Riding Coach for First Class Returns

Coach (COH) is the designer and manufacturer of fine quality leather goods and accessories. They also license watches, footwear, and other product lines. They were acquired by Sara Lee Corp. (SLE) in 1985 and subsequently spun off as a separate entity in October 2000.

From their IPO through fiscal 2008 (ended June 2008), sales and earnings did nothing but surge higher. Last year’s recession likely caused the first year-over–year EPS decline with the consensus estimate for FY 2009 now at $1.90 versus last year’s $2.06. Analysts are taking a conservative stance even further out by projecting a second straight earnings decline into FY 2010 to $1.80/share.

Coach shares were savaged in the final panic in early March briefly touching $11.41 before a better than expected March results got the shares moving again to Tuesday’s $25.30 [3:24 PM EST].

The company has no net debt. Total debt of $25.6 million was dwarfed by their cash holdings of over $551 million as of March 28th. Value Line rates their ‘financial strength as ‘A’ and notes their ‘earnings predictability’ and ‘price growth persistence’ were in the 85th and 90th percentiles respectively (with 100th being best).

Here are the per share numbers from recent years as reported by Value Line:

FY …... Sales ….. C/F….... EPS ….. B/V ….. Avg. P/E
2003 … 2.60 ….. 0.48 …. 0.40 …. 1.17 …… 21.4x
2004 … 3.48 ….. 0.80 …. 0.68 …. 2.06 …… 26.5x
2005 … 4.52 ….. 1.18 …. 1.00 …. 2.73 …… 25.8x
2006 … 5.71 ….. 1.51 …. 1.27 …. 3.21 …… 26.2x
2007 … 7.01 ….. 1.93 …. 1.69 …. 5.13 …… 24.7x
2008 … 9.45 ….. 2.50 …. 2.06 …. 4.50 …… 17.7x

At Tuesday’s quote of $25.30 these shares are 13.3x this year’s estimate and 14x the even lower (and possibly too pessimistic view for FY 2010). The bad news seems to be factored in already.

Here’s my combination play on Coach that allows for great results even if the shares stay flat or go down to $20 over the next 20.5 months.

.........................Pay.........Collect
Buy 1000 shares @ $25.30 ….......... $25,300
Sell 10 Jan. 2011 $20 calls @ $9.20 ……......... $9,200
Sell 10 Jan. 2011 $20 puts @ $4.40 …............. $4,400
Net Cash Outlay ……......... ...............$11,700

On expiration date in January 2011…

If Coach shares are still > $20:

• Your $20 calls will be exercised.
• You will sell your shares for $20,000.
• Your $20 puts will expire worthless (a good thing for you as a seller).
• You will end up with no shares and $20,000 cash for your $11,700 cash outlay.

That’s an $8,300 net profit achieved in 20.5 months on shares that:

• Went up.
• Stayed unchanged.
• Declined by up to $5.30 /share or (-20.9%) from trade inception.

• $8,300/$11,700 = 70.9% total return or over 41% annualized.

What’s the risk?

If Coach shares are below $20 on expiration date:

• Your $20 calls will expire worthless.
• Your $20 puts will be exercised.
• You will be forced to buy another 1000 shares and to lay out an additional $20,000 cash.
• You will end up with 2000 shares of COH.

What’s the break-even on this whole trade?

On the original 1000 shares it’s the $25.30 purchase price less the $9.20 /share call premium = $16.10 /share.

On the ‘put’ shares it’s the $20 strike price less the $4.40 /share put premium = $15.60 /share.

Your break-even is the average of:

$16.10 + $15.60 / 2 = $15.85 /share.

That $15.85 break-even is $9.45 or (-37.3%) below the price right now.
It’s also lower than the lowest trade price for COH from late 2003 right through most of 2008.

If you had to own COH at $15.85 it would represent just 8.4x current FY estimates and 8.8x the very conservative $1.80 projections for FY 2010.

Summary:

This trade allows for upside of 70.9% if COH shares go up, stay unchanged or even if they decline by up to 20.9% from your starting price.

You have a 37.3% margin of safety even if the shares go lower than that.

Unless you feel this high-quality, cash rich company will do substantially worse than expected the risk/return on this trade looks to be outstanding.

Disclosure: Author is long COH shares and short COH options.

Comments

[Paul Price:]

Dividend Day-trader,

I am eagerly awaiting your first officially santioned published article here on SA.

Don't you have anything substantial to contribute?

May 06 04:00 PM

[Paul Price:]

Dividend Day-Trader,

Just for apples to apples I looked up the historical prices for your favorite stock MO and COH for the period Jan 1, 2008 through May 5, 2009.

Here are the results [as per Yahoo Finance historical prices]:


..........Jan. 1, 2008............May 5, 2009 ......... % Change

MO .... $21.32 ................... $16.06 ................(-24.67%)

COH ..$30.55 .................... $25.42 ................(-16.79%)


What's was your poiint?

May 06 04:27 PM

[Paul Price:]

You recommend MO everyday, everywhere and under multiple names. I've never seen you put out a sell on MO ever.

May 06 06:25 PM

[Paul Price:]

A Smoother Ride for Coach

Coach (COH: NYSE)
By Jefferies & Co. ($32.97, Oct. 30, 2009)

WE ARE UPGRADING our rating on Coach (ticker: COH) to Buy from Hold and increasing our price target to $40 from $38.

Sales trends are about to reaccelerate. Recently reported fiscal first-quarter results show management initiatives to adapt product offering to changing consumer landscape are working. Coupled with improving mall traffic, increased consumer willingness to spend on durable and nondurable goods again, and nearing an end in the department-store inventory destocking cycle, mean Coach’s sales trends are poised to reaccelerate.

Margins should also begin to rise soon. In fiscal first quarter, gross margins were down only one third of the decline seen in the prior quarter on better sourcing and less channel mix impact versus last year. Gross margins should now stabilize at current levels and soon show improvement year over year as the company laps more substantial margin declines from late fiscal 2009. As a partial offset, sales, general and administrative should begin to deleverage after cost-cuts opportunities wane, but the impact should be minimal and is already in Street models.

The catalyst will be upside to sales/earnings per share. As sales/margin compares ease and the economic environment slowly improves, we see sales and earnings having upside opportunity at Coach. Our current fiscal 2010 and fiscal 2011 earnings estimates are near Consensus, which we think is conservative given our model incorporates operating-margin assumptions 800 basis points below peak levels.

Don’t forget quality matters. These statistics are industry-leading and impressive… $1 billion in cash on balance sheet (about 10% of market cap), greater than $600 million in free cash flow annually (near 7% yield), operating margins 30%, return on capital greater than 20%. Oh by the way, the company now pays a dividend (greater than 1% yield).

Shares trade at about 15 times calendar 2010 year price-to-earnings multiple and about eight times enterprise value/earnings before interest, taxes, depreciation and amortization (a discount to the group average and to its own historic average). We believe shares deserve a premium given stronger global-growth prospects, industry-leading returns, and a strong management team.

Our $40 price target is based on 20 times EPS and about nine times EV/Ebitda. Risks to price target include a deceleration in consumer spending and the accessories category from current levels.

– Randal J. Konik
– Taposh Bari, CFA, CPA
– Shreya Jawalkar

Oct 30 07:01 PM