Lately, I've been looking very closely at the retail industry. The group has been flogged over the past six months. Fears of triple-digit oil prices, rising interest rates, and a total collapse to the housing market have investors worried that consumers will stay home indefinitely, shutters drawn, credit cards in the freezer. I don't share this extreme pessimism. I think our economy is doing fine, save for runaway federal spending -- an opinion that Nobel Prize-winning economist Milton Friedman holds as well.
The net result is that just as investors are selling retail stocks to annual lows, I've begun recommending them for long-term buyers in Stock Advisor. For that reason, I jumped at the recent opportunity to talk with Lew Frankfort, CEO of Coach (NYSE:COH). The introduction was made by Dan Levitan, co-creator (with Starbucks founder Howard Schultz) of Maveron, the lead private equity investor in The Motley Fool.
Coach, the retailer of leather handbags and women's accessories, has delivered 11-bagger returns to its shareowners since the company's IPO in 2000. That amounts to stunning gains -- in excess of 50% per year -- during a period in which the S&P 500 has actually fallen. But the stock has not been spared in the recent industry shellacking, and it's now more than 30% off its highs.
That's typically when I ask myself, "Is it time to buy?" I started my research by talking with Coach's CEO about the company's history and its prospects for growth. Here's what I learned.
1. The history and culture
Coach was spun off into the public markets by Sara Lee (NYSE:SLE) at the turn of the century, after struggling for years under organizational and compensation models that tried to mash together pound cake with handbags. It couldn't work; it didn't work. The company's growth ground to a halt in the late 1990s. Frankfort then negotiated the liberation of Coach from Sara Lee, something he compares to the separation of Lithuania from the Soviet Union.
The net result today is a focused business that concentrates on hiring talented people with a passion for the integrity of Coach's brands. Together with his senior VP of human resources, Felice Schulaner, Lew Frankfort has designed a compensation plan that earns employees an average salary for the industry, with an opportunity to go 25% higher for superior performance. "Our aim," Frankfort told me, "is to reward our best performers and to compel them to become better leaders of others. Collaboration is non-negotiable at Coach. Our company is a family, but you do have to perform to fit in."
Everything I hear about Coach's culture convinces me it's a place I'd like to work.
2. Prospects for growth
During its 11-bagger run, Coach -- now valued at just less than $11 billion -- has driven and benefited from the doubling of the women's-handbag business from less than $2.5 billion to nearly $5 billion today. Women are buying an average of four handbags per year, twice what they were in 2001. And during that period, Coach has extended its market share from 17% to 25% by integrating fashion (multiple colors and shapes) with function (space for a laptop and a BlackBerry).
The organization has plenty of fuel to continue this growth. On the balance sheet, Coach has more than $800 million in cash and investments. Management of working capital over the past six years has been simply fantastic. Remember, dear Foolish investor, that most retail companies struggle or fail because they build up far too much inventory. Coach has the advantage of not needing to offer the multiple sizes that shoe and apparel companies do. The company has capitalized on this advantage, driving massive sales growth alongside low inventory counts.
As a check to all these positives, over the next 10 years, Coach will have to open up more markets outside the United States (where it does 70% of its sales) and Japan (where it does 20% of its sales). These two markets account for 70% of worldwide luxury spending on handbags. Even though there is growth potential here, with Coach executing on plans to double its store count in the United States, the company must still demonstrate the ability to inspire handbag demand in emerging countries.
3. Leadership
Whenever I'm considering great investment opportunities among stocks that have fallen more than 25%, I look for:
- A corporate culture I believe in.
- The promise of superior growth backed by sound financials.
Coach has them both. And to these demands, I add my interest in finding leadership groups that understand their commitment to outside shareholders. After my conversation with Lew Frankfort, my assessment of the board of directors, and my analysis of the company's ownership structure, I came away with the conviction that Coach has thrived since coming public because of the great people it has attracted, people who understand their duty to treat shareholders as partners. I don't expect any of the sort of controversy that today surrounds companies like UnitedHealth Group (NYSE:UNH), where allegations of backdated stock options are tainting the company's achievements. Coach grants all of its options at the market price of the stock, and Frankfort told me that he finds options backdating and other compensation shenanigans "disgusting ... reprehensible."
My only concern about Coach's leadership is one that I have with a number of American companies. Coach bundles together the positions of chairman and CEO. And while I have the full confidence that Frankfort is a man of the highest ethics, I simply abhor the American practice of "rewarding" CEOs with board chairmanship. Kenneth Dahlberg, chairman of Buffalo Wild Wings (NASDAQ:BWLD), one of my favorite companies (and one that, not coincidentally, splits the roles of chairman and CEO), wrote to The Wall Street Journal that combining the chairman and CEO roles is like merging the pitcher and umpire in baseball. The result is that the board of directors cannot be considered independent.
I agree with him. I think it's a mistake. I urge Coach to split the roles, not because I worry about present leadership. Rather, I worry that future CEOs of the company 10 to 20 years hence will not be so good at standing as objective umpires of the company.
So, is it time to buy Coach?
With an owner earnings run rate of approximately $485 million, a sturdy balance sheet, and reasonable expectations of 17% to 18% profit growth over the next five years, I value this business around $27 billion by the close of 2011. That would generate 20% yearly growth for investors. I have no opinion on what Coach will do between now and the end of the year. But for long-term owners, I think the stock is attractively priced today.
With a depressed stock price, strong market position, and dedicated and talented leadership, Coach is exactly the sort of market-beating stock I look for every month at Stock Advisor. A free 30-day trial, with no obligation to subscribe, is just a mouse-click away.
Fool co-founder Tom Gardner does not own shares of any of the companies mentioned. Sara Lee is an Income Investor pick. Starbucks is a Stock Advisor pick. UnitedHealth is a Stock Advisor and Inside Value recommendation. Buffalo Wild Wings is a Hidden Gems recommendation. The Fool has a disclosure policy.
