We think Coach (COH), the high-end bag and accessory maker, is ripe for a trade to the upside, and we've spent the last few days acquiring the shares. John Fogerty's "Centerfield" lyrics not withstanding, the stock looks to be bottoming and the fundamentals aren't too shabby either.
When COH reported their 4th quarter, 2012 results in late January, the stock traded lower on what was thought to be a disappointing quarter and the somewhat ambiguous comments by Lew Frankfort, the CEO on "transforming Coach into a global lifestyle brand". Revenues missed the consensus estimate by 6% and operating EPS of $1.18 missed the consensus of $1.23 so it was a bad quarter all the way around.
The fact is COH is seeing more competition in the high-end woman's handbag market. North American comps have been in a downtrend for the last 6 quarters, and the last quarter was the first where NorthAm comped negatively:
North American comp by quarter
COH traded down from over $60 to $48 after the January warning and is down 12% year-to-date in the first 6 weeks of 2013, versus the SP 500's +6.5% return. Another somewhat discomforting trend has been the relationship of sales growth to inventory growth:
Comparison of sales to inventory growth (by qtr)
*Source: internal s/sheet
This relationship isn't uncommon with earlier stage growth retailers, but it could become an issue with COH if it's evidence that the inventory build is a function of unwanted inventory versus having inventory for new store growth.
Retail has been hit pretty hard with SuperStorm Sandy, the payroll tax hike, which was a surprise to many, what will be the effects from the snowstorm that blanketed the Northeast this past weekend, and the rising price of gasoline. However, the compelling metrics to COH on the fundamental side that support the technical action, is that COH is now trading at 9(x) 4-quarter trailing cash-flow with a 9% free-cash-flow "yield".
Put simply, COH has a lot of cash after generating $628 million in cash-from-operations in the 4th quarter alone. They have recently increased the dividend and the share repo program and "capital allocated" back to the shareholder is growing once again.
4-quarter trailing free-cash-flow as of the December quarter was $1.23 billion and management returned $1.1 billion to shareholders in 2012, most of it by the share repurchase program.
We think COH is good for an upside trade here. As the attached chart indicates the stock is testing its 200-week or longer-term moving average, a support area not seen since mid-2010. The mid 2011 lows are down near $45.70 and we'd buy more until that point.
Our internal model values COH at $55, and Morningstar has a fair value on the stock of $63. We think the trade is good for at least a 10% move to the upside over the next few months.