</p> </td> </tr> </tbody> </table>

(Financial Metrics of Michael Kors Holdings)

But the shares of Michael Kors have appreciated by nearly 32% over the last year, and at the CMP, its shares appear to be overvalued. Moreover, Coach enjoys better margins and carries a modest yield.

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Forward P/E</p> </td> <td> <p>Net Profit Margin</p> </td> <td> <p>Dividend Yield</p> </td> </tr> <tr> <td> <p>Ralph Lauren</p> </td> <td> <p>18.98x</p> </td> <td> <p>10.36%</p> </td> <td> <p>0.9%</p> </td> </tr> <tr> <td> <p>Michael KORS</p> </td> <td> <p>24.7x</p> </td> <td> <p>17.31%</p> </td> <td> <p>-NIL-</p> </td> </tr> <tr> <td> <p>Coach Inc.</p> </td> <td> <p>12.07x</p> </td> <td> <p>21.31%</p> </td> <td> <p>2.4%</p> </td> </tr> </tbody> </table>

Ralph Lauren loses out due to an expensive valuation, and significantly lower net margins. Its gross margin is greater than Kors, but its low net margin indicates an expensive operating business structure.

Conclusion

Although shares of Coach have lost nearly 33% of their value over the last year, I believe that there’s a significant upside potential in the stock. Of course, risk-averse investors should buy Michael Kors, but as a contrarian play, Coach seems to be a great stock due to all the mentioned reasons.


PiyushArora 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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