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Coach is a Value Play. Target Price is $71. Stock Report Included.


Jae here.

Real excited today.

I’ve got an impressive guest post to share with you today on Coach (COH).

This is the second time that a contributor to Old School Value has discussed Coach.

The first being Dan Myers and his video explanation and valuation of the company.

There are two reasons I’m excited about this post.

The first is that the author is a first time user of the Old School Value spreadsheets. This helps me gain insight into how users are interpreting the same numbers and suite of features I use myself on a daily basis.

The second is that the author has gone above and beyond my imagination with his use of the Stock Analysis Software.

Instead of just plugging stocks in and using it like any normal analysis software, the author has created his own stock report format by grabbing and importing the data into this report format. If he wanted to, he could send it off to friends, students, interviews, or clients to show off his work.

It’s making me think that I should do something similar for when I write about stocks.

A copy of the PDF stock report is at the bottom of the article for you to download.

The author is Fred Rockwell and runs a new blog titled Bulldog Investor.

Take a look through his argument and leave any comments or questions regarding COH or anything that comes to mind.

Recommendation Summary

Coach, Inc. (COH) is well positioned to continue double digit growth by seizing global opportunities, adding to their current product line, and emphasizing a focus on men’s products.

The company is currently trading below its intrinsic value, creating an opportunity for investors to purchase a steadily growing company with a wide moat and margin of safety.

My 1-year price target for COH is $71.25, a 28% upside over its current trading price of $55.65.

Company Overview

Coach is a leading designer of luxury accessories, primarily leather goods and most notably handbags.

It operates in North America (69% of 2013 Sales) and internationally (31% of 2013 Sales).

Design is done in-house, independent manufacturers produce products, and merchandise is sold via retail stores, wholesalers, and the internet.

Investment Thesis

International Expansion and Factory Stores to Fuel Growth

Coach is becoming a global brand and potential still exists to grow domestically.

International sales increased 9.9% in fiscal year 2013 and this is a trend expected to continue. First quarter currency neutral international sales were also up 9.3% in fiscal year 2014. Coach opened 30 new locations in China and 11 new locations in Japan in the 2013 fiscal year.

While same store sales have been flat in North American retail stores, comparable store sales in Japan have seen double digit growth. Management believes that North America can support 500 retail stores and currently only 350 exists.

The strategy is to close the under-performing retail stores while growing the number of lower end factory stores. Management is yet to act on the remaining capacity for retail stores in North America.

Coach has successfully used joint ventures with established companies as a catalyst for the proliferation of its brand in other countries. This method has produced positive results in Japan and China and the company plans to implement the same strategy in Latin America in 2014.

Coach currently is a market leader in North America and is the number one accessory importer to Japan by units sold.

Launching new factory stores has helped to overcome recent flat North American retail store sales. Coach closed three retail stores and opened 24 new factory stores including 10 Men’s, bringing the total number of retail and factory stores to 351 and 193, respectively, at the end of fiscal year 2013.

The growth of factory stores has stolen some sales from higher margin retail stores but remains an attractive investment for the company, which has grown sales every year for the last 10 years and boasts industry leading margins.

Strong Moat Will Insulate Earnings for Years to Come

Coach’s competitive advantage comes from the emotional attachment consumers have to the brand.

Coach has become synonymous with quality and this can be seen by surveying almost any American consumer.

The accessory and handbag market is growing and has many new entrants and fierce competition amongst competitors. Despite these facts, Coach continues to grow year after year. This can be illustrated by an average earnings growth between 15.8% and 18.5% over the last 10 years.

Warren Buffet’s measure of growth in intrinsic value and the existence of a strong moat is growth in book value per share (BVPS).

Coach’s BVPS has increased by more than 4x in the last ten years.

Comparables

Coach is trading at a P/E below most of its competitors while having better margins and returns.

COH traded at an average P/E of 28x in the four years before the credit crisis, between 2004 and 2007. It now trades at 15.4x, below many of its peers.

Because of the company’s effective business model, using independent manufacturers, and carrying little debt, it has been able to boast industry leading profit margins.

Positive Earnings Notes

While first fiscal quarter earnings met median analyst estimates, earnings were depressed by currency fluctuations of the yen. This temporary problem deterred investors.

Coach continues to team with other brands to license products such as shoes and fragrances for sale under the company’s name. These products create upside as Coach establishes its global brand as a lifestyle company.

Plans to target the underserved male market have been successful. Coach has seen men’s products go from 5% of sales in 2011 to 11% in fiscal year 2013.

Investors are slow to purchase shares because of the stepping down of designer and creative director Reed Krakoff, making the stock cheap for those who believe in COH’s strong moat and effective business model.

Risks

1. Keeping up with consumer preferences by creating new and desirable products is a major risk.

In fiscal year 2013, 69% of sales came from new products that had $0 of sales in the same quarter the previous year.

2. To add to the risk, in 2013 President and executive creative director Reed Krakoff stepped down to start his own brand.

3. Additionally, an economic downturn could drastically impact sales. Although luxury items do better in a downturn, the retail business is still difficult and can damage any business.

4. Coach is expanding in Asia, Europe and Latin America, which poses risks related to new consumer preferences and price points that could erode margins.

5. Competition remains fierce and Coach could lose market share to its closest competitor, Michael Kors, or to new market entrants.

Stock Valuation

I valued Coach with a multi-stage DCF model based on FCF, using stock analyzer software from oldschoolvalue.com.

I added back restructuring costs in 2013 to arrive at a base FCF and I made assumptions on growth rate, discount rate, growth decay rate, and terminal growth to arrive at 3 scenarios for stock price.

I then used a sensitivity matrix to see how sensitive those stock prices are to varying discount rates and growth. Growth rates were based on the above mentioned graph of last 5 year and last 10 year performance.

Base Case Scenario: 1-year price target of $71.25, 28% upside.

This forecast assumes that Coach continues to grow at the average of its 5 year and 10 year performance. It further assumes that growth begins to decay by 10% per year in year 4, and by 10% more in year 8. I used a discount rate of 11.5% slightly higher than the current beta dictates.

Bull Case Scenario: 1-year price target of $85.66, 54% upside.

This forecast assumes that Coach grows at slightly below its average rate over the last 3 fiscal years, 14%. We will be slightly conservative and assume again that growth begins to decay by 10% per year in year 4, and by 10% more in year 8 as COH begins to saturate the North American market. I used a discount rate of 11%.

Bear Case Scenario: 1-year price target of $54.65.

Under my most pessimistic scenario, my value reflects that the market has accurately priced Coach . This forecast assumes that Coach grows at below its slowest rate of growth over the most recent 10 year period, 8%. Because Coach has so many opportunities for growth, for this scenario to occur, Kors would have to steal market share, new entrants would have to come into the space, and international expansion would have to fail.

I also assumed that growth began to decay by 20% per year in year 4, and by 15% more in year 8. I used a discount rate of 12%, higher than the current beta dictates.

Conclusion

Coach’s potential for price appreciation is high based on growth prospects and its strong moat around earnings.

The company is currently priced below intrinsic value in my base and bull case financial models and priced accurately in my bear case model. If the company continues to grow anywhere near the pace it has averaged year-over-year for the last 10 years then an investor could purchase its stock today with a 22% margin of safety.

To further ensure you are insulated, I would wait till the price reached around $53.44, a 25% MOS, to make a purchase.

Coach is a strong steady grower to add to a portfolio but not a 10-bagger.

I originally identified Coach after using Joel Greenblatt’s magic investing formula to screen stocks. The formula rank stocks based on return on capital and EV/EBIT ratio, respectively, then combines the rankings to give each stock one score. This method produced average annual returns of 30.8% for 17 years between 1988 and 2004.

Click to Download the Stock Report

After you’ve read everything, let me hear your thoughts in the comments. Agree? Disagree?

Disclosure

Author is long COH.

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10 responses to “Coach is a Value Play. Target Price is $71. Stock Report Included.”

  1. Ian says:

    Coach is complicated. Since the recession the largest $ value source of growth has come from management’s shift from retail to factory int the US. International expansion is certainly an opportunity but Coach has an uphill battle to fight since the US factory outlets have diluted the brand’s value (it is not respected in Europe, Japanese love the brand but TBD on China in my opinion). Add to that the presence of real, newer competitors (Kors) and you have a long road ahead with lots of potential mistakes for management to make.

    The fact is the more the company juices US sales by going factory, the more they dilute their brand value. Either sales growth or margin has to suffer. Just track retail square footage over time, split between retail and factory. Retail square footage has stagnated and they don’t have the cache to breathe new life into the brand.

    Finally, I suggest you track searches such as “coach handbag” or “coach factory” etc. on Google Trends. This gives a good picture of the difficulty Coach has and will continue to face.

  2. Rob Urban says:

    I always use a 15% discount rate for DCF valuations. From this COH is worth $52 IMO. However, using competitor comps and historical P/E valuation gives COH a fair value of around $70. Given it has no debt and an INSANE ROE given no debt, the valuation is likely higher than $52, maybe $60 or so. I would buy it with a 25% MOS given their moat and ROE and EPS predictability, so I’m hoping to see it trade down to $45 again. At that point I’d enter a small position and continue buying if if goes lower. Then, this would be a no-brainer. At $53 it’s not a no-brainer quite yet. Great analysis. COH is definitely on my watch list.

  3. Rob Urban says:

    Coincidentally, I just discovered Morningstar has a fair value of $61 on the stock.

  4. interesting to see MSTAR give it slightly above the bear case.

    Here’s one point I mentioned to somebody else regarding COH.

    Personally, I don’t see much of a moat for any fashion brand. Ultra luxury lines do better because of pricing power, but for mid range brands, it’s really just a consumer choice and how much marketing is done.

    I do get the factory outlet point, and this is worth investigating further, but I wonder how many people living in the States buy it for themselves.

    I live near a couple of big outlets and when you go the coach stores, it’s usually Asians.

    A lot of them buy them and send it overseas because it’s so much more expensive.

    In the US, Coach isn’t luxury. 200-400 bags are considered mid range. Same with Michael Kors, but the MK brand is considered more hip and flashy as opposed to a more conventional and conservative style for Coach.

    In Korea, Coach is still very expensive. 2-3x what they sell in the US, so I see a lot of Koreans, Chinese, Japanese and other Asians buying for their mum, relative etc

  5. Thanos Pasias says:

    Hi Jae,

    Why did you add back the restructuring costs to the FCF? I thought that it’s more realistic to deduct them. Do I miss something? Thanks

    “A quick way to understand the economic reality at a company like Alcatel that
    records restructuring charges every quarter is to simply reduce operating
    income by the amount of those charges.” Financial Shenanigans p.102

  6. Hey Thanos,

    I believe the author is doing his own adjustments to the entire valuation. It’s not going to the case for every company so take it as a case by case basis.

  7. Charles says:

    I strongly agree with you.
    Coach is not a luxury brand at all although it has a high price in Asian. But someday people find the truth, it is of little competence with Gucci, LV and Prada.

  8. catherinekylie says:

    The stock price of Coach is down 12% year to date which shows that they have missed out on their domestic segment due to weakening demand.Read More: http://bit.ly/1dUrZuY

  9. xuamox says:

    Coach is now at $34.07 – Do you still see it as a value play? They are obviously going through a transition period, but can they recover and continue to be a leading global brand?

  10. Jae here. Although I didn’t write the original post, it’d be better to wait and see. There are better value plays out there. Retail is tough so be careful.

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