Grab Coach Now Before The Market Figures Out It's On Sale

Jul.30.14 | About: Coach, Inc. (COH)

Summary

Investors have tossed shares of global-brand Coach into the clearance bin.

COH is a well-run company with good fundamentals that treats shareholders well.

It faces similar risks as other retailers but offers much more value to the prudent investor.

The market has given up on this quality business and you can own it on the cheap today.

The Situation

Coach (NYSE: COH), a world-renowned designer of luxury handbags and accessories, has been placed on the clearance rack. After failing to meet lofty expectations set by Wall Street Analysts and giving into fears that high input costs and an unstable China-based supply chain would wreck the company's outlook, investors have tossed shares into the clearance bin.

They are making a huge mistake.

The reality is, while Coach does have some near-term issues to finish ironing out in regards to its target-market and some underperforming stores, this elite globally-branded company is on solid financial footing and knows how to take care of its shareholders. Plus, its current dividend yield is nearly 4%, which is around 50% higher than 10-year U.S. Treasuries. In today's ultra low interest rate environment, this makes Coach quite attractive.

Some may argue the safety of Treasuries would trump the risks imposed by owning equity in a company thrown in the discount bin. To the contrary, I would argue that the risk of holding bonds is much higher when you consider that after inflation and taxes, one would be lucky to break even on the proposition of buying bonds at these prices.

On the other hand, owning stock in a globally recognized brand like Coach offers the potential for respectable current income. If held for the medium-to the long term, add dividend growth and share price appreciation on top of that.

The Numbers

At current price levels of around $35 per share, Coach offers tremendous upside potential both in terms of income and capital gains. Let's look at the numbers and see what you get by owning Coach at today's share price:

(Below based on trailing-twelve months of quarterly SEC filings)

  • Operating Margin: 27%
  • Net Profit Margin: 19%
  • Return on Equity: 38%
  • Payout Ratio: 35%
  • Price-to-Earnings: 10.13
  • Price-to-Book: 3.93
  • Price-to-Sales: 1.92
  • Price-to-Cash Flow: 9.0
  • Price-to-Free Cash Flow: 11.67
  • Current Ratio: 2.27
  • Debt-to-Current Assets: 0.67
  • Debt-to-Equity: 0.50
  • Dividends Paid Per Share (-ttm): $1.03
  • Stock Repurchased : $5.24 Million

The Facts

Coach has all the signs of a quality power-brand. A power-brand is my little nickname for a solid, shareholder-friendly company that also has strong brand name recognition.

As of July 2013, there were over 500 Coach stores in North America, over 400 directly operated locations in Asia, and 20 in Europe. Coach also operates e-commerce websites in the United States, Canada, Japan, and China with informational websites in over 20 other countries.

Beyond the company's direct retail businesses, Coach has built a strong presence globally through Coach boutiques located within select department stores and specialty retailer locations in North America, and through distributor-operated shops in Asia, Latin America, the Middle East, Australia, and Europe. Source: Coach's Website.

While a shrinking middle class in the U.S. has undoubtedly hurt Coach in certain ways, it is fortunate enough to be able to regroup and target the upper levels of affluent society and the growing wealth of the middle class in China and other eastern markets. These economies, thanks to perpetual trade deficits by the west, are now beginning to see a rapid rise in their standard of living.

Macro-issues aside, business operations at Coach are fundamentally rooted in prudent, methodical growth and quality management. This is evidenced by the financial data shown above.

With stiff competition from other international luxury handbag makers, it is impressive to see Coach sporting a Return on Equity (ROE) of over 38% and buy back over $5 Million of stock within the past year while still maintaining an overall Debt-to-Equity (D/E) ratio of 0.50. This shows that management is not willing to merely borrow a ton of money just to "pad the stats."

Additionally, the 3%+ dividend yield should lure in more income-hungry investors while the 35% payout ratio of Free Cash Flow maintained by Coach will keep them sleeping well at night knowing the dividend is fairly secure. Other indicators of value support the case such as a Price-to-Earnings (P/E ttm) ratio of 10, a Price-to-Sales (P/S ttm) ratio of 1.92 and an Enterprise Value / EBITDA of only 5.66 all point to Coach being a solid long-term-value at current price levels.

The Risks

Cap-Ex is one area on which you might want to keep a close eye as it has been rising in recent quarters. However, this is to be expected during times of new product development and while a company refreshes itself with a new consumer demographic. Over an extended time frame, this should not be a big problem, especially if management can deliver on its efforts to reach new consumer segments.

As always, owning equity is risky in the face of a market-wide downturn or recession. At this point, the likelihood of a major stock market crash (25% or greater) in the near term is minimal. Corrections of 5% or 10% are more likely, which would only make for good buying opportunities.

Additionally, if investors panic based on not meeting overtly rosy analyst expectations, it could also cause shares to take a small hit. But again, this will only give you additional entry points to continue accumulating shares. It won't fundamentally affect the continued operations of the company.

If you are concerned about short-term price movements, consider scaling into a position over the course of four to six months rather than all at once. This will help you dollar cost average away any share price volatility caused by company-specific or market-wide price fluctuations.

The Conclusion

If you are looking for a well-run business with global brand power trading at a good price, look no further than Coach. If management can succeed in its plan to shutter its underperforming stores, rejuvenate its selling efforts, and bring new products to market for its core and growth demographics, then this stock should be a huge winner over the medium-to long term. Oh, and don't forget about all that extra income you can collect along the way from the generous dividend!

Regardless, it's a quality company that has been around since 1941. It knows how to manage its finances and treat its shareholders well by returning excess cash back to its rightful owners.

BONUS: if you really want to juice your returns and don't actually need the current income, reinvest your dividends to get more shares while you hold this stock. Doing so will significantly boost your overall returns in the long run.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.