Coach Beats Expectations; Earnings Up 19%

Leather goods maker Coach, Inc. (COH) announced an increase of 19% in earnings per diluted share to $0.46 for its third fiscal quarter ended March 29, 2008, up from $0.39 per diluted share a year ago. The results were slightly ahead of expectations on both the top and bottom lines.

At first glance, my only significant concern with the report is a faster rise in inventories than in sales. This could indicate sales running below expectations, the potential for future inventory clearance at reduced margins, or a number of other potential operational issues.

When I said Coach shares were selling on the bargain rack Coach had $900 million in cash and virtually no debt, so even the toughest recession should be survivable. With an enterprise value of just under $10 billion, and $679 million in free cash flow (cash from operations less capital expenditures) over the last 12 months, its free cash flow yield of 6.8% offers a 400 basis-point premium over the current 5-year Treasury. That would almost justify buying the shares even if no growth were expected.

Since then cash has come down, apparently due to accelerated share repurchases. It repurchased and retired 11,349,802 shares of its common stock at an average cost of $28.85, spending a total of $327 million during the quarter.

Disclosure: At time of publication, William Trent has written put options against shares of Coach.

Comments

[Camille]

It seems to me that the number of women purchasing handbags in the price range of Coach's handbags will be reduced as credit tightens and the purses can no longer be charged to credit cards. This coupled with the higher cost of gasoline and food would logically reduce the spending here. I thought this would have already happened, but it really has not. I am wondering what I am missing.

[Camille]

I should add, I own COH and am also short the Jan09 call against them.

[Manny Otero]

In general, the demographic purchasing Coach bags is not likely to be the demographic most affected by food and fuel prices. Furthermore, Coach is absolutely a global player. I live in Copenhagen, Denmark, and with the strong Euro I can tell you that fashion is doing very well. Furthermore, the growing middle cass in China, India, and Brazil, would suggest Coach has excellent prospects.

[Hans Wagner]

I suspect women who are encountering a tighter budget will still buy Coach bags. They just will be the lower priced ones, which is why their margins are shrinking.

International sales should do well, especially in Japan as the dollar shrinks. Brazil and Asia should also contribute over time.