This article is an update of my earlier article explaining my investment thesis on Coach (COH). To get a more complete view about the company, check out my first article.
North America turnaround
My investment thesis for Coach centers on the idea of a great business, shown by returns on equity and returns on invested capital in excess of 15 percent in every year over the last decade, that had a big but solvable one-time problem. In this case, management did damage the brand equity by being overly promotional and focusing on the outlet channel.
I recommended shares of Coach after management had admitted its mistake and focused its attention on rebuilding brand equity by renovating its retail stores and stopping its promotional events.
After two quarters, one can say that all of what the management has said how this turnaround would happen has happened.
Catalyst I: Return to positive comps
For the company as a whole, comparable same-store sales were flat last quarter. This is a clear improvement from the comps seen a year ago at over -20 percent and the comps seen the quarter before with -3 percent.
The comparable same-store sales are positive in all the renovated stores, even the ones renovated over a year ago. With further renovated stores maturing and new stores being renovated management guidance for positive comps in the next quarter should be no problem.
In fact, during the last conference call, management said that the comps were already positive in February and March. Comparable same-store sales are one of Wall Street's favorite metric for retailers. Therefore, I expect shares rise after Coach reports positive comps.
Catalyst II: Sale of the old HQ and the Hudson Yard's JV
Another catalyst should follow soon after the year-end results are in. Coach is in negotiations to sell its former headquarter and its interest in the Hudson Yard's joint venture where the company's new headquarter is situated. In an excellent article, Seeking Alpha contributor Paul Goncalves valued the value of those real estate assets at $1.1 billion.
Price: Still a bargain
This money could be used for share repurchases at very attractive prices. Given that Coach trades at a normalized free cash flow yield of around 10 percent and in the past has traded for a free cash flow yield around 4 to 6 percent.
I estimate that Coach will generate $1 billion of free cash flow in its financial year 2018. If the company will trade at its normal valuation multiple, the IRR will be over 20 percent.
Management: ROIC mind set
I love the fact that management has shareholders' best interest on the forefront of their mind and initiated a cost cutting project to improve margins going forward.
The management at Coach is really top notch. See for yourself by watching this video of Coach's CFO giving a talk at Darden. Especially interesting are the section about corporate culture from 29:30 to 32:40 and the evolution of the luxury retail space from 49:00 till the end.
Luxury brand with pricing power
Lastly, I might extend my thesis on Coach. Management's elevation strategy is working. Goods sold with a price point above $400 represented 40 percent of the company's revenue up from 30 percent a year ago.
Additionally, this season Coach came out with a vintage collection of handbags from the 60s and 70s. This, in combination with its extended service offerings like the craftsmanship bars, reminds me of elite European luxury companies like Louis Vuitton (OTCPK:LVMHF) and Hermes (OTCPK:HESAF). Their goods are basically price inelastic and don't decline in price even after 10 to 20 years. Maybe Coach is on its way of getting there, but fortunately this will only play a role in my decision to sell Coach after it has appreciated or hold it long term due to its big franchise.
Why would not I sell Coach in the instant it could become a luxury franchise like Louis Vuitton or Hermes? Because its competitive advantage period would be nearly infinite. That is something very rare indeed, especially with such competent managers on board as in this company. Check out this excellent article by Michael Mauboussin to learn more about CAP.
Stay the course! The thesis is playing out as planned and the upside potential is still huge.
Disclosure: I am/we are long COH.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.