Coach: The Bad And The Good News

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Summary

The recent sell-off has opened the opportunity for income and growth investors to step in.

Earnings are under pressure due to heightened competition in North America, but the international business is strong and the company is undergoing a major transformation.

The company delivers a dividend yield of 3.7% with low payout, a compounded 5-years growth rate of 38% and strong free cash flow figures.

Coach (NYSE: COH) is a manufacturer, distributor, and retailer of handbags and accessories and is expanding to broader product categories. Its products offer the quality of higher luxury brands but at more attractive price points. While 60% of sales come from more than 500 North American retail stores, Coach also sells its products through department stores, international shops, the Internet, its catalog, and Coach stores in Japan and China. Coach recently established a foothold in Europe, where it plans to reach $100 million in sales in fiscal 2015.

Why Coach is attractive?

The company is very attractive for the investor willing to buy and hold for at least one year. The shares are trading close to a 52-week low of $33.25. Coach's earnings are under pressure due to heightened competition in North America. Although the risks are real, so too are the opportunities.

Coach is undergoing a major transformation, with management attempting to make it a lifestyle brand, expanding its footprint in new niches and new lands. Coach's international business in China, Europe, and Asia is still underdeveloped and represents an opportunity.

The bad news

Coach's sales in North America declined 19% for the last quarter and the adjusted earnings per share, on a year-over-year basis, dropped 44.2% to $0.43, missing the analysts' estimates of $0.45. This is mainly the effect of increased competition, especially due to Micheal Kors (NYSE: KORS), and of strategic reduction of promotional events in the region.

The good news

Coach's international sales increased 6% on a constant currency basis. The company is constantly increasing his China business year-over-year since 2010. In Europe, Coach initially entered the market through department store partnership and is now opening retail stores and planning to increase revenues. The company has experience with international development in Japan where the company has had constant growth for the past decade while the competitors struggled.

Coach's CEO Victor Luis is planning a transformation to make the company a lifestyle brand and to bring greater fashion relevance by transforming its products, marketing strategies, and stores. To lead the way a new creative director, Stuart Vevers, has been hired.

Put-to-Call Ratio

The total outstanding ratio between put options and call options has marked a strong increase from 0.70 to 1.50 in mid-October ahead of the missed earning release. The ratio is constantly decreasing and is now 1.20 predicting a possible volatility in price in the short term. The ratio is likely to drop in next months to previous values.

Insider and Institutional Investors

During Q1 and Q2, 355 funds reduced or closed their position, while 277 funds increased or created a position in Coach. The share price went down to the low of June signaling a nice entry point for long term investors that likely created or increased their position. This resulted in the uptrend for July and August. The Q3 missed earning has triggered a sell-off that brought the price back to the June low and allows long-term investors to increase their position further.

Financial Health

The company has an Altman Z Score greater than 7. The downtrend of the current ratio and the quick ratio started in 2007 seems to have been halted in the last quarter posing the company in a better financial health.

Liquidity/Financial Health

2005-06

2006-06

2007-06

2008-06

2009-06

2010-06

2011-06

2012-06

2013-06

2014-06

Latest Qtr

 

Current Ratio

2.67

2.85

4.27

3.07

3.04

2.46

2.45

2.51

2.87

2.28

2.37

 

Quick Ratio

1.69

1.82

3.17

1.79

1.98

1.52

1.42

1.52

1.81

1.31

1.37

 

Financial Leverage

1.30

1.37

1.28

1.50

1.51

1.64

1.63

1.56

1.47

1.51

1.50

 

Debt/Equity

-

-

-

-

0.01

0.02

0.01

-

-

-

-

 

Source: MorningStar.com

Conclusions

Coach Inc. is trading around $37, still close to its 52-weeks low price, and has a limited upside potential in the short term. Nonetheless, the price is already up more than 8% since the first time we suggested our Premium customer to buy the shares. In the long run, the company has big opportunities to grow internationally and to restructure his brand in North America further driving the price up in the next one to three years.

The attractive low price and the high dividend yield, still more than 3.7% at the time of writing, make this stock a good option for income investors and long term investors. The dividends have been constantly rising in the last 5 years, an average growth of 38% YOY, with a sustainable payout ratio supported by consistent generation of free cash flow.

In our opinion, it is unlikely that a strong brand like Coach will see further big reduction in the market share in North America while failing their international expansion as well.

Disclosure: The author is long COH.

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.