September 5, 2008

Value Idea: Coach

Coach, Inc. (COH) is a marketer of fine accessories and gifts for women and men. The Company offers lifestyle accessories. Coach’s handbags and accessories use a range of leathers, fabrics and materials. The Company’s product offerings include handbags, women’s and men’s accessories, footwear, jewelry, wearables, business cases, sunwear, watches, travel bags and fragrance. Coach operates in two business segments: Direct-to-Consumer and Indirect. The Direct-to-Consumer segment consists of channels that provide Coach with immediate, controlled access to consumers, retail stores and factory stores in North America and Japan, the Internet and the Coach catalog. This segment represented approximately 80% of Coach's total net sales, during the fiscal year ended June 28, 2008 (fiscal 2008). The Indirect segment represented approximately 20% of total net sales in fiscal 2008.
Business Economics The business is very well managed by all statistical and fundamental measures management has done a superb job. So lets review some of these elements:
  • Cash-to-cash cycle has been compressing over the last few years, which always means that inventory and working capital is managed quite well.
  • Sales per square foot in north America are increasing while in Japan, where COH has a strong following and a large international presence, has been flat or slightly decreasing over the last few years, but nothing significant. The company reckons that it can have 450 to 500 stores in North America, so I suspect that productivity figures for sales per sqr ft will come down with the expansion plans.
  • Revenue growth has been stellar over the last 7 years but it is starting to slow. Some will argue that international growth into China and emerging markets will allow COH to continue its horrid pace, it is a strong possibility if the China story continues, so that remains to be seen. As you can see in COH revenue growth profile its current revenue growth rate is below its 3 year average growth rate and its 3 year average is below its 5 year average growth rate, so growth is starting to slow. Nevertheless we are talking about 19% growth rate in revenue nothing to sneeze at.
  • COH margins are very solid and at all time high due to reorganization of their supply chain that managed to reduce their cost of goods sold and better utilize their working capital.
  • My only concern here as an investor is the company so well manged that there no more room for improvements. I think margins have reached their limit as most efficiencies from supply chain redesign have been achieved. There is a strong possibility that these efficiencies are going to start reversing. Since their supply chain has gotten longer their transportation costs will increase as a result of higher energy costs.
Competitive Advantage Brand name is what most people will point to as a strong competitive advantage for COH, but the problem with that is there no consumption habit or search cost to deter customers from buying another brand. So I may go with the brand thesis but it is not a very strong advantage overall. This is magnified even more in my second point that COH goods are second tier luxury goods as compared to Hermes, Gucci or others.

COH goods are at the lower ladder of luxury goods. Actually they are geared towards consumers who want to trade up from common brands to luxury brands. Certainly they are not a brand to be associated with the rich. COH brands are associated with middle income who want to pretend or look as if they are rich. In other words COH revenue may be susceptible to economic pressures more than a Gucci, Hermes or Louis Vuitton, as the rich spending is impervious to economic cycles. Recently Hermes, Gucci and other luxury goods companies reported solid growth numbers, see here, although COH reported good growth numbers they were relatively tame in comparison.

COH is trying to be more upscale but it is doing so by raising its price for its leather goods. Several of my female family and friends who I surveyed for this analysis said they would rather own Hermes, Burberry or something from Louis Vuitton collection, if they are going to pay what Coach is asking for its leather bags. So COH may price itself out of the market at the new price points that it is rolling out. Moreover many have objected to the logo imprint on coach bags. COH logo imprints on its bags are so aggressive and the trendy may find it tacky.

Another risk to their brands is the distribution channels that COH is pursuing. Their own retail stores obviously is essential to control the brand but the indirect and outlet channels may lead to brand dilution. Their discount stores will never propel the brand into the luxury category they hope to be one day.


Growth rate is what can make this business undervalued or overvalued. COH had an exceptional growth rate over the past several years; it averaged a historical growth rate in revenues 29% over the last 5 years. Do you assume the same growth rate going forward? In my discounted cash flow models I hate to assume anything over 5%, actually I try to assume zero growth to see if the current cash flow stream is undervalued by the market. Take a look at the following table where it displays COH intrinsic value assuming different growth rates. In the vertical column it has revenue growth rates for the next 10 years, while the horizontal line displays its terminal growth rate beyond the initial 10 years. Please see my model here.
G % 5% 7.5% 10%
5% 15.00 17.00 22.25
10% 18.40 25.79 30.00
15% 23.54 28.39 40.07
29% 48.62 61.66 94.77

As you can see if I assume historical growth rates to continue COH is undervalued but if my expectation is right about slower growth rates then valuation by the market is fair.

I figure COH valuation is somewhere between $19-24 where the growth assumptions are very conservative. If I attempt an Earning Power valuation model I come up with an intrinsic value of $19 per share for COH assets. The main adjustment is for goodwill as COH has no history for M&A so its brand name in not reflected on its balance sheet. I have taken multiples of its competitors and looked at revenue to goodwill ratios and applied similar ratio to COH to arrive to a comparable figure.

In conclusion, COH is a well run company that have a fairly valued stock. I have no problem owning Coach but I would rather own it at $20-22 per share and its future growth can serve as my margin of safety.

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