COACH A BUY OR NOT

“You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.”— Ben Graham

COACH A BUY OR NOT 

Business / What the company does: 

In their own words:
Coach has grown from a family-run workshop in a Manhattan loft to a leading New York design house of modern luxury accessories and lifestyle collections. Coach is one of the most recognized fine accessories brands in the U.S. and in targeted international markets. We offer premium lifestyle accessories to a loyal and engaged customer base and provide consumers with fresh, compelling and innovative products that are extremely well made, at an attractive price. Coach’s product offering uses a broad range of high quality leathers, fabrics and materials.

Coach is now selling products in Men's market and trying to make it a global lifestyle company, more on it later.
Brief History :

Founded in 1941, Coach was acquired by Sara Lee Corporation (“Sara Lee”) in 1985. In June 2000, Coach was incorporated in the state of Maryland. In October 2000, Coach was listed on the New York Stock Exchange and sold approximately 68 million shares of common stock, split adjusted, representing 19.5% of the then outstanding shares. In  April 2001, Sara Lee completed a distribution of its remaining ownership in Coach via an exchange offer , which allowed Sara Lee stockholders to tender Sara Lee common stock for Coach common stock.

Products: 

And as you can see Handbag business slowly declining and representing smaller portion of the Net sales, though still selling healthy, thanks to the International segment growth.

Also noticeable that Men's Segment now represent 14% of sales. 

Industry : 

Coach is in Luxury retail industry which has done remarkably well in the past as they don't compete on price as the rest of the retail industry does, so this is unique segment of retail. 

Competition : 

Michael Kors ( KORS) and Kate Spade are some of the noticeable competitors who are taking market share away from the Coach, there are numerous articles on Seeking alpha bout Coach and the competition its facing. 

And that's the main reason that Coach has recently lost ground to its competitors and its stock price has tumbled a lot this year from 54 to 36 at the time of writing this article. You can see from the graph below which is actually from COH annual statement that the Price performance has suffered in last 2 years.

Here the Peer group involves Gap, Guess, Tiffany, PVH, L Brands, Ralph Lauren, Williams Sonoma. Though I dont think Coach directly competes with all of them

Another thing I wanted to touch upon was 

Manufacturing :

Coach carefully balances its  commitments to  a limited  number of “better brand” partners with demonstrated integrity ,  quality and  reliable  delivery .  Our manufacturers are  located  in  many countries,  including  Vietnam,  China, the  Philippines,  India,  Thailand, Italy , Hong Kong and the United States. 

5 of these vendors supply >10% of Coach's Total Units, though these vendors may have multiple geographic locations themselves, Reason I mention it here is when I went through Its competitor Michael Kors statements they don't have any contracts like these with their suppliers. 

Highlights from latest Earnings report : 


In fiscal 2014,  we reported net sales of $4.81 billion,  net income  of $781.3 million  and net income  per diluted share of $2.79. 
This compares to net sales of $5.08 billion, net income of $1.03 billion, and net income per diluted share of $3.61 in fiscal 2013. 
In  fiscal  2014, the  comparability  of our operating results  has been affected  by $131.5 million  of pretax charges ($88.3  million 
after tax or $0.31 per diluted share) related to our Transformation Plan. So Non GAAP basis EPS is $3.10. In fiscal 2013, the comparability of our operating results was affected  by $53.2 million of pretax charges ($32.6  million after tax  or $0.11 per diluted share) related  to  restructuring  and transformation-related charges. So Non GAAP Earnings was $3.72 in 2013.

Operating performance for fiscal 2014 reflected a decline in revenue of 5.3%, primarily due to decreased revenues from our North  America business partially offset  by gains in  our International  businesses. 

North America Net Sales  decreased 10.9% or $377.7 million  to $3.10 billion. This decrease was primarily driven by lower comparable store sales of $460.5 million or 15% largely due to lower traffic, and lower wholesale sales of $26.1 million due to lower shipments.

Now lets Go through the steps of Stock selection to see if COH is a wonderful business. 

Do I understand what the company does, Is it beyond my circle of Competence?  

Yes I do understand and though no expert in Fashion/ Luxury Industry I am very comfortable with knowing what the company does and can relate to it. 

Does The Company has a Competitive advantage ? 

Yes, The company has been earning large profits for the shareholders year after year despite recent price decline. The margins are healthy, though there is recent decline which I think is temporary, there is no Price competition. 

A company earnings Net margins close to 20% with ROE consistently from 34% to 50 % range over last  10 year. 

Shareholder Friendly management : 

Yes, Look at the cash flow statements below and you will see management has been consistently returning money to shareholders through dividends and Share buybacks, and growing the business. Though there has been recent change in management including Lew Frankfort leaving the CEO position in 2014 and now leaving the chairman position too by end of year ( with company since 1979, CEO 1995), Victor luis joined as CEO who has been with company since 2006. 

Reed Karakoff left as executive creative director and Stuart Vevers joined in 2014.

The new management seems to take over and giving the company a new direction. COH enjoyed earnings growth over last many years through their affordable Luxury segment, which is exactly whats hurting them now, as that segment of the  business is hard to compete with Kors and Kate spade as they seem to be offering more competitive products in that price range, but now COH seems to understands that they need to stay as a Luxury brand and need to build their brand image again in their loyal customers who are usually higher income segment of the population who really doesn't care about price. 

Dividends : Started paying in 2009 at  $.08 which has increased every year to 

$ 1.35 now giving currently a Dividend Yield of 3.72% at the time this article is written. Payout ration is currently approaching 44%. 

Stock Buyback : 

Shares outstanding has gone down since 200 when it was 372 mil approx and is now 273 mil. 

During fiscal 2014 and fiscal 2013, the Company repurchased and retired 10.2 million and 7.1 million shares, respectively , or $524.9 million and $400.0 million of common stock, respectively , at an average cost of $51.27 and $56.61, respectively . 

 As of June 28, 2014, Coach had $836.7 million remaining in the stock repurchase program.

Is the company buying more stock when its cheap ? well its been buying the stock consistently without break, so not sure on that point. But good thing is that now that the stock is cheap and getting hammered company isn't holding back on buyback :)

Is The company Conservatively Financed :

Yes, till 2014 it had negligible debt.

Will Not need to calculate Debt to equity, Quick or current ration or Interest coverage Ratio here.

Is the Business Profitable and has a Consistent Track Record of doing so :

Yes and they have been doing it for long time. 

Now lets talk numbers: 

PE ratio is 13.06 ( from Google finance) 

Will use Dividend adjusted PEG ratio ( as the company pays healthy dividend and will continue to pay so) is depending on what growth rate you use, for simplicity lets use Yahoo Finance estimates of 5.75% for next 5 yrs. = 13.06 / ( 5.75+3.72) = 1.379


I am not going to give details on the Financials but will go through important ones. 

From 2014 Annual report 

EPS vs Diluted EPS : less than 1 % difference ( 0.72% dilution) Acceptable. 
( > 2 to 3 % is considered bad) 

From 2014 Annual report, Decrease in Margins in 2014 is obvious give the transformation company is going through and it should be temporary for things to workout in Shareholders favor. 

Company is converting every Dollar of sales into 16 Cent Free Cash now, used to be much higher.

So lets look at some more numbers :

ROA = Option 1: Net Profit Margin X Asset Turnover = Return on Assets

Option 2: Net Income ÷ Average Assets for the Period = Return on Assets

781336/3597514 = 21.71%

ROE:  lets look at DuPont model.  ROE = Net profit ratio * Asset turnover * Equity multiplier. Its The Return you will get without Equity ( ROE ).


ROE = 0.163*1.3360*1.4897= 0.3236 which is 32.44% ( Whic s ROA x Equity Multiplier )

 We can calculate this via other simpler method too:  ROE = Net Profit/ Average Shareholder Equity  =781,336[( 2,420,653 + 2,409,158)2] = 781,336/2,414,905 = 32.35% which is approx same as we calculated above. 


Growth in Equity and Book value over last 10 years.

     I will use Value line numbers for these. 

CAGR for Shareholder Equity 11.86% over last decade. 

CAGR book value is 15.09% over last decade. 

Lets also look at ROIC : ROIC  = NOPAT/Invested Capital
NOPAT = EBIT (1 - tax rate) Net operating profit after taxes.  Same as Net income with interest Expense (Net of taxes) added back.

Invested Capital = Average Debt Liabilities + Average Stockholder's Equity ( equals Equity and all Short term and long term Debt or preferred share if it exists) + Capital lease obligations

So here :  NOPAT = 1,120,074( 1- 0.304 )= 779,571

Operating Capital = Average debt of {(401.2+140.5)2} + 2,414,905 = 270.85+2,414,905 = 2,415,176 

ROIC = 779,571 / 2,415,176 = 32.278% Pretty close to our ROE

CROIC =  Free Cash Flow / Invested capital

FCF = Cash from Operations –  Total CAPEX 
Many times CAPEX can be find in cash flow as PPE
985,410 - 219,587 = 765,823 

FCF per share = 765,823/ 280,379= 2.731 

FCF can be replaced by Owner Earnings if you prefer 

Owner earnings = Net income + depreciation & amortization +/- one-time items +/- Changes in Working Capital –  Maintenance capital expenditures (Maintenance CAPEX)
= 781,336 +189,360+108,204 -162,403-189,360 = 727,137

What percentage of the Sales are represented by Amortization/Depreciation. = Amortization + Depreciation/ Sales  = 4,806,226 /189,360 = 3.94% Roughly 4 % 

Inventory and Receivables : 

COGS / Average Inventory for the Period = 1,509,263/525440.5 = 2.872 turns. 

 Coach sells its Inventory 2.87 times every year. 

Using Inventory turnover to calculate average days to sell products = 365/2.872 = Approx 127 days. 

100k Invested 10 yrs ago will be how much ? 

Its an interesting question to answer, I have done the tedious math, but the answer is approximate. 

So 100k Invested in COH yr ago will be 383,240 with Dividends reinvested, that comes out to be CAGR 14.38%

This is despite the recent price decline, Had you Backed out and sold it a year ago,

 you would have roughly 538,706 which is 18.34% CAGR over 9 yrs. 

Adjusted for Splits you would have 10,357 shares and your Dividend check alone will be 

13,983 for this year and is ready to grow next year. 

Which gives a rough Dividend yield of 14 % on Original Investment. 

Obviously  I haven't Taken Inflation into Account. 

How about Yield ? 

PE ratio is 13.06

Earnings yield ( 1/PE ) = 7.66% 

Dividend adjusted PEG ratio 1.379

Dividend Yield of 3.72% 

EBIT multiple at current price : Market cap/ EBIT = 8.91 times. 

EV/ EBIT = Here EV = (Market Cap + All Debt - Cash) = 9,528,562/1,120,074= 8.50 

FCF yield = 1/(36.33 current price/ 2.731) = 7.52% 


DCF Analysis : 


Using the last 10 yrs of FCF and taking average CAGR of 4, 5 & 7 yr period median gives me roughly 10% growth over last 10 yrs. 
will use same number going future too. though future might be Rough. Some Analysts are predicting growth rates of 4-5% 

Using terminal growth rate of 2 % for 10 yrs and 12% discount rate gives us a Fair Value of 37.59 which leaves no Margin of safety.

But as said future is hard to predict, This company isn't going anywhere in next 5- 10 yr, I am getting healthy dividends ( which will be reinvested),  I cant see worse situation in next 5 yrs for reasons outlined below. 

So How does the future looks like. 

Well the reason stock price is down because many thinks its in permanent trouble.

--Company has a Transformation Plan : 

Company's Transformation Plan Focus on these 4 elements 
•  Grow our business in North America and worldwide, by transforming from a leading international accessories Company into a global lifestyle brand, anchored in luxury accessories.
•  Building market share  in  markets where  Coach  is  under-penetrated,  most  notably  in  Asia  and  Europe, South America and Central America. 
•  Focus  on  the  Men’s  opportunity  for  the  brand
•  Harness  the  growing  power  of  the  digital  world. Key elements include 
www.coach.com,  our  invitation-only  outlet  Internet  site,  our  global  e-commerce  sites,  marketing sites  and  social media. 

--COH is focusing on selling more higher priced handbag:  here's an answer to question asked in Their 2014 Transcript: This seems to be a trend away from Affordable Luxury or the segment where Kors is hurting them the most. 

"As you go into the bottom of that first page or into page two or three, you'll see that we have not given up the $200 price bucket, $300 or $400 price bucket and that we continue to be very active in that space.  These are strategies that we've been leveraging globally quite successfully. What is increasingly happening globally is brands headed further into the leather space. As many of you know, our European competitors have a very hard time achieving price points below $1,500, below $2,000 when it comes to leather handbags. So the opportunity for us is not just to play with lower prices, but to play with increased value and perception through quality and that's where we're going to look to change the value proposition in the months ahead; but doing so by re balancing the assortment not by shifting completely."

Francine Della Badia - President, North America Retail

"More generally, the above $400 price bucket grew in penetration and represented 22% of handbag sales, with the strongest performance at the upper-end of our range, $600 and higher. Emotion clearly trumped price, as our consumer is willing to pay more for compelling elevated products."

The combined North American premium women's and men's market rose about 9% in FY '14 to over $12 billion, with Coach representing a combined market share of about 23%.

--Company is cutting on All promotional activities through Internet  : 

- As noted on our previous calls during this fiscal year and as expected, our online business dampened our overall North America comp in the fourth quarter by about 3 percentage points. Specifically, our year-over-year comparisons continue to be impacted by our strategic decisions to both eliminate third-party flash events this fiscal year and limit access and invitations to our outlet flash site. Excluding these factors, our Internet comp would have contributed to our aggregate performance.

-- Much better Potential for International growth: 

In addition, other key Asian markets and Europe offer significant potential for the Coach brand. In line with our plan, over the next two or three years we will be making significant investments in building new flagship stores and renovating existing flagships to our new concept with a key focus on international cities.

 "For the fiscal year, sales decreased 5% totaling $4.81 billion with North America down 11% and international up 6%. On a constant currency basis total sales declined 3% for the year with international sales up 12%."

--Company is closing lower Performing stores : 

Turning now to our financial outlook for FY '15, as our annual plans have not changed from those shared during our June Analyst Day meeting

First on sales. We expect to deliver a low-double digit decline both in constant currency and on a reported basis in fiscal 2015, largely due to our reduced promotion and store closure activity. We are projecting a high-teens comp decline in North America store with our e-outlet pressuring the aggregate North America comp by an additional 10 points. This equates to a mid-to-high 20% decline in aggregate comps.

In closing, our transformation required substantial investment and focused execution. We have a clear strategy and a well-articulated implementation plan for FY '15. We expect to realize a positive impact on the annual financials beginning in FY '16 with FY '17 being the year when we return to growth in line with the category.
So, Be patient here. 

We look at all of our product inventory and looked at certain products that we thought were not consistent with the brand image that we were trying to move into.

whole SKU lines that we eliminated from inventory and took those as a write-off rather than flowing them through the outlet channel and moving them into the market. So we really looked at where we're headed, where is the inventory not consistent with that direction, and we took the opportunity to write-off that inventory into the fourth quarter. We will destroy that inventory consistent with the write-off charge. 

-- Company destroyed Inventory worth 82 Million Charged to COGS which could have given additional 100 to 250 million of sales depending on the price if they were sold, But company wants to Focus on brand image and long term growth so they want to cut all promotional activities and not sell at cheaper prices and remain a luxury brand. 

--There are some other points which I might have missed here. Also at bottom line I believe COH makes better products for its customers and have been doing so for decades and will continue to do so. If I am willing to Hold COH for long period of time  ( at least 5 yrs maybe more) then the downside is limited, this transformation plan even if it has limited success will result in better future, and Potential for International and Men's segment is huge. I kind of feel this is "Heads I Win, Tails I Don't Lose Much." Lets wait and see.