Counting On Coach (COH)

Coach (COH) sells expensive handbags and accessories that it designs and has made by independent manufacturers according to COH standards and controls. 

The recession has been tough on Coach: three years ago, it was Better Investing’s Growth Company of the Year, but its sales slumped to 1.6% last year.  Coach has fought back by dropping prices, launching a new line of more affordable handbags, and expanding further into China. 

With a recovery in the U.S., Morningstar expects solid sales growth and increased profit margins this year. Value Line also gave a glowing report and forecasts healthy EPS increases for the foreseeable future.

I just compared AnnC’s SSG, which I got from BI’s First Cut page, with mine and with Take Stock.  I also assessed Coach’s downtrends in Pre-Tax Profit Margin and Return on Equity, its financial condition, and its competitors.

Company Background:

- In FY 2009, handbags accounted for 62% of COH’s sales while accessories were 29%; the U.S. accounted for 72% of sales and Japan 21%.

- According to Coach’s latest 10K annual report, the company is organized into two segments: Direct-to-Consumer and Indirect.

** Direct-to-Consumer consists of Coach stores in North America, Japan, Hong Kong, Macau, and mainland China as well as the Internet and the Coach catalog.  This segment represented 89% of FY 2009 sales, with the North American stores accounting for 61%.

### In North America, COH had 330 full-price retail stores and 111 factory stores at the end of FY 2009.  Coach Japan consisted of 155 stores and Coach China 28.

** The Indirect segment represented 16% of FY 2009 sales with COH products sold at more than 930 department stores (wholesale customers) in the US, in over 20 countries at some 160 department stores, and at 155 in Japan.

### U.S. indirect sales have been flat at around 10% for several years.

** The company has identified four key growth initiatives:

• Increase market share re North American women’s accessories;
• Grow North American retail stores, in both new and existing markets;
• Expand market share in Japan by opening new locations; and
• Raise brand awareness in China by opening new locations.

- Morningstar explained that COH fills a void between designer labels and moderate brands with its high-quality, smartly priced goods.  “Accessible luxury” is how Coach describes its products.

** COH recently reduced its handbag prices from the $300-400 range to $200-300 and also launched its Poppy line which sells for an average handbag price of $260.

** In 2010, the company has plans to open 20 stores in North America, 10 in Japan, 15 in China and 30 wholesale stores in international markets.   

- Value Line reported that COH’s stock price has risen 25% since its February report, mostly on the basis of its third quarter results with Sales up 12% and EPS up 28% (based on S&P data).

** The company has announced plans to open 14 stores in France over the next three years and, within the next year, new stores in the U.K., Ireland, Spain, and Portugal.

** These plans, together with COH’s doubling of its quarterly dividend, prompted VL to substantially raise its estimates in May for the next 3-5 years by 24% for EPS and its High Price estimate from $45-65 to $55-80.

SSG Discussion:

- Armin-1 used the same judgments and price as Ann except that I projected future growth from the end of the last quarter while she projected from the end of the last FY.  I got a SSG Buy, but Ann did not.

- Armin-2 used a slightly lower EPS estimate (12.00% instead of 12.90%) and still got a SSG Buy.

Coach                   (COH)	AnnC	Armin -1	Armin-2	Take Stock
Date	7-9-10	Same	Same	7-14-10
Data	S&P	Same	Same	Hemscott-Morningstar
Price	$36.50	Same	Same	$37.16
52 week High &    Low Price	$44.37 &           $22.94	Same	Same	Not Used
Last Quarter of   Reported Data	Q1 ending              3-31-10	Same	Same	Same
Software Used	Online SSG	TK 6	Same	TS Online
Project Growth   From End of	Last FY	Last Q	Same	Last FY
Sales Growth	10.00%	Same	12.00%	1.5%
EPS Growth	12.90%                 (from PP)	Same	12.00%	-10.8%
High PE	21.0                         (ave 2008-09)	Same	21.1	24.8
High EPS	$3.50	$3.87	$3.72	$1.08
High Price	$73.50	$81.30	$78.50	$26.70            (51% < VL)
Value Line Estimated High Price = $55-80 as of 5-7-10
Low PE	11.0                         (ave 2007-09)	Same	10.7	10.2
Low EPS	$2.11                     (ttm)	Same	Same	$1.76
Low Price	$23.21                   (low PE x              low EPS)	Same                    (Same)	$23.60 (Same)	$17.96 (Same)
Upside/Down	2.71              (under 3.0 criteria)	3.4               (satisfies 3.0 criteria)	3.0	Not Used and Impossible     to Calculate
Estimated Payout Ratio	24.0%	Same	Same	Not Used
Total Return	16.17%	18.5%	17.7%	- 6.2%
SSG Buy Under	N/A	$37.73	$38.20	$13.47
RV/PRV                   (outliers eliminated)	N/A	108.8/96.4          (3 high PEs out & 2 low out)	111.5/98.7 (Same)	Not Used
RV/PRV                 (no outliers)	N/A	83.9/74.3	82.8/73.3	Not Used
Quality	N/A	S&P = B+	Same	TS = 1.1 (fails)
PTPM – 5 yr ave	36.74%                  trend N/A	Same                   trend down	Same              Same	36.2%              trend N/A
ROE – 5 yr ave     End Yr Equity	38.02%                  trend N/A	Same                   trend down	Same             Same	Not Used
ROE – 5 yr ave    Begin Yr Equity	N/A	45.9%                 trend down	Same              Same	46.5%              trend N/A
Debt to Equity – 5 yr ave	N/A	0.5%                  trend up	Same             Same	Not Used

 Estimating Future Sales and EPS Growth:

 Ann’s SSG:

- Ann estimated 10.00% future Sales growth for the next 5 years based on COH’s expansion into international markets, especially China, but mentioned nothing to support her 10.00% estimate.

** COH’s Sales Growth has been declining during our recession and was 20.6% for the last five years, 15.9% for the last three and 1.6% for the last two.

** Morningstar was estimating long-term Sales growth in the mid to high single digits while Zacks.com was forecasting 15.99% for the next five years.

- Ann used BI’s Preferred Procedure to estimate future EPS growth for the next 5 years. 

** The PP involves 4 other estimates: Sales growth (Ann used her 10.00% estimate); Pre-Tax Profit Margin (33.00%, down from the 38.0% default which is the last 5 year average); Tax Rate (38.0% default); and Shares Outstanding (current shares default, 304.2M).

** Ann’s estimate of a 5% decline in Pre-Tax Profit Margin was a guess unsupported by any guidance.  VL, for example, expects COH’s Net Profit Margin to decline slightly from 19.3% actual to 19.1% in the next 3-5 years.

** Moreover, VL was estimating 275.0M future Shares Outstanding and that one change would have substantially increased Ann’s PP from 12.90% to 16.80%.

** I no longer use the PP because it involves too many estimates and too much guesswork; see: Pondering The Preferred Procedure.

Armin’s SSG: 

- When I did my SSG, the SEVEN analysts I always check were estimating long-term EPS at an average of 13.96% with Morningstar high at 16.00% and VL low at 10.00%.

** YahooFinance and Zacks.com were both at 14.00%, Reuters was 14.25%, S&P was 14.50%, and CNNMoney was 15.00%.  Reuters 8 analysts ranged from a low of 12.00% to a high of 15.00%.

** Armin-1 used Ann’s estimate of 12.90% EPS growth while Armin-2 used 12.00%, the very lowest estimate by one of the Reuters analysts.

** To learn more about estimating EPS, see: Estimating EPS.

Final Results:

- Of the four studies, only Armin-1 and Armin-2 satisfied the SSG BUY criteria of a minimum 3.0 Upside/Downside Ratio and a 15.0% Total Return. 

- The only difference between Ann’s SSG and Armin-1 is that I projected growth from the last quarter while Ann projected from the end of the last fiscal year.  In all other respects, we used the identical judgments, data and price.

• Ann got a 2.78 U/D and a 16.17% TR;
• Armin-1 got a 3.4 U/D and a 18.5% TR;
• Armin-2 got a 3.0 U/D and a 16.6% TR; and
• Take Stock got a -6.2% TR and the U/D was impossible to calculate because its Forecast High Price for the next 5 years was lower than COH’s current price (a SSG NO-NO).

- Ann used the Online SSG at the Better Investing website which only projects future growth from the end of the last FY whereas I used SSG software which offers three options for projecting future growth (from the end of the last Q, last FY, or the end of the EPS trend line). 

Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE):

- Both PTPM and ROE are trending down which are often red-flag warning signs of deteriorating fundamentals.

** The SSG software I use provides an explicit indication of these trends, but Ann used the Online SSG which does not.  Maybe that’s why she did not comment on them in her First Cut write-up.

- These downtrends don’t bother me because COH’s metrics remain outstanding:

** Morningstar-Hemscott data places COH in the Textile: Apparel, Footwear & Accessories Industry with 14 companies total:

• COH’s PTPM is way, way better than its industry average (36.5% vs 13.0%) and ranks 2^nd  out of 14; and
• COH’s ROE is also way, way better than its industry average (38.6% ending/46.5% starting equity vs 15.2% industry) and also ranks 2^nd.

** S&P places COH in the Apparel, Accessories and Luxury Goods Industry.  There’s no company-by company listing so no ranking is possible:

• COH’s PTPM is again way, way better than its industry average (36.7% vs 10.4%); and
• COH’s ROE is again way, way better than its industry average (38.0% ending/45.9% starting equity vs 18.1% industry). 

- I conclude that COH’s PTPM and ROE are trending down because they are unsustainably high and do not represent a troubling decline.

- This is the third time I have reported on Coach and its PTPM and ROE have always been high. See:

** Checking Out Coach (COH), November 5, 2009;

** Coach (COH): Better Investing’s Growth Company for the Year 2007 , September 3, 2007.

Financial Condition:

- Value Line gives COH an “A” for Financial Strength with $907M in cash and $25M in debt as of 3-27-10.

- Morningstar concludes that COH is in excellent financial health with little debt and the ability to turn 20% of its sales into free cash flow.

- The super-duper one-click spreadsheet by Bob Adams gives COH’s latest Annual Report a 52 out of 100 with 11 Bullish results (good things) and 10 Bearish (not-so-goods):

** The Bullish, good stuff includes: ROE, free cash flow, and long term debt to equity all rate a green flag (tops), and sales are increasing while shares outstanding are decreasing;

** The Bearish, not-so-goods include: accounts receivable, inventories and long term debt are all increasing, and the cost of sales is increasing faster than sales.

Competitors:

- No competitors are named in COH’s latest 10K report and the company says that it “competes with European luxury brands as well as private label retailers, including some of Coach’s wholesale customers.” [page 9, PDF page 12]

- According to YahooFinance, COH’s direct competitors are Dooney & Burke, kate spade, and Michael Kors, all three of which are privately held.

- Dooney & Burke’s website shows handbags selling for $165 to $395, kate spade from $195 to $695, and Michael Kors from $148 to $2295.  Cole Haan, still another private company, sells handbags for $129.95 to $498.

- On the other hand, Coach’s website shows handbags selling from $118 to $1200 with the Poppy line ranging from $118-$598.

- The unnamed European competitors referred to in Coach’s 10K are probably Louis Voitton (French and one division of LVMUY, handbags from $500 to $4260), Gucci (Italian, croodile handbag at $29,900, crocodile trim at $2450), and Prada (Italian, handbags from $410 to $3200). 

** It may be wishful thinking by Coach to consider “European luxury brands” as competitors since their purses are way more expensive.

 

 Armin

 

 

 

 

 

 

 

 

 

 

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