Since Coach (COH +0.33%) initiated a dividend in 2009, the annual cash payout has grown rapidly. But recently increases have leveled off. Is Coach's dividend growth coming to an end or is this a temporary blip?
Coach bag. Source: Coach.
Coach's dividend history
In order for investors to look at Coach's dividend potential, it's important to first look back. Since it initiated its dividend, annual payments have increased from $0.8 to $1.35. But this healthy stretch of growth came to an abrupt halt in the first half of 2013 -- the last time the company increased its dividend.
Leading up to 2013, significant dividend increases made perfect sense. Between 2009 and 2013, free cash flow increased at an annualized average rate of 20%, driven by soaring revenue and a rising gross profit margin.
But things have changed.
What were the drivers behind Coach's pause in dividend increases? The company's business, in general, has faced significant headwinds since 2013. For instance, Coach's trailing-12-month revenue of $4.2 billion is well below its $5.1 billion in revenue in 2013, when the retailer's revenue peaked. Free cash flow is also down since 2013, falling significantly from $1.2 billion to $728 million. And its impressive gross profit margins have narrowed, declining 347 basis points during this period.
Red flag or buying opportunity?
While Coach has certainly been operating in a challenging environment that is probably more competitive than most Coach shareholders anticipated, the retailer still looks like an enduring business with a powerful brand. A heady gross profit margin of 69% speaks to its continued pricing power with consumers, and the record levels of cash on its balance sheet -- $1.5 billion -- provides some comfort, too. Yes, Coach's business isn't where it was in 2013, and it may take years for it to ever get back to this point, but consumers are still buying Coach products at premium prices and there's no reason to believe this will change.
Even more, a quick look at its financial statements reveals its dividend has plenty of room to grow. Of Coach's fiscal 2014 and 2015 free cash flow of $766 million and $728 million, it paid out just $376 million and $372 million in dividends, respectively. Coach's dividend payouts, therefore, amount to just 51% of its free cash flow. This leaves some significant wiggle room for dividend payouts.
Of course, with Coach's earnings and free cash flow on the decline, investors shouldn't automatically expect it to resume meaningful dividend increases in the years to come. But, fortunately, Coach doesn't need to increase its dividend to achieve a respectable dividend yield. After a major pullback in the company's stock price during the past two years, Coach's dividend yield has increased -- even as dividend increases have leveled off. Shares are down from over $55 less than two years ago to $30 today. During this same period, its dividend yield has increased from 2.5% to a meaty 4.75%.
Given the underlying strength in Coach's fundamentals, the stock looks enticing for dividend investors looking for high dividend yields. Sure, income investors buying Coach stock shouldn't bet on meaningful dividend increases in the near future, but the retailer's enduring brand and strong business should support a dividend around these levels for years to come.
And who knows? Maybe Coach will eventually work its way back to decent increases. This would just be icing on the cake.
