This Steep Stock Price Decline Makes for an Attractive Buy
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The stock price of Coach (NYSE: COH) has taken a beating dropping 18.57% in a single day after the company announced its fourth quarter results recently. The major setback was the modest North America Same Store Sales growth of 1.7% as compared to the consensus estimates of 6.4%. The earnings were not that bad as the reported EPS of $0.86 was a penny higher than the consensus estimates despite SSS shortfall as tight control of SG&A spending helped deliver operating margin expansion ahead of expectations. COH management gave a conservative FY13 earnings outlook with new investments in the acquisition of its Korea and Malaysia businesses, ecommerce initiatives and marketing to support its brand positioning. Management still expects double-digit sales and earnings gains and 31% operating margins in FY13, including some deleveraging from the additional investments.
The North America SSS shortfall was a function of a slowdown in traffic in the factory channel and heightened promotional environment. Going forward, Coach has multiple growth drivers beyond factory. We believe, while a slowing US women’s business is likely to weigh on the stock in the near term, emerging growth drivers like China & Men’s (and the potential to re-accelerate US Women’s) could offer EPS downside support.
4Q SSS miss not a sign of market share loss
Factory stores were largely responsible for the changes in the overall retail SSS trend from the prior quarter. Trends in full-price stores and overall e-commerce channels were consistent with prior quarter. Therefore, we do not consider 4Q SSS miss as a sign of losing market share to Michael Kors Holdings Ltd (NYSE: KORS) as KORS presents competition in full-price stores rather than factory stores. We believe factory channel traffic decelerated significantly in the 4Q and conversion slowed with the elimination of couponing.
Emerging Growth Drivers Still Intact
In FY12, COH accelerated the acquisition of key Asian domestic distributors and expanded distribution rapidly in emerging luxury markets such as China, thus making significant progress on its key initiatives of aggressively growing International business and becoming a market leader in the Men's accessories category. As a result, China revenues (~6% of mix) and SSS remained strong with 60% and double-digit growth respectively, despite a deteriorating macro environment & tough times for luxury brands in that region. Japan sales were also up 16% in constant currency. The Men’s business exceeded its sales goal of $400 million for FY12 and going forward we expect good growth in Coach's Men’s business (8% of mix) due to huge white space and less competition.
Strong cash flow and share repurchase provide support
The company ended the quarter with total cash and investments of $917.2 million. During the quarter, the company repurchased 2.5 million shares at an average cost of $67.79, spending a total of $169 million. The company had approximately $260 million remaining under its repurchase authorization. We are confident about COH’s business model’s ability to generate significant cash flow and invest in the brand while continuing to return capital to shareholders.
Going forward, we recommend investors to look beyond the short-term results given the resilience of Coach’s business model over the years and management’s practice of conservative guidance which it usually beats. Apart from major growth drivers in China and the Men’s category, the brand is increasingly focused on digital, which should contribute significant future growth. We believe Coach will continue to grow earnings and do better than others. It has multiple growth drivers and is investing at the right time to fuel long term growth. While FY13 EPS growth will likely be in the low double digits due to investment spending, long term we continue to see solid high-teens to low 20s EPS growth. With the recent weakness, the stock is trading at a forward P/E of 10.52x. Considering the long-term opportunity, we believe the risk/reward profile remains attractive and suggest buying.
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