3 Reasons I Still Like Coach

It's been a bad year for Coach (NYSE: COH  ) . The company has been steadily taking it on the chin since missing an earnings estimate in January. In the last quarter of the 2012 calendar year, Coach lost focus on its core brand, and spent too much time hyping its men's and international offerings. Those areas did well, but at the expense of U.S. sales of women's handbags. That's a bad miss, and the fall from grace is at least partially deserved. But there's still a lot of room left for Coach to run, and even rivals like Michael Kors (NYSE: KORS  ) aren't going to be able to stop it from making headway. Here are three reasons you should consider adding Coach back into your wardrobe.

Financial security
Coach may have made a branding misstep, but its CFO, Jane Nielsen, has kept it on the straight and narrow when it comes to the books. In that last quarter, the company generated free cash flow of $567 million, which was only a small drop from the $572 million a year ago considering that the company moved up its dividend payment to the end of December. Along with being cash-friendly, the company also has little long-term debt, only $23 million at the end of last year. That's the kind of cash cow that investors should love.

That strength comes mainly from the company's excellent margins. Gross margin was still above 70% last quarter, and operating margin was 35%, a half a percentage point increase over the previous year. All of these financial strengths point to the second reason that I still like Coach.

Brand strength
Yes, I know that Kors is growing like kudzu. The company boasted a 41% increase in comparable-store sales last quarter -- which is just mean. Who does that? Coach is having to contend with those sales, but the success of Kors doesn't mean the death of the Coach brand. However, it can't be overlooked that Coach did have a 2% drop in comparable sales last quarter. As investors, we have to decide if that's the beginning of a trend, or merely a bump in the road, and I believe we're looking at a bump.

The main reason that Coach saw a drop could be seen in its windows and on its website -- it focused too heavily on men. The company made the right choice to open more men's locations and add more menswear to its existing locations, but it made the wrong marketing move. By focusing on menswear, it allowed Kors and others to step in with easy sales to women. The company has recognized that shortfall, and now it needs to do something about it, which I believe it will. This isn't going to be a one-quarter spring-back, but Coach should be back on track by the end of the year.

Brand integrity
The final reason I like Coach is tied to both its brand and its management philosophy. While brand strength represents the value that consumers see in a brand, brand integrity refers to the value that the company sees in the brand. Last quarter, Coach's management team decided not to increase comparable sales by pushing promotions, thus protecting the value they saw in the brand. Compare that to what Tiffany (NYSE: TIF  ) did during the market crash.

The jewelry company decided to reach out to a wider audience, and in doing so lost sight of the exclusivity that made it Tiffany. Gross and operational margins fell, pulled down by lower-price-point items and the competitive environment that the company waded into. Since 2009, though, Tiffany has made strides to polish its image, and now gross margin is almost back to 60%, with operational margin back above 12%. Coach has defended its brand, and refused to sell at lower price points just to drive short-term income. That's going to help it later down the line when it needs all the brand value that it can get.

The bottom line
Coach is a profitable, well-run, and well-branded company. I love the focus that management has on the products, and I think that the plan to get back on track is clear enough. With some work on its marketing message, and a view toward getting more of its core customers back through the door, Coach should be in a position to do very well this year, and for years to come.

Is Kors on the right course?
Michael Kors is one of today's hottest high-end fashion brands, and that's translated into one of the best-performing stocks in retail -- since its debut on the market in late 2011, the share price has more than doubled. But with all that growth, has the stock finally become too expensive, or is there still room left to run? The Motley Fool's new premium report on Michael Kors gives investors all the information they need to make the right decision. We cover the key must-watch areas, opportunities, and threats to the company that investors need to know. To claim your copy, simply click here now for instant access.


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