Coach Is Down, But It's Not Out

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

Shares of luxury retailer Coach (NYSE: COH) are down 10.5% since the end of July when the company reported poor fourth quarter results. There are multiple reasons to believe that this price dip presents investors with an enticing opportunity to buy a high-quality company at a good price.

What caused the drop

Coach recently reported its fourth quarter and full fiscal year 2013 results. The results were generally decent, with sales rising 6.55% and the company's debt load remaining tiny. There were also some less-than-encouraging signs, however. Net income declined by half of a percentage point, and operating margins shrunk by 1.8%.

After a fiscal year like the one Coach had, many investors are considering other fashion stocks that are currently flying high like Michael Kors (NYSE: KORS) or L Brands (NYSE: LTD). I think that investors would be making a mistake if they bought either of those companies over Coach--here's why.

Coach has a strong history of profitability

Results such as Coach's will hardly make investors jump for joy, but shouldn't have them running for the hills either. Coach has increased its sales every year since 1999, with an 18.9% compound annual growth rate (CAGR.) Net income was positive in every year for the past decade, growing at a 23.8% rate during that period. 

Michael Kors has also experienced rapid growth, increasing sales at a 53.5% CAGR since 2009. I'm skeptical that the company can duplicate such amazing growth in the coming years, however. After all, Apple only grew its sales at a 38.1% CAGR for the decade ending in 2012. Michael Kors is off to a hot start, but I doubt it can grow revenues at a faster 10-year rate than the world's largest company did during its ascent. 

Net income for Michael Kors grew at an even more impressive 235% CAGR between 2009 and 2013. If that kind of growth continued for the next five years, Michael Kors would have greater net income than Microsoft. I highly doubt that will occur. 

Annual sales for L Brands fluctuated between a low of $8.6 billion in 2010 and a high of $10.7 billion in 2007. The company's 10-year CAGR for sales is a less-than-stellar 1.6%. Even more anemic was the company's net income growth over the past decade, which was one half of one percent.

Check the dividends

A large yield is a desirable characteristic for an investment, although some companies have good reasons for not dishing out big dividends. Coach has paid a dividend in every quarter since June of 2009 and has never lowered the payout. Shares yield 2.5% with a 34% payout ratio. 

Michael Kors has never paid a dividend. That is understandable, as a company in maximum growth mode is not in a position to pay out a dividend. Given Michael Kors' status as a fledgling company, its lack of a dividend should not be construed as a sign of weakness. 

Shares of L Brands are yielding 2%. The company has paid dividends since 2000, and has grown payouts at an impressive 11.3% CAGR. The company's payout ratio is 193%, however. The 2% yield on L Brands is far from certain to continue in the future.

Balance sheets and cash flows

These three have fairly similar market values at the moment, making a decision as to which company you should buy all the much easier. The following chart outlines some key data from the companies' balance sheets and statements of cash flows.

     COH       KORS       LTD   
Market Cap:   $15B    $14.6B  $17.7B
Working Capital:   $1.35B    $965.1M  $634M
Equity:   $2.4B    $1.2B ($994M)
       
Operating Cash Flow (2012):  $1.2B   $356.3M  $1.35B
3 year OCF growth (compound):    7.2%      47.8%     1.7%

For fashion stocks, the balance sheet value is only be so enlightening. A large portion of that value is in the form of inventories that can lose a ton of their value very quickly. Still, investors ought to consider the fact that Coach has nearly double the balance sheet value of Michael Kors while both companies trade at similar valuations.

The statements of cash flows tells a similar story to the income statements. Kors is the high flyer, posting sensational numbers year after year. Coach has solid, though less impressive, growth. L Brands, meanwhile, has been increasing its operating cash flow (OCF) at a snail's pace. 

Coach barely has a higher valuation than Michael Kors and generates over four times as much in operating cash flow. For Kors to catch up it would need to continue that 47.8% growth rate for the next three years. Over the past six years, Apple grew its OCF at a 45% CAGR. Once again, I am dubious that Michael Kors can top Apple when it comes to growth. 

Foolish final thoughts

The recent selloff in Coach presents investors with an opportunity to snag a high-quality company at a very reasonable price. Coach has steadily been increasing its sales and net income for over a decade, and it has an impressive track record.

Michael Kors, on the other hand, would cost you nearly as much as Coach and has nowhere near the record of sustainable growth that Coach does. Despite sporting a similar market cap, Michael Kors generates far less cash than Coach. Catching up would require besting growth rate records set by Apple. 

L Brands barely generates more cash flow than Coach does. Its growth has been practically non-existent over the past decade, however. The company also has a weak balance sheet and a dividend that looks ready to be cut.

In conclusion, take this opportunity to scoop up some shares of Coach. It appears to be a much more attractive investment than Michael Kors or L Brands at this time. 

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Fool blogger Ryan Palmer has no position in any of the stocks mentioned in this article. 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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