(NYSE:KORS)

Source: Coach.

Beating expectations
Coach reported $1.14 billion in fourth-quarter revenue, down 7% from the year-ago quarter but 5% higher than analysts expected. The company also beat analysts' earnings expectations, reporting $0.59 earnings per share compared to a consensus estimate of $0.54.

Coach's earnings surprise comes a day after Michael Kors' earnings surprised to the downside. Shares of Coach's key competitor fell on Monday after reporting 43% revenue growth, including 30% growth in North America, but they were climbing on Tuesday.

North America slowly getting better
That Michael Kors shares declined after reporting such growth is a testament to the changing fashion retail environment. Coach's grip on the U.S. handbag market is in decline. Its market share fell from 19% to 17.5% between 2011 and 2012, while Michael Kors' share increased from 4.5% to 7% in the same period, according to information from Euromonitor International as noted in a Reuters article from January. Coach derives nearly 60% of its revenue from women's handbags, so the market share decline is worrisome, though the percent attributable to handbags has been declining for Coach. 

Although U.S. handbag competition is not letting up, Coach's North American business performed somewhat better this quarter than last, though sales still fell. North American comparable sales declined 17% in the quarter, better than Q3's 21% decline. Still, Coach needs to adjust its offering if it wants to fend off the growing number of competitors in the U.S. handbag market.

Overseas growth is promising
With the U.S. market already saturated with luxury brands, Coach's best growth markets are overseas. The company's international sales grew 9% in the quarter, including 20% growth in China. China is Coach's third-largest market in terms of store count, behind North America and Japan, and represents a strong growth opportunity going forward.

However, Michael Kors' presence in Japan and the country's mature economy will temper Coach's international growth. Coach's Japanese sales declined 6% year over year, but rose slightly after adjusting for inventory movements. This could serve as an anchor on Coach's international growth prospects going forward.

Returning capital to shareholders
Although retail trends are fickle, Coach's best days are probably behind it.  With competition heating up in the U.S. handbag market, and even strong growth in China not enough to outweigh Japan's sluggishness, investors are best served if the company manages its decline and returns capital to shareholders. 

Luckily, management is doing just that. Coach used $525 million -- more than half of its annual free cash flow -- to retire 10.2 million shares in fiscal 2014 at an average cost of $51.27. The company has $835 million remaining under its current repurchase authorization that expires in June 2015. It also maintained a $0.3375 per share quarterly dividend, or $1.35 per year. That's a 3.9% yield based on yesterday's closing price of $34.31 per share.

Taken together, the share repurchases and dividends ensure that the vast majority of Coach's free cash flow is returned to shareholders. For a stock trading at 10 times earnings and trying to stave off further declines in the U.S., Coach's capital allocation strategy likely favors long-term shareholders.

Foolish takeaway
Coach turned in a better-than-expected quarter this week while Michael Kors disappointed expectations. Although Coach's U.S. sales continue to decline and Michael Kors' are increasing, the former's decline is decelerating and the latter's ascent is slowing. This is good news for Coach shareholders, who were rewarded today with a boost to the stock price. Moreover, management reiterated its commitment to returning cash to shareholders – the best strategy in Coach's current situation. If Coach's U.S. sales outlook continues to improve, 2015 could be a much better year for Coach investors.

Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends Coach and Michael Kors Holdings. 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.