Coach (COH) has recently taken a hit due to investor's pessimism regarding the retail sector. After hitting a high of $79 in mid-March, the stock has dropped all the way down to $55. When a company's stock drops 30% over a span of nine months, one might think there must be something wrong with the company. On the contrary, Coach's profits are up, free cash flow is growing, the company is buying back shares, and its international expansion plan is working out perfectly. Coach continues to pump out excellent returns on invested capital, and has a strong focus on long-term shareholder value.
So why is the price dropping? Simple: The market doesn't realize the growth potential Coach has in other foreign countries, including China, and even in the men's product line. Coach has a very simple, but extremely effective, method to successfully grow: It enters into partnerships with distributors all over the world, learns how these distributors do their business, and then buys them out. What does this mean for Coach? It means much more control over product pricing, distribution, and the company's presence in foreign countries. These acquisitions will allow Coach to increase its margins, and speed up its international growth. Investors should begin to recognize the outstanding growth potential Coach currently has, and make an investment while the company trades at a substantial discount.
Understanding Coach's Business
Founded in 1941, Coach is a luxury retailer that specializes in handbags. Over the years, Coach has provided its customers with the perfect balance of luxury and price, while keeping up with fashion trends for the past 71 years. The company currently receives 65% of sales from its Men's and Women's Handbag division, 28% from Accessories, and 7% from other products (Wearables, Footwear, Jewelry, etc.). Coach sells its products through its two divisions: Direct-to-Consumer and Indirect.
- Direct-to-Consumer: This is Coach's most profitable segment, contributing 89% of total sales in 2012. Coach makes these sales through its high-end retail outlets where its goal is to provide customers with an excellent shopping experience, along with its high-quality products.
- Indirect: This segment includes Coach's wholesaling outlets, where it sells its outdated products at a much lower markup. It also includes profits made from licensing some of its products.
Where Coach Is Growing
Coach's growth is broke into three primary segments: North America (63% of sales), Japan (18% of sales), and China (6% of sales).
|July 2012||July 2011||July 2010||July 2009||July 2008|
|North American Retail Stores||354||345||342||330||297|
|North American Factory Stores||169||143||121||111||102|
|Coach Japan Locations||180||169||161||155||149|
|Coach China Locations||96||66||41||28||24|
|Coach Singapore and Taiwan Locations||34||27||22||20||17|
Coach utilizes a brilliant strategy to successfully expand internationally. The company first enters into agreements with distributors to sell Coach products, learns how those companies do business in their respective countries, and then buys them out. It surprises me that investors haven't talked much about the many acquisitions Coach has made. Here's an excerpt from the company's recent 10-K:
In June 2001, Coach Japan was formed to expand our presence in the Japanese market and to exercise greater control over our brand in that country. Coach Japan was initially formed as a joint venture with Sumitomo Corporation. On July 1, 2005, we purchased Sumitomo's 50% interest in Coach Japan, resulting in Coach Japan becoming a 100% owned subsidiary of Coach, Inc.
In fiscal 2009, the Company acquired the Coach domestic retail businesses in Hong Kong, Macau and mainland China ("Coach China") from its former distributor, the ImagineX group. These acquisitions provide the Company with greater control over the brand in China, enabling Coach to raise brand awareness and aggressively grow market share with the Chinese consumer.
In fiscal 2011, the Company acquired a non-controlling interest in a joint venture with Hackett Limited to expand the Coach International business in Europe. Through the joint venture, the Company opened retail locations in Spain, Portugal and Great Britain in fiscal 2011 and in France and Ireland in fiscal 2012. The Company currently anticipates further European expansion in fiscal 2013.
In fiscal 2012, the Company acquired the Coach domestic retail businesses in Singapore and Taiwan, which were operated by Valiram Group and Tasa Meng, respectively. In connection with the fiscal 2011 agreement with the Valiram Group, the Company assumed direct control of its domestic retail business in Malaysia in July 2012. Additionally, in connection with the fiscal 2012 agreement with Shinsegae International, the Company assumed direct control of its retail business in Korea in early August 2012.
As you can see, Coach is making large acquisitions all around the world, and is setting itself up for a big push in international sales. The company may not be getting many sales from those countries as of now, but it is positioning itself to successfully penetrate those international markets. So far, the company's strategy has worked perfectly in its two first international endeavors: Japan, and China. Coach currently has the second highest market share of 17% in Japan (only behind Louis Vuitton (LVMUY.PK)), and Coach already has captured a 10% market share in China since 2009. This demonstrates the company's phenomenal success in China, even with the recent economic downturn.
As you can see in the chart above, Coach China has almost quadrupled its stores since 2008, and plans to open 30 more stores in 2013. China has posted double-digit organic growth, and provides Coach with a very strong growth opportunity in a market that has been barely touched by foreign luxury handbags. Even in North America, where many people believe Coach is slowing down, the company is posting a 6.6% increase in organic growth. Coach believes it can open 500 retail stores in North America, including 30 in Canada. In 2013, the company plans on opening 10 new retail stores and 18 factory outlets. Although a much smaller segment, Singapore and Taiwan have also done very well for Coach, doubling its stores since 2008. The men's segment also provides a large growth opportunity for Coach, especially in markets where men's handbags represents a much larger market share. For example, in China and Japan, men make up 40% and 25% of the market, respectively, compared to 10% for the U.S. As a result of focusing more on the men's opportunity, Coach's men's segment doubled its sales this year from $200 million to $400 million.
(Sources: Coach 2012 10-K, Reuters.)
One of the biggest things that catches my attention is how Coach's stock price is only four dollars more than it was in mid-2007. That means even after all these acquisitions and record high profits, the stock price has only up gone up 8% in five years. With the amount of value Coach has added since then, the stock price should be much higher. Let's break down how much has changed since then.
- Revenues and Profits: Since July 2007, revenues have grown from $2.6 billion to $4.7 billion, a 81% increase. During the same time period, profits have grown from $993 million to 1.5 billion, an increase of 51%.
- Return on Invested Capital: Since July 2007, ROIC has increased from 43% to 54%, a 25% increase in a ratio that is already miles higher than other competitors.
- Free Cash Flow: Since July 2007, Coach's FCF has grown from $638 million to $989 million, a 55% increase. Coach has also maintained an extremely strong balance sheet through this large cash holding, by operating with little to no debt, and by effectively managing its inventory.
- Share Buybacks: Since July 2007, Coach has purchased back 85 million shares. That means every dollar that the company paid back to you through earnings in 2007, would now be the equivalent of $1.29. a 29% increase in shareholder value.
- Acquisitions: Since July 2007, Coach has acquired its retailers in China, part of Europe, Singapore, Taiwan, Malaysia, and Korea. All of these acquisitions have the possibility of providing substantial future growth opportunities.
- Dividend Program: Since July 2007, the company has also initiated a dividend program, currently paying $1.05 per share.
After seeing all those numbers, it does not make any sense that Coach's stock price has only gone up 8%. The company has added on an enormous amount of value for investors, and the market has yet to recognize it. As you can see in the graph below, Coach is also trading at one of its lowest P/Es since the recession.
Click to enlarge image.
Valuing Coach Against Its Competitors
Let's see how Coach stacks up against its competition:
|Owners Earnings (FCF Yield)||6.16%||3%||1.06%|
As you can see, Coach is outperforming its competitors in many areas. Coach has much higher margins and generates much more efficient returns than its competitors. The company also does very well with its inventory and shows this through its large free cash flow and FCF yield. Michael Kors (KORS) has product line similar to Coach, and is trying to expand its handbag segment. Although it may be the "hot" company right now, it hasn't been around nearly as long as Coach, trades at a much higher P/E of 43x, and hasn't had the international success Coach currently has.
On the other hand, Louis Vuitton (LVMUY.PK) has been around for quite some time. Louis Vuitton's products are much higher priced than Coach's, since the company appeals to a much wealthy consumer. Louis Vuitton's growth will be limited due to its niche market, whereas Coach's lower priced offerings provide it with a much larger opportunity to expand. The company also trades at a P/E of 22x, a value much higher than Coach's 15.5x.
The bottom line is the market is not representing the tremendous value Coach has created over the past five years. Coach has many more plans for expansion in other countries, including Malaysia, Korea, Spain, Portugal, and Great Britain, where it has recently acquired direct control of its retailing businesses. The company's success in setting up a wide distribution network around the world gives it a strong competitive advantage against other companies that haven't fully taken the step international yet. At its current price, investors are getting a excellent, rapidly growing company with a very wide margin of safety.
Disclosure: I am long COH.