Sure, you love the 3.7% dividend yield headline that Coach (NYSE:COH) is broadcasting, but do you love the outlook for the future, too? Coach's sales have taken a hit over the last two years as competition has heated up and the company hasn't managed to hold onto its core North American audience. With sales at risk, is there a risk that Coach's dividend might take a hit as well?
The company's cash on hand position has weakened over the past year, and its free cash flow dropped from $1.71 billion in fiscal 2013 to just $766 million in 2014. The company was still able to clear its dividend commitment this year, but the payout used up $376 million. It also spent $525 million on share repurchases over the year.
There are some troubling trends here for dividend investors, and there are two main themes that investors should keep an eye on. The first is sales, and the second is capital allocation. Here's a deeper look at what the company is doing and what it needs to be doing.
Sales leave much to be desired
Strong brands eat up market share. Coach has had sharp drops in comparable sales, with North American comparable sales dragging the whole business down last year. American comparable sales fell 15% last year, an indication that Coach is having trouble keeping shoppers interested.
Over the same period, the company estimated that total premium market in North America grew by 9%, casting Coach in a very weak light. The problem is that companies like Michael Kors (NYSE:KORS) are taking more than their fair share. Kors has managed to keep its brand fresh and strong, growing comparable sales by 20.6% in North America in its last fiscal year.
It's not just a matter of comparing Kors and Coach, though. Coach is struggling because it's had trouble focusing on its core demographic due to its expansion. The business has been growing its men's line, pushing it out to stores across the U.S. and seeing good results.
The problem is that the strong sales in men's aren't strong enough to replace the sales lost from women who feel like the stores have shifted away from their values by embracing more menswear. Worse than that, Coach's re-imagining of the brand might not resonate with shoppers. Stuart Vevers' new designs are a vast departure from Coach's classic lines, and that's a big risk.
Jumping from the top of the statement to the very bottom, it's clear that Coach is still spending cash -- even if it's not making enough of it. The company has been increasing its dividend -- yay -- but by doing so is it eating into its reserves -- boo. That means that dividend growth isn't sustainable as it stands. It also means that, even if things start to get better, the company might need to hold off on making increases in the future just to catch up with itself.
Beyond its payments and repurchases, Coach is also spending on rebranding and reorganizing itself. The company spent $53 million in the fourth quarter on restructuring. It's also going to have to spend on marketing and design to launch its newly refreshed face over the next year.
To cap it all off, even the money spent on buybacks has been questionable. The $525 million it spent on repurchasing shares took another 10.2 million out of circulation, but at an average cost of $51.27 per share. That was 14% off of last year's high, which would be a great deal -- but it's also 40% higher than today's share price.
Looking to the future
Coach isn't dead in the water, and its turnaround program may connect with shoppers to boost sales over the next year. The concern is that it's chasing a new audience at the expense of its core demographic. That's going to hurt sales and hurt the company's cash position.
If Coach takes too many more hits, it's going to have a very hard time keeping its foot to the pedal when it comes to dividends and buybacks. That level of uncertainty is the opposite of what dividends are meant for. Coach needs to rethink how it's spending its cash, and perhaps take a break from upping its payments. It's not good news, but it's realistic.
Andrew Marder 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.