Coach's Shares Are Starting To Look Cheap

| About: Coach, Inc. (COH)

Luxury bag retailer Coach (COH) reported fourth quarter and fiscal year 2012 results Tuesday. Earnings per share grew 26.5% to $0.86, about a penny north of consensus expectations. Revenue climbed 12% year-over-year to $1.2 billion, which was about in-line with the Street's expectations. Gross margins for the quarter registered about 72.6%, 90 basis points higher than the same period in fiscal year 2011. The firm also announced that its 2013 fiscal year would be an "investment year," which we think was made to temper expectations.

Perhaps the most surprising piece of information from the quarter was the performance divergence in North America and in China. Same-store sales in North America, which grew 6.7% in the firm's third quarter, grew just 1.7%, far lower than its guidance of equal or better results. Management blamed lower foot traffic and buying at its factory stores, and they also noted that the firm will have to restart its couponing program. Though the entire retail environment has recently become more promotional to compensate for slower traffic and growth, Coach did not follow until the latter part of the quarter.

We also think that the firm's focus on accessories and men's growth may point to increased competition from Michael Kors (KORS) in the traditional women's purse and handbag business. Of the 30 new North American locations Coach plans to open in its 2013 fiscal year, 10 will be men's stores. If the firm isn't keeping up with Michael Kors, we worry about the company's ability to retain market share in North America and consequently grow abroad. Most of the firm's sales come from its retail outlets, but orders to North American department stores decreased year-over-year. Buyers from the likes of Nordstrom (JWN) may be noticing less interest in Coach's products.

Yet again, China reported relatively strong growth, with revenue growing 60% during fiscal year 2012. The company attributed the expansion to double-digit same-store sales growth, as well as greater distribution channels in China. Sales in the country now exceed $300 million, and Coach opened 11 new stores in the country in its fourth quarter. Although the firm didn't report a specific quarterly update on China, we suspect growth for Coach is slowing in the country, but not unlike that of several other firms. We think weakness from Asian tourists may have also harmed same-store sales expansion in the United States.

Coach now has 5 stores in Europe, so the economically-challenged region is fairly immaterial to results at this point. We are ultimately skeptical as to whether Coach has a place in Europe, which is already home to so many popular designer brands. The brand is targeted to middle class Americans that we view as an incredibly different consumer.

Nevertheless, Coach's quarter didn't warrant such a sharp sell-off, in our view. In fact, shares are now trading at a discount to our estimated fair value range. Still, we're cautious given the firm's mediocre North American results and warning that fiscal 2013 will be an "investment" year. All things considered, we're not interested in scooping up the company's shares at this time.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.