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Coach (NYSE:COH) seems to have a lot of growth potential in the next few years, like I discussed in a previous article. It has now recovered from its lows of 2009. The luxury brand industry gets impacted a lot by the market sentiments. Therefore the next few years might prove to be a boom for the industry because of the improving economic scenario in the US. As Coach is a major player in the industry, it is also expected to experience better financial performances.

Previously its stock dropped from around $75 in May 2012 to around $46 in February 2013. Since then, the stock has been steadily rising and has now reached a level of around $55. But the stock still seems to have some upside potential and is expected to rise in future because of certain factors discussed below.

Growing Chinese luxury market

China's contribution to the global luxury market has been discussed a lot. According to McKinsey & Co., China accounts for more than a quarter of the global luxury market. This is expected to further increase to a share of around one-third by 2015. This is helping the U.S. and European luxury brands to increase their revenue, despite slow growth in their respective markets. The European luxury goods sector is expected to expand at a rate of 6-7% over the next five years. This would be driven by rising demands in emerging markets, especially China.

Coach has more than 110 stores in China. It announced an increase of sales by 40% in the last quarter with a double digit increase in same store revenue. The full year guidance for sales in China has been increased to $425 million from $400 million previously. Chinese market is therefore a big factor in the company's growth plans.

Expanding product categories

Coach has been implementing its strategy to become a lifestyle brand by moving further into the segments where it is not a major player. It is now diversifying into segments such as shoes and clothing. It has also been trying to expand both its men's product category and its licensing opportunities. The revenue from men's business is expected to double to reach $600 million per year. The company now offers its men's offerings in more than 600 locations globally. This is being done to compensate for the falling sales in North America, which is by far the biggest market for the company. This will help the company in increasing its customer base and therefore presents an upside potential in future.

Financial Performance

Coach has recently released its Q3 2013 financial results. The company's sales increased 7% to $1.19 billion, beating the consensus estimate by $0.01 billion. Net income also increased by 6.1% to $238.9 million. This resulted in an EPS of 84 cents a share, beating the consensus estimate of 81 cents a share. The company saw its sales increase by 7% in North America. Gross margins also increased to 74.1% from 73.8%. This indicates that Coach didn't drive up sales by compromising on margin. This robust financial performance suggests that the company's strategy to expand and diversify has started to show results.

Dividend growth

The company has recently announced a 13% increase in its annual dividend to $1.35 a share. This resulted in an absolute increase in dividends by 15 cents a share. The current dividend yield is around 2.4%. This dividend yield is higher than all its competitors. With an annual increase in its dividend, this is expected to further increase. The dividend payout ratio is also high at 31%. This indicates that the company believes in giving back to the shareholders for their investment. The company has also been repurchasing shares at around 5% per annum. Since 2003, the number of shares outstanding has decreased by 89 million, or 24%. This has given its investors even higher returns. It is also an indication of the company's robust cash flows.

Competitors

Michael Kors (NYSE:KORS) has been an old player, but had an accelerated growth since its IPO in 2011. It has recently released an incredible quarterly earnings report. Its EPS has increased from $0.20 in Q2 2012 to $0.64 in Q3 2013, an increase of 220%. The company has also been continuously expanding in various parts of the world, with a special focus on the Chinese market. It is planning to open 100 stores in China in the next two to four years.

Since its IPO, its stock has been on an upward trend with intermittent bearish periods. Because of such phenomenal quarterly results, its stock has given its investors a return of more than 50% since last June. The stock is currently trading with a P/E ratio of 31.71, which seems to be a little expensive. But its forward P/E ratio is lower at 22.71, indicating a strong EPS growth forecast. Therefore, investors might want to hold the stock for at least a year for considerable returns.

Ralph Lauren (NYSE:RL) operates at all the levels of the value chain. The company reported its EPS as $2.31 in the recently released quarterly earnings report against an estimate of $2.19. This was an increase of around 30% over the last year same quarter. It has also been expanding, though majorly in the US itself.

Its stock has been very volatile over the last one year and is now currently trading at around the same level. It fell to a low of around $136, but has recovered since then. In the last four months, it has given its investors a return of around 16%. It is currently trading at trailing P/E of 22.46 and forward P/E of 18.28, with an EPS growth forecast of around 16% over the next five years. This makes this stock a good investment for long term.

Conclusion

Coach has been performing strategically and is expected to deliver one of the best returns in its industry. The trailing P/E ratio of the company is 15.32, which is lower than the industry average of 17.8. Its forward P/E ratio is even lower at 13.48 because of a high EPS growth forecast over the next five years. This makes this stock extremely cheap.

The growth prospects of the company looks really optimistic, because of its success in China and other emerging countries. It is also expanding its product categories in order to reach a larger consumer base. This is expected to drive the future growth of the company.

The company is expected to reach $5 billion of sales in the year ending June. An EPS of $3.69 is expected during current fiscal year, an increase of around 4% over last year. According to Thomson Reuters, Coach could earn $4.11 a share, and grow its net income with an average of 15% annually over the next three to five years. This might lead to further increase in its dividends and therefore will provide higher overall returns to the investors. All these factors make the stock a good investment for a long term period of two to three years.

Source: Coach Inc. - Bag It, Part II