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