Coach (COH)

Coach has $900 million in cash and virtually no debt, so even the toughest recession should be survivable. With an enterprise value of just under $10 billion and $679 million in free cash flow (cash from operations less capital expenditures) over the last 12 months, its free cash flow yield of 6.8% offers a 400 basis-point premium over the current 5-year Treasury. That would almost justify buying the shares even if no growth were expected.

Did the following research after my first retail experience with Coach which came abt early this year when i was on a working trip to the US - 2 weeks, 4 guys, at least 10 visits to the Coach retail and factory stores, and a total purchase of 20+ bags 0f all sizes, for all occasions, and for all the ladies at home!

The Coach Value Proposition - What i really like abt the company: - Positioned itself in the affordable luxury market segment - bags are priced on average US$200-$400. The so-called 'white space' between Coach's price points and those of the European luxury brands continue to widen - Great under the current economic environment where the consumer is highly price sensitive!

- Strong product innovation and lineup. Typically, there are 3 to 4 collections per quarter and 4 to 7 styles per collection. Poppy, Madison, Kristin, Alex, Maggie, Brooke... if u have never heard of any of their collections, visit their website!

- Market leader, having nearly 25% market share in the category. Its top competitors include Dooney & Bourke, Kate Spade and Michael Kors. These brands are similar to Coach in pricing with price ranging on average $200 to $400 US dollars. i visited some of these brands during my trip to US, and i can't imagine how 4 guys can buy that many bags from these stores vs what we had accomplished in Coach!

- Solid growth strategies: (1)Building share in the $8.7 billion North American women's accessories market through product innovation. (2) Growth in North American Retail through more stores, although at a slower pace under the current economic enviroonment. (3) Increase market share with the Japanese consumer, driving growth in Japan primarily by opening new locations and by expanding existing ones. (4) Raise brand awareness in emerging markets to build a foundation for substantial sales in the future - specifically, China, Korea, and other such geographies are increasing in importance as the category is growing rapidly and Coach is taking hold. In China, the longer term growth focus, Coach is expected to open about 15 new locations for this year compared with four net new locations opened last year.

- Selling bags to women is a great business - Gross margins at 72%, operating margins at 30%, down to net margins at 20%!!!

DCF Valuation: $53 - i did a dcf with the following inputs. Conservatively, i placed it on a growth trajectory of 8% over the next 5 years (given that the american consumer will take some time to recover + international growth to take time to build up a strong base). This is very conservative under most standards, i read that most market analyst place expected growth for the company at >15%. http://4.bp.blogspot.com/_0APGKMRBfYA/SxUhZr6SZ6I/AAAAAAAAADY/9Z3HWREsytY/s1600/DCFValue.jpg

Relative Valuation: - Current price at $35 trades at a PE of 18 times earnings. Historically, we have seen the PE to fall to 13 in 2008 and as high as 35 in pre-crisis periods.

- interesting point to note is that the company value tracks closely to the enterprise value ie equity+debt-cash&mkt securities, as the company holds very low debt in its balance sheets! http://2.bp.blogspot.com/_0APGKMRBfYA/SxUhRN2yS7I/AAAAAAAAADQ/X3SJ-8iFS0s/s1600/RelValue.jpg

Income Statement Analysis: - Rev growth averaged 23% over the last 7 years. - Retail store growth in US is slowing as part of their revised strategy. - During the fiscal year ended June 27, 2009 (fiscal 2009), the Company acquired the Coach China from the ImagineX group. As discussed in their long term growth focus, we expect the number of wholly owned stores to rise in the territory. - return on capital invested averaged 30% over the last 7 years. http://3.bp.blogspot.com/_0APGKMRBfYA/SxUhKSDGHWI/AAAAAAAAADI/4Q_NcLxGMXA/s1600/IS.jpg

Balance Sheet Analysis: - Very low debt level at only 2% of capital - Return on assets averaged 27% over the last 7 years. http://3.bp.blogspot.com/_0APGKMRBfYA/SxUhBGSXGvI/AAAAAAAAADA/tfbKoy5ah44/s1600/BS.jpg

CashFlow Analysis: - Business generates strong consistent free cashflow. http://3.bp.blogspot.com/_0APGKMRBfYA/SxUg1kDdN9I/AAAAAAAAAC4/zrVhWdcY-PY/s1600/CF.jpg

Conclusion: - Despite the run up in the stock price since Mar 09 lows, i strongly believe that Coach continues to be a great company to hold in a portfolio with its valid value proposition. However, with the equity markets currently trading cautiously range-bound, do take advantage of any dips/corrections to accumulate on this counter!

Luxury spending saw a 29.4% increase from the second to the third calendar quarter of 2009, with ultra-affluent consumers responsible for a large part of the rise. Those with income above $250,000 are returning to their previous spending patterns as wealthy consumers are believed to be releasing some pent-up spending frustration caused by the recent economic downturn. As Coach continues to develop its higher-end luxury goods division and targets the ultra-affluent, the company will benefit from the rise in luxury spending.

Luxury spending saw a 29.4% increase from the second to the third calendar quarter of 2009, with ultra-affluent consumers responsible for a large part of the rise. Those with income above $250,000 are returning to their previous spending patterns as wealthy consumers are believed to be releasing some pent-up spending frustration caused by the recent economic downturn. As Coach continues to develop its higher-end luxury goods division and targets the ultra-affluent, the company will benefit from the rise in luxury spending.

The company has also been putting its cash flow to good use. During the second fiscal quarter, it repurchased and retired 20,480,927 shares of its common stock (more than 5% of the total shares outstanding) at an average cost of $34.51, spending a total of $707 million. At the end of the period, $661 million was available under the company’s current repurchase authorization, which was put into place in early November.

With the shares now more of a bargain than they were then, I’d expect that authorization to be used up quickly. And when I look under the covers, I come away thinking management knows what they are doing by buying back the shares now.

Although the retail market overall is struggling to get customers in its stores, Coach has been able to keep its customers shopping. Its strong product offering--namely the Madison handbag line--is priced lower than most of its other bags, making it especially attractive to money-conscious customers and buoying the company's sales. In addition, higher sales in Japan have helped pick up the slack from decreased American sales.

Counter-cylical. As a well-established and stable luxury goods retailer, Coach can weather economic downturns because its customer base tends to have deeper pockets than average and the company has a practically debt-free balance sheet flush with cash.

Attentive to consumer needs. With a heavy market research-based approach, Coach will continue to anticipate the fashion and practical needs of its customers and retain its already large customer base. Yes, the recent, explosive growth may have to slow but it will not drop off.