The 15% drop in Coach's (COH) share price today following its results release was painful (for me at least) and took me back down a tad below my entry price, all in one swoop. But the real question is: Do I hold or do I fold?
This is a continuation of an earlier article, so you might want to refer to that for details. Our investment thesis was that Coach has sufficient brand strength to hold on to its North American business while growing its Asian business. And that its yield, buy backs, and potential to increase its dividend were good reasons to wait.
China sales were up 40%; we can't complain about that. This reinforces the Asia growth story. Gross margins held steady at over 72% and operating margins rose to 35% (36% excluding special tax related charitable donations). In addition, Coach bought back 4 million shares at $56 (in reality I should be hoping the share price stays low, but somehow I can't seem to feel that way). While inventories dropped vs. last quarter (though it is up vs. same period last year, I am less concerned about this given the increase in owned stores particularly in Asia).
Lastly, management did not increase promotional activity in order to achieve better comparisons vs. same quarter a year ago. I see this as positive; many teams take value destroying decisions that make the company look more attractive in the short term.
Net sales were up 4% (5% on constant currency basis), net income up 2%, and EPS up 5%. These are all disappointing numbers (and foreshadow what is ugly about Coach earnings); we are looking for 8% to 10% growth over the next few years to support our valuation of $70. If they can only manage 5%, then a valuation of $55 (+/-10%) would be more appropriate. Not much of a margin of safety there. That said management expect to increase square footage by 10% over 2013, which should boost overall growth.
U.S. same-store sales declined 2% (ouch). During the call, management blames the Fiscal Cliff, Hurricane Sandy, and very strong price competition. They claim that store traffic was down, but conversions (walk in to buyer) and average revenue per purchase were flat. Also during the call they mentioned that the drop-off took place in December, adding some strength to the Fiscal Cliff/Sandy argument. Management goes on to say that the market in the U.S. grew by 10%; if true, then they are losing market share and the argument that Michael Kors (KORS) is eating their lunch (albeit with high promotions and low pricing) rings true.
Overall, if they cannot arrest the share decline and decline in same-store sales in the U.S. market, then the opportunity to make above-average returns will not exist. Management claims they will get it under control, but who knows.
On a technical front, today's drop comes with the highest volume in 12 months and smells of panic selling to me (I hate to sell into a panic). Even though the price has been recovering from the open, I would not be surprised to see some more selling tomorrow. However, my judgment is that the price will stabilise above the panic-induced level.
The Bottom Line
For now I am holding, given that it is trading around what would be fair value if they can't get their growth back up and at a discount if they can. I get compensated in cash while I wait to see how the next quarter pans out.
Disclosure: I am long COH.