In our last article on luxury retail stocks, we had a hold rating on Coach (COH) due to the economic pressure on its sales and competitive pressures from the likes of Michael Kors (KORS). We had stated that we would be bullish once we see the company showing continued gains in international sales, which will be the primary driver of its future growth, along with seeing the economy getting better.
Coach is an established "affordable" luxury brand that has been through several ups and downs. The stock has climbed, from $53 to more than $58, on beating earnings for Q1 FY2013. North American sales recovered from Q4 levels after the reinstatement of coupons, as the environment remains highly promotional amidst competition from KORS. Chinese sales were robust again, though slightly lesser than last year. Lower margins are expected in 2013 as the company looks to expand and spend on e-commerce. We recommend buying COH primarily because of its current upside potential from a valuation point of view.
The decline in the stock price since April presents a good entry point. However, over the long run, we would continue to be mindful of valuations (as the growth rate is expected to be lower than in the past) and about any loss of market share to competitors e.g. to KORS in handbags sales. The company's share buyback program, international plans and brand name should also benefit share price.
Q1 FY2013 Results:
The company's sales were in line with expectations i.e. $1.16 billion (11% YoY growth). EPS of $0.77/share beat analyst estimates by 1 cent/share (5.5% YoY growth). This compares to a 16% growth in EPS in Q1 last year. The bottom line was affected by growth investments, mainly in Asia. The company completed its acquisition of distributors in Korea and Malaysia in Q1. Coach has termed 2013 an "investment year".
Same store sales in North America and China were healthy. The gain in North American was 5.5%, compared to a disappointing 1.7% in Q4 FY 2012. This might be due to the reinstatement of coupons at factory outlets, which are a major attraction for customers. North American same store sales increased 9.2% last year, which means that growth in the US is slowing down. Future growth would be driven by international markets. International sales were up 15%, with comparable sales in China (a key market for luxury brands) showing a double digit increase and Chinese sales increasing by 40% as compared to 60% in FY 2012. There was a 1% increase in Japanese sales in constant currency terms, same as last year's quarter. Roughly 31% of sales came from international operations in Q1, while 67% came from within the US. Regarding the new legacy line, CEO Frankfurt said "Legacy has been embraced by consumers across all geographies and demographics, providing us with a major platform for the years to come." We think that the Legacy line faces tough competition from KORS
Previously, analysts expected the next 5 year growth rate to be 14%, compared to almost 16% over the last 5 years. The company expects double digit growth during the holiday season due to its brand name and international expansion.
The company announced a share repurchase program of $1.5 billion of its common stock that is outstanding. This is almost 9% of the current market cap ($16.79 billion) of COH. The company has almost a billion dollars in levered free cash flow and pays dividends. The dividend yield is 2.1%, with a payout ratio of 28%. The free cash flow yield, according to Reuters, is 5%.
The consensus target price is $67 for COH. At a forward P/E of 13x, last 5 year average P/E multiple of 16x and EPS estimates, the valuations come out to be:
*FY2015 EPS is calculated by applying 14% growth rate to the consensus EPS estimate for FY2014.
Ralph Lauren (RL) trades at a forward P/E multiple of 17x, while KORS trades at 29x due to its hyper growth stage.
To reiterate, we recommend buying COH for its potential (after the decline earlier this year) international growth, safe dividends and share buyback program. The Q2 FY2013 results show the strength of the Coach brand amidst strong competition and unfavorable economic conditions in the US.
Disclaimer: The article has been written by Qineqt's Retail Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.