Shares of Coach (COH) have seen a bit of pressure at the start of the trading week, which might offer long-term investors a nice entry point.
On Monday, the luxury retailer received a downgrade from analysts at Canaccord Genuity, citing increased competitive pressures. On Tuesday, competitor LVMH, which is known from Louis Vuitton, reported slower revenue growth.
While the North American operations of Coach are crucial, they continue to struggle, prompting analysts to be cautious.
Despite the issues I remain a bit more upbeat than analysts. The strong balance sheet, cash flows to shareholders, solid growth in the international activities and the efforts to stabilize the brand in the US should provide enough appeal at the moment.
Cannaccord Genuity Is Cautious
Analyt Laura Champine downgraded Coach from "Buy" to "Hold" while lowering the price target by three dollars to $62 per share. Even after the price target has been negatively adjusted, the target still implies that shares of Coach have some 15% upside.
Champine expects Coach to report a 6% decline in same store sales within the US, which makes up 70% of total sales. Traffic trends appear to be deteriorating, and Champine believes Coach will be hard pressed to maintain its leading 30% market share with the current production in stores.
Champine furthermore believes that fast-growing rival Michael Kors (KORS) will continue to gain ground, as consensus estimates for 2014 top-line revenue growth stand at 30% vs. just 3% for Coach.
Given the limited near-term visibility, Champine is downgrading Coach while lowering the full year earnings forecast. Full year revenues for 2014 are seen at $5.22 billion, on which Coach is expected to report earnings of $3.61 per share.
Coach ended its fiscal year of 2013 with $1.13 billion in cash, equivalents and short term investments. Coach operates with merely $1 million in total debt, for a solid net cash position.
Revenues for the full year of 2013 came in at $5.08 billion, up 6.5% on the year before. Net earnings fell by 0.5% to $1.03 billion, while earnings per share actually rose on the back of share repurchases.
Trading around $54 per share, the market values Coach at $15.2 billion, or its operating assets around $14.1 billion. This values operating assets of the firm at 2.8 times annual revenues and 13-14 times annual earnings.
Coach pays a quarterly dividend of $0.3375 per share, for an annual dividend yield of 2.5%.
Some Historical Perspective
Coach has created solid returns for its shareholders over the past decade. Shares have steadily risen from levels around $15 in 2013 to highs around $78 at the start of 2012. Ever since, shares have lost roughly 30% of their value, as competition from Michael Kors, among others, started to have a real impact. On top of that, Coach has some brand image issues in North America, while the general retail environment has become tougher.
Between 2010 and 2013, Coach has managed to increase its annual revenues by a cumulative 40% to $5.07 billion. Net earnings grew at a similar pace to $1.03 billion, as earnings per share saw an extra boost after Coach retired a tenth of its share base outstanding.
Coach is continuing to make progress with its brand transformation strategy. The rapid growth in the outlet activities might have put a "discounted" image on the brand, especially in the key North American markets. Coach is generating strong international results, driven by the Men's business, the online operations and China. The performance in the key women's handbag and accessories business in North America remains an issue.
Despite international growth, North America is still generating two thirds of total revenues as 80% of total sales are directly related to women, either through handbag or accessories sales. Despite the North American issues, the long-term prospects look good as female purchasing power for luxury accessories, notably in Asia, is on the rise.
Coach offers accessible luxury products which are of high quality and excellent value. The firm competes against the likes of Burberry, Louis Vuitton and Gucci, among others.
Coach has made good progress internationally, growing its international business by 17% on a constant currency basis in the fourth quarter, while reporting growth in dollars of 7%. Growth was driven by the Chinese business as annual sales for 2013 rose by 40% to $430 million, while the men's business grew by 50% for the year to $600 million. The latter remains on track to become a $1 billion business in three year's time.
The issue remains the North American operations as Coach sees a low single digit negative comparable growth rate in North America for the short term. The recovery here will take some time as Coach is rebuilding the brand, aided by the hire of Stuart Vevers as Executive Creative Director for the brand.
Back in April of this year I last took a look at the prospects for Coach. I concluded that China and the Men's business were giving allure to this luxury stock. At the time, shares were trading around $55 per share, as shares have fallen some 5% ever since.
The strong balance sheet and cash flow generation allows for strong payouts to shareholders, both in terms of dividends and share repurchases. At the same time, China and the Men's business should boost the allure of the stock, despite the North American issues.
Note the Coach is still rapidly returning cash to shareholders. Its planned $700 million in share repurchases and dividend yield of 2.5% provide investors with a combined yield of 7.1%. Coach is pretty much paying all of its earnings out though dividends or share repurchases, which is not really an issue given the balance sheet strength.
Back in April, I concluded that the valuation at 13-14 times earnings is more than fair, given the rock solid balance sheet and strong payouts. I reiterate my stance today. Shares offer excellent value for the medium to long term.