Coach Stock Appears Undervalued

Coach, Inc. (COH) is engaged in design and marketing of accessories and gifts for men and women in the United States and internationally. Coach’s product offerings include handbags, women’s and men’s accessories, footwear, outerwear, business cases, sunwear, watches, travel bags, jewelry and fragrance. The product mix has not changed significantly in the past three years. 65% of the revenues come from Handbags and 28% through accessories and the 8% from other products. The products cater to the premium segment and have very good brand recognition. Coach Inc. conceptualizes and designs its complete range of products from New York.

Segments:

1. Direct Sales

Coach retail stores are located at high visibility locations such as NY, Chicago and San Francisco. These stores contribute about 80% of the sales. Coach Factory stores are located about 50 miles from major markets. Through these factory stores, Coach targets value-oriented customers who would not otherwise buy the Coach brand. Prices are generally discounted from 10% to 50% below full retail prices.

2. Indirect Sales

Coach’s products are sold in approximately 900 wholesale locations in the U.S. and Canada.

Net sales to U.S. wholesale customers grew 31% in fiscal 2007 from fiscal 2006. Total international wholesale locations: 140

Capex Plans for the year FY2008 - $200 million

North America
No. of new stores targeted - 40 (23 were opened by the end of the first half of fiscal 2008).
No. of factory stores opened - 6 (additional stores planned)

Capex in Japan
No. of retail stores opened - 5 (A total of 15 to be opened)

Past data:

As per the past (FY2007,FY2006 and FY2005) data,80% of the sales in USA is through Direct Sales. Hence the sales realized per sq.ft in USA has increased from $1285/sq ft to $1606/sq ft and in Japan, it has remained stagnant to low at $2143/ sq ft.

• Avg Sq ft of a Coach retail store in US is 2597 sq ft
• Avg sq ft of a factory store in US is 3456 sq ft
• Avg Sq ft of a retail store in Japan is 1678 sq ft

Projections for FY 08

Total Sq ft retail stores by June FY08 end in North America (as per capex plans)= 2597 * (40+259) = 776503

Total Sqft Factory stores by June FY08 in North America = 3456 * (6+93) = 342144

Total Projected Direct sales = (776503+342144)*1606 (assuming the sales per sq ft has saturated at 1606) = $ 1.796 billion

Total Sales from North America = $1.796/0.8 = $2.245 billion
Total sqft in Japan by June FY08 = (15+137)*1678 = 255056
Total Sales from Japan = 546.5 million
Total international sales, (6% increase in international sales, same as last year) = $ 130 million

Total Sales for FY08 = 2.245 + 0.546 + 0.130 = $ 2.921 billion

As per the latest SEC Filing, half yearly Sales ending Dec 07 = $ 1.654 billion. This indicates that management is on track to achieving its goals, something that has been reiterated in every conference call held in the past. Increase in sales (YoY) for last 4 years = 24%, 24%, 30%, 40%.

Projected sales for FY08 based on historical rates of growth (least of all 24%) = $ 3.2 billion
Relative Valuation (Assumption that sales will grow at 20% CAGR (although it has grown at 24% or more in the past) for coming years and net margins will go down to 20% from 24-25%:

In Billion dollars:

Six year historical forward P/E for Coach is 25.

Assuming Coach commands the same P/E in FY10 , its price = 2.22*25 = $55.5 (most optimistic)

Conclusion: Coach thus appears undervalued

Disclosure: I hold a laughable (very small) long position to test my analysis.