Founded in 1941 as a family run workshop, Coach Inc. (COH) is a leading American marketer of fine accessories (including handbags) and gifts for women and men. Coach is sold worldwide through Coach stores, select department stores and specialty stores, and through its website. It boasts over 500 stores in the U.S. and Canada, along with over 300 locations in China, Japan, Singapore and Taiwan.
Coach follows four strategies:
- Grow its Women's business in North America by increasing its distribution,
- Raise brand awareness and build market share in Asia,
- Increase in Men's business, and
- Maximize its e-commerce sales.
Coach announced rather disappointing 2Q results with its North America business posting negative same store sales (SSS) of 2% and modest increases in sales and operating income. Further, management mentioned that its market share was 10%, which indicates that its competitor Michael Kors (KORS) is eating into its market share. The bright side - its strong growth in China which posted a 40% increase in sales. Its inventory was lower by 2% at $4.9 billion despite its recent acquisitions in Asia (explained below). Further, as seen below, its margins have remained steady, with Gross margins of 72% and operating margins rising to 35%. Further, the Management did not increase its promotional activity in this quarter in order to achieve better comparisons vs. same quarter a year ago.
- Coach operates through two segments North America and International business (reporting segments were changed in 1Q13).
- Total revenues increased 3.8% while North America sales increased modestly by 0.6% with negative SSS of 2.2%. Its North American business suffered due to lower traffic in its full price and factory stores and lower shipments to its wholesale stores partially offset by significant improvement in its Internet business traffic. As per Management, the main reason behind the decline was due to lingering concerns regarding the Fiscal cliff, Hurricane Sandy and very strong price competition. International business increased 11.8% mainly due to double-digit SSS in China and acquisition of its domestic retail business in Malaysia (ten retail stores) and Korea (47 retail and department stores).
- Despite the impact of higher cost of inventory related to the acquisitions, Gross Profit margins remained flat at 72%.
- Despite increase in Selling, General & Administrative Expenses (SG&A), SG&A margins leveraged by 41bps to 37.2% due to operating efficiencies and sales leverage. SG&A expenses increased due to the new acquisitions, continued infrastructure investments in Asia and increased marketing and digital spend.
- As a result, EBITDA increased 8% to $5.7 billion and margins increased 140bps to 38%.
- Cash balance was lower by $58 million at $858 million as the company increased its capital expenditures by 67% to $1.2 billion reflecting increased capital investment, increased dividends of $2.5 billion, $4 billion share repurchases ($1.4 billion available under the program) and $45 million for acquisition of distributors in Malaysia and Korea (as explained below).
- On 07/01/12, Coach acquired 100% of its domestic retail business in Malaysia (ten retail stores) and in August acquired 100% of its domestic retail business (47 retail and department stores) in Korea from the former distributor. Through the acquisition, it would have greater control over the brand in Malaysia and Korea, enabling Coach to raise brand awareness and grow market share with regional consumers (in line with its strategy).
- Liquidity remains ample with $8 billion in cash on hand and full availability under its $400 million Revolving credit facility (RCF). Its cash on hand sufficiently covers its debt of $22 million. Further, its subsidiaries have credit facilities with regional banks for short-term working capital requirements. E.g. Coach Japan has Yen6 billion ($70 million) RCF and Coach Shanghai has RMB63 million ($10 million) facility.
- Coach's key competitor Michael Kors posted spectacular 3Q13 results with sales increasing 70% and SSS jumping 41%. Gross margins, although below Coach, jumped 80bps to 60.4%, reflecting the firm's increase in its store base as well as fewer discounts and a favorable shift in product mix. Despite weak economic environment in Europe, sales jumped 112% y-o-y to $58 million with SSS increase of 58% while North American sales jumped 67% driven by a SSS increase of 41%.
- Though not a direct competitor, I am also comparing Gap Inc. (GPS). Gap posted good 4Q12 results as its products resonated well with its customers. Sales increased 10% with 5% SSS due to improved product performance and global expansion.
Pick up this stock only because of its low valuations. Its shares are trading at its 52 week low of $49 (52 week range: 45.87 - 79.70) as investors have dropped the company because of its better competition and recent modest financial performance. Further, as seen Coach's PE is lower vs. its peers making it a cheaper investment. Besides being cheaper, it also provides a better dividend yield vs. its competitors. Importantly, Michael Kors is a more expensive stock and also does not distribute dividends.
Further, Coach gives an added benefit of steady and higher operating margins. Hence, I would recommend a BUY on this stock, given its cheaper valuations, sufficient brand strength, and growing Asian business along with its strong dividend yield and buy-back policy.