Two weeks ago, in an exercise of self-abuse, I delved into luxury accessories company Coach (NYSE:COH). We looked at its history, its repositioning, and its remarkable success over the last couple of years -- all in the context of Coach being a business I should have invested in a long time ago.
Today, we'll carry it further by getting into Coach's financials, how it makes its money, and its plans for sustaining growth. We'll dig as deep as someone searching for a hidden lip-gloss at the bottom of her Mini Signature Ergo Zip. We'll get down. We'll get dirty. We'll get answers.
From the top
Let's start with the top line: revenues. Coach makes money from two main channels: direct-to-consumer sales and indirect sales. Its direct sales come from its 150 retail stores, 75 factory stores, and catalog and Internet operations. Its department store locations and Coach Japan generate the indirect component of sales.
For the first nine months of the fiscal year, direct sales constituted 58.1% of total sales, down from 62.1 % in the same period last year. Coach Japan's success is boosting the indirect side of things, with sales for that segment up 45.6% so far this fiscal year. Direct sales were up 23.2%, and Coach's total net sales increased 31.7% during the time period, to $721.7 million.
As I pointed out in my previous column, the company's sales grew 12% from fiscal 2000-2001, and 20% from fiscal 2001-2002. It expects net sales for this fiscal year to grow somewhere around 30% compared to last year, to $935 million. It's also shooting for at least 15% sales growth in fiscal 2004, which would bring sales up to around $1.1 billion.
To get there, it will have to maintain its plan to build lots of new stores. Coach plans to open 20 new stores this year, and intends to break ground on 100 new U.S. retail locations in the next four to five years. That'll bring the number of stores up from 150 to 250.
Coach is also banking on continued good times and acceptance in Japan. Its comparable store sales, which have been consistently strong even as such retailing giants as Wal-Mart (NYSE:WMT) have struggled to keep things on track, must stay solid, too.
Earnings aplenty
What about the company's earnings? They're also looking snazzy. Net income grew 66% from 2000 to 2001, and 34% from 2001 to 2002. So far this fiscal year, earnings are outpacing last year's by a hefty 70.5%, coming in at $116.8 million.
Assuming there are no negative surprises (and that seems unlikely since Coach routinely beats earnings estimates even after raising guidance), it should earn at least $1.54 a share for fiscal 2003, representing earnings growth on a diluted basis of 64%. For fiscal year 2004, it is hoping for 17% earnings growth.
Free cash flow
Free cash flow growth hasn't been as steady. Coach produced $58.9 million in fiscal 2000 and $91.1 million in fiscal 2001 in free cash flow. For fiscal 2002, however, its free cash flow fell to $51.4 million. (Tax benefits from stock options have been stripped out of all these calculations.)
The 2002 comparable shortfall was partly because in fiscal 2000 and 2001 Coach's cash flow benefited from two substantial payments for accounts receivables from former parent Sara Lee (NYSE:SLE). If we removed those payments for those years, free cash flow would have been $36.5 million for 2000 and $59.6 for 2001.
For the first nine months of the current fiscal year, the retailer has generated $99.8 million in free cash flow. That compares to $44.6 million during the same period last year. Given its huge earnings growth so far this year, and the fact that capital expenditures are expected to come in around $60 million, Coach's free cash flow this fiscal year should handily surpass last year's.
Capital expenditures will continue to grow in the coming years, as it adds stores upon stores to its U.S. retail network. The company spent $42.8 million last year, will end up spending around $60 million this year, and anticipates $70 million in capex for fiscal 2004. It's necessary here for Coach to shell out for growth.
Margins to gawk at
Turning now to margins, Coach has crafted gross margin growth almost as lovely as its handbags. By making the shrewdly smart decision in January 2002 to shut down its own production plants and outsource the manufacturing of its goods, the company has hit upon outsourcing magic, leading to much lower costs. The mix of leather and fabric that go into so many of its bags now, as opposed to leather only, has also helped out gross margins.
Check out the company's gross margins:
fiscal 2000: 59.07%
fiscal 2001: 63.61%
fiscal 2002: 67.19%
And for the first three quarters of the current fiscal year, gross margins have been 68.1%, 70.3%, and 72.5% for Q1, Q2, and Q3, respectively. Coach thinks it can continue to squeeze out gross margin growth thanks to better sourcing. That's impressive.
Net margins have been improving as well, as you can see below:
fiscal 2000: 7.18%
fiscal 2001: 10.66%
fiscal 2002: 11.93%
Net margins during the first nine months of the current year are sitting at 16.18%. Sweeeeeet.
Balance sheet findings
Let's take a quick peek at the balance sheet to make sure all is well there, too. As of March 29, 2003, Coach had $192.3 million in cash and equivalents, and about $3.6 million in long-term debt. The $33 million revolving line of credit sitting there belongs to the Coach Japan subsidiary.
The company's Foolish Flow Ratio was a respectable 1.21. Inventory levels inched up only 3.2%. Accounts receivables, though, rose substantially, to $46.7 million from $25.6 million. According to Coach, half of this jump belonged to Coach Japan and another $5 million of it came from credit card receivables. It recently changed the payment terms on some cards to get more favorable fees. There doesn't seem to be anything to worry about here, but it's always good to watch the receivables line for adverse changes.
What now?
So exactly how is Coach going to keep the fun rolling? As I've said, it intends to build lots more U.S. stores. It also will be concentrating more on its Japanese division, which is a joint venture.
It currently has 90 locations in Japan, and its products have been a huge hit there. Whether it's the hint of Americana, or just the subtle styling that Japanese consumers love, one thing's for certain: They want more Coach. And Coach wants to give it to them.
Right now, the company's luxury goods market share in Japan is 3%. Coach aims to double that to 6% over the next few years. Japanese and American customers buy more luxury accessories than anyone else in the world, so it's on the right track here.
It will also keep innovating and testing its products with consumers to make sure that they remain as fresh and hip as ever. Perhaps the biggest danger to Coach is one faced by any super-fashionable and trendy company: fashion risk. For Coach to keep growing like it has been, it must keep its cool, literally.
Even though it's been quite a ride for the past few years, the prospects for its business still look outstanding from here. Its U.S. luxury goods market share is 18%, and Coach thinks it can boost that to 30% in the coming years. Put that alongside the company's strong financial condition, plans for Japanese and U.S. growth, great-looking products, and a devoted following and this is one winner that still has some road left in front of it.
I only wish it weren't trading at 43 times trailing free cash flow. Everything else suits me just fine, but I want to pay a smaller premium for this premium-goods maker. I've got my eye on you, Coach, and will be waiting to pounce if a more reasonable price presents itself.
LouAnn Lofton doesn't own any shares of the companies mentioned. The Motley Fool is investors writing for investors .
