Why Coach Has Been a Fashionable Buy

Coach's current valuation presents a buying opportunity because it has a sound turnaround plan.

Apr 17, 2014 at 7:51PM

If you follow luxury retail companies, a search for commentary that bashes Coach (NYSE:COH) and praises Michael Kors Holdings Ltd (NYSE:KORS) takes just a few seconds. The industry space is extremely competitive, and other names such as Kate Spade & Co (NYSE:KATE) and Tory Burch look to take market share, but consumers continue to prove that the space has room for many successful brands. While Michael Kors' and Kate Spade's runs have been exciting, Coach is preparing to get back in the race for luxury love.

Flying coach under the radar
Short-term investors will gripe about Coach's stock being down over 10% for 2014, but long-term investors will focus on metrics such as the company's 24% growth in free cash over the past three years. Buybacks over the same three years have aided earnings per share to bring the stock to a P/E that that stands 35% lower than the industry average as classified by Morningstar

Despite its stock's struggles in the US, Coach opened 24 new factory stores that helped its North American sales rise 4.9%. Although this growth pales in comparison with the 138 total store openings Michael Kors has achieved as of its fiscal year that ended just over one year ago, Coach's growth is significant considering that the company is in a rebranding phase.

The rebranding mentioned above is led by Coach's executive creative director Stuart Vevers. The designer often receives credit for giving English luxury brand Mulberry a high-profile image and he received the award of Accessory Designer of the Year at the British Fashion Design awards during his tenure at the company. This is no guarantee of success, but appointing a designer who has worked with Marc Jacobs at Louis Vuitton is a move in the right direction. 

A crowded catwalk
Hearing people say "Coach is a dead brand" confuses me. Struggles aside, Coach raked in over $5 billion in revenue in 2013 and increased its sales in China by 25%.  The underlying problem when it comes to the stock is that rebuilding phases are rarely favorable for share prices, and it doesn't help that Coach's main competitors are breaking company records every quarter. 

Fashion is a cyclical business because people are temperamental by nature. Beyond human psychology, markets are becoming healthy enough to support multiple big names in the same sector in the world of luxury retail and beyond. A stroll through a local mall will reveal customers at AT&T, Verizon, and T-Mobile; rarely is one store packed while the other two are empty because phones are always in demand. Luxury retail goods aren't going anywhere either.

Department stores feature luxury handbags with custom displays, but when consumer habits change some brands will get more space than others do. At the moment, Michael Kors is the handbag of choice and the brand is extremely popular across generations. However, Coach is still growing ahead of the September fashion lineup, which will bring the first collection from Vevers. If his proclamation that "this brand resonates with everyone in America" is anywhere near true, things are looking bright after the summer. 

Lifestyle competition
Michael Kors gets the most attention among the Coach competitors, but Kate Spade could be even more formidable in the future. Much like Coach, Kate Spade is after more than being the handbag of choice. On a mission to hit $4 billion in sales, Spade's chief executive officer Craig Leavitt is focusing on categories such as fragrances, jewelry, watches, and sunglasses. Just as with the smartphone war for brand supremacy, Kate Spade is trying to become the brand of choice in luxury retail. Leavitt comes from Ralph Lauren Corp and looks to follow in that company's footsteps in gaining a presence in the home as well; the company will offer table linens this year. 

Coach is becoming known for more than handbags as well, which shows in its successful men's business. In its fiscal 2013, Coach's men's division increased its portion of company net sales by 3%. It may not sound like much, but this steady growth could result in the division hitting $1 billion in sales by fiscal 2016.  The only other division that grew along with the men's division is categorized as "all other products," which includes smaller goods, sunglasses, and fragrances. 

Wake up before September
The new collection from Vevers will hit stores in September, but the stock may not remain as attractive for too long. Although it hasn't exploded in growth like Kate Spade or Michael Kors, Coach sports a forward P/E which is a quarter of the value of Kate Spade and half of the value of Michael Kors, as reported by Morningstar. At just 13.8, this stands below the average of the entire S&P 500, and the stock yields a healthy 2.72%. If Coach's growth plan pans out anywhere near its projected success and the company can maintain its 31.4% median operating margin, it's simply a steal. 

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Kyle Vaughan has no position in any stocks mentioned. The Motley Fool recommends Coach, Michael Kors Holdings, and Morningstar. The Motley Fool owns shares of Coach and Michael Kors Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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