Coach's Recent Earnings Created a Great Opportunity

Coach (NYSE: COH  ) reported a less-than-stellar quarter a couple of weeks ago, so I'd like to take a moment to examine where the company stands now. Coach's stock is extremely earnings-reactive, generally shooting up or down by 10% or more after issuing a quarterly report, so it is a pretty good idea to wait until the dust settles and the initial market reaction has played out. 

Source: TD Ameritrade.

As it stands now, after two not-so-great quarters Coach has lost more than 13% of its value and it is one of the few S&P 500 companies that have declined in value over the past year. Is Coach an undervalued buying opportunity right now, or is the increasing competition from rivals such as Michael Kors (NYSE: KORS  ) and Fossil (NASDAQ: FOSL  ) beginning to take its toll?

Recent performance and the quarterly numbers
The market in general seems to have such lofty expectations that it seems to react badly to any company that doesn't issue stellar earnings. Coach's quarter was not bad, by any definition of the word. The company earned $0.77 per share for the quarter, which is exactly what the consensus projected. Revenue fell just shy of estimates, at $1.15 billion versus $1.19 billion, mainly due to currency fluctuations. On a constant currency basis, however, sales actually rose by 2% year over year. 

Other significant items from the recent report included an increase of 35% in Chinese sales and a 2% actual sales dip in Japan. The latter hit the company like a ton of bricks due to the soft yen, which turned the 2% decline in sales into 22% less revenue. 

Part of the decline is likely due to the fact that competitors are posting much better numbers, which leads investors to believe that Coach is losing some of its momentum in the fashion marketplace. However, I believe that most of Coach's issues have more to do with the global economy and less to do with competitors. For instance, one of Coach's main growth areas is the men's business, and specifically the men's business in Japan, where men tend to be more fashion-conscious.

Valuation
On a valuation basis alone, it is looking like a good time to get in. After the recent share price decline, Coach trades for less than 15 times this year's expected earnings of $3.47 per share. The consensus projects earnings of $3.84 and $4.25 for the next two fiscal years, which translates to annual earnings growth of 10.7% for both years -- which alone would more than justify the valuation multiple. Adding to the company's value is the fact that there is about $855 million in cash and liquid assets on the balance sheet and virtually no debt, which makes the current valuation look even cheaper.

Threats?
Coach is not without risk, however. There is stiff competition in the fashion world, and some high-growth competitors are causing concern with investors.

Michael Kors in particular is a big threat, especially in regard to Coach's efforts to compete in the watch business. Watches currently make up less than 5% of Coach's sales, and this is an area the company has been focusing on improving. However, Kors is simply updating its watches faster than Coach and has thus far prevented Coach from taking any significant market share. 

Also worrisome to investors is the fact that Kors' sales rose 31% year over year in North America, while Coach's were flat. Also troublesome to Coach's watchmaking efforts is the growth in established competitor Fossil, whose sales grew by 18.1% year over year. 

However, I think that the biggest threat to Coach is not the competitive nature of the fashion watch business; it is the global economic trends and the company's success (or failure) in expanding its men's product lines. Even after nearly doubling its men's sales over the past year, men's products still only made up 11% of Coach's total sales, which leaves a lot of room for growth. If Coach can successfully replicate its women's handbag success with its line of men's products, that could make the competition from Kors and Fossil a moot point.

Bottom line
With cheap valuation and sales that are still projected to grow, I think Coach is worth taking a chance on after the recent decline in share price. Once Japan's currency begins to rebound and Coach's men's line realizes its full potential, shareholders stand to be handsomely rewarded.

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