Have These Luxury Brands Lost Their Luster?

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Luxury brands are under fire.  The combination of painfully stagnant employment and wage growth, impending tax hikes, and possible spending cuts is proving to be a toxic combination for America’s luxury retailers.  Shares of companies such as Coach (NYSE: COH) and Tiffany (NYSE: TIF) wallow while the broader market continues to climb this wall of worry.  After the market was thoroughly disappointed from the heavily scrutinized holiday sales period, investors may be tempted to give up on these names and rush for the exit.  In times like these, it’s worth digging in to the underlying fundamentals to see whether there’s a reason to stick with these underperforming stocks.

When growth isn’t good enough

Coach is well-known for its namesake handbags, jewelry, footwear, and accessories. The company operates in the luxury apparel industry and has a premier brand.   In early February, Coach released its results for the crucial holiday period—and investors gave a collective shoulder shrug.  Net sales for the quarter ended December 29 rose almost 4% versus the same quarter in 2011.  At the same time, diluted earnings per share rose 4.2% during the quarter year over year.

For the fiscal year ended June 30, 2012, Coach reported an increase in net sales of 14.5 percent. Earnings per diluted share grew from $2.92 in fiscal 2011 to $3.53, representing growth of almost 21 percent.

The story is very similar with regard to Tiffany.  In January the company revealed that worldwide net sales increased 4% to $992 million during the holiday period.  In addition, full-year sales and net income per share each climbed more than 18 percent year over year.    

What lies beneath

You might think that these figures really aren’t that bad, especially in light of the persistent headwinds facing the consumer.  However, while these growth numbers might sound great to more fundamentals-oriented investors, the markets certainly weren’t pleased with these results.  After breaching $78 a year ago, Coach has steadily fallen to its current level of $48.  Tiffany, meanwhile, rose to over $80 per share during the summer of 2011 only to steadily fall since, to its current level of $65.

One stock bucking this trend of luxury retailer underperformance is Michael Kors (NYSE: KORS).  Since its initial public offering in 2011, Michael Kors has more than doubled and now enjoys a loft valuation, trading for more than 30 times trailing earnings and almost seven times sales.  To be sure, the company’s holiday sales performance was stellar:  total revenue increased 70.4% to $636.8 million from $373.6 million in the third quarter of fiscal 2012.

The bottom line

Underneath the negative headlines, there appears to be a lot to like in both Coach and Tiffany.  Between the two of them, I prefer Coach.  Coach trades for only 13 times trailing earnings and offers shareholders a solid dividend yield of 2.5% at recent prices.  In 2012, the company increased its cash dividend by 33 percent. Coach has an impressive three-year dividend CAGR of 58 percent.  Tiffany is much more richly valued, exchanging hands for 20 times earnings.  Moreover, the stock yields only 2% and hasn't offered nearly the same level of dividend growth as Coach over the past few years.

Coach is in a great financial position, with almost no long-term debt.  Tiffany, however, has a much higher long-term debt to equity ratio of 32%.  While still manageable, I nevertheless believe investors should prefer Coach for its more attractive valuation, higher dividend, and a more conservative balance sheet.  As a result, Coach represents a compelling investment opportunity.

Robert Ciura 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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