Coach's (NYSE:COH) third quarter results were solid if not spectacular. Its Chinese business, however, continues to provide hope for its floundering stock. While the premium brand's not out of the woods just yet, there's enough promising signs to indicate its business hasn't stalled out. Should you be buying its stock on the news? I'll have a look.
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When I last wrote about Coach in late January, it had just reported anemic earnings. Many speculated that Michael Kors (NYSE:KORS) and other competitors like Tiffany & Co. (NYSE:TIF) and Fifth & Pacific's (NYSE:FNP) Kate Spade were taking market share from the premium brand. Three months later and it appears that Coach is holding its own despite the intense rivalry that exists between all of these firms.
First let's get to the nitty gritty. Revenue in the quarter increased 10% on a constant currency basis to $1.2 billion while net income increased 10% to $0.84 per diluted share. In North America it managed to stem its same-store sales decline with a 1% increase versus a 2% decrease in Q2. Overall, revenue on this continent in the third quarter increased by 7% to $792 million. Doing most of the heavy lifting was its online business which saw double-digit increases in sales and traffic from both its Coach.com and CoachFactory.com websites.
Outside of North America business was even stronger with revenues increasing by 14% on a constant currency basis to $382 million. They now represent about a third of Coach's overall business. China, its biggest success story by far, achieved revenue growth of 40% in the quarter with a same-store sales increase in the double digits. Coach expects its full-year revenue in China will top $425 million in fiscal 2013. Equally exciting is the news that it bought back its 18 stores in Europe that were operated by a joint-venture partnership. With 20% of the $6.5 billion global premium market at stake, it was vital for the company to control its destiny.
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Two new markets for Coach are footwear and menswear. Michael Tucci, president of its North American group, suggested in its third quarter conference call that footwear is the biggest opportunity in its women's business. In March it launched an assortment of footwear in 230 stores around the globe. Wells Fargo analyst Evren Kopelman commented on the footwear business in a note to clients April 23 suggesting that in a matter of five weeks some Coach stores were generating 12% of their revenue from footwear. Meanwhile its menswear business has become a bona fide success in its own right with revenues expected to increase by 50% in 2013 to $600 million. If it keeps up this pace of growth it could be a billion dollar business by 2015.
As most investors are aware, CEO Lew Frankfort is stepping down in January 2014 to be replaced by Victor Luis, currently its president and chief commercial officer. While Frankfort will remain as Executive Chairman, he will step away from the daily grind of running a global enterprise. As a result of his departure, creative director Reed Krakoff, who became a close business associate of Frankfort's over the past 16 years at Coach, is moving on next June to focus on his own brand, which Coach currently owns. Some see it as a loss for the company but the fact his departure is planned so far in advance means all involved knew it was time for Krakoff to work on his own brand full-time. I doubt Krakoff will have trouble finding investors to help him buy it back from the company. If a brand wants to grow and expand, it has to be able to move beyond its creative founding. This is a healthy transition.
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Coach's stock gained 9.8% April 23 on its better-than-expected earnings report. It's now flat year-to-date in 2013 after a negative return of 7.2% in 2012. Essentially its stock's been stalled for 15 months. Historically, its stock's valuation is lower than it's been over the past five years. Its earnings yield and cash return are 7.1% and 7.3% respectively. The average earnings yield of its three peers mentioned in the beginning is 2.6%, less than half Coach. While there might be some uncertainty in its North American business, this is a company that's on solid footing. Before its 10% bump on earnings, it was trading at a level it hasn't seen consistently since 2010. It's definitely oversold in my opinion.
Michael Kors might be kicking Coach's butt at the moment. But this business is cyclical. Soon consumers will tire of their product offering and Coach will be waiting with open arms on their return. This is definitely a buy-on-the-dips kind of stock. Don't miss out on the attractive valuation while you still can because a couple more solid quarters and it will be revisiting its all-time high near $80.
At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.
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