Coach (NYSE: COH ) earns a pretty penny for each handbag it sells, but its shareholders haven't shared in the profits as of late. The luxury handbag maker's stock price has declined 33% since the start of the year. Things obviously haven't been going the company's way lately, but that likely won't stop investors from making money buying its stock. In fact, this out-of-fashion stock could be a terrific investment for investors willing to buck the trend. Let's investigate further to find out whether it's time to buy Coach's stock.
There's a bargain in the premium aisle
In investing, it rarely pays to buy what's already in fashion. While Michael Kors (NYSE: KORS ) and Kate Spade (NYSE: KATE ) trade at 24 times earnings, Coach is on sale for just 11 times earnings. Although Coach's stock is out of style, it represents a compelling bargain for long-term investors. Michael Kors and Kate Spade together generate the same amount of revenue as Coach, yet their combined enterprise value is twice the latter's enterprise value.
Photo: Coach.
Granted, Michael Kors is growing much more quickly than Coach and Kate Spade has significant upside potential, but Coach remains the market leader in women's handbags. If Coach's brand maintains its market position, the stock could be a bargain.
The competition is heating up
Not everyone believes that Coach's earning power will remain intact. Coach tripled revenue from 2005 to 2013 -- a 15% compound annual growth rate. The market's low earnings multiple shows that many investors believe that Coach's best days are behind it. Although the company is unlikely to triple revenue again within a decade, the market's concerns may be overdone.
To begin with, women's handbags are extremely profitable for established brands. Although it doesn't break out gross profit by product line, Coach's overall gross profit is just under 70% of sales. That's incredible for any retailer -- and it's also why Michael Kors, Kate Spade, and other competitors are so eager to expand their handbag offerings.
Increased competition for luxury handbags will result in lower sales growth, but not necessarily lower profit margins. Although price can be a factor in the purchase decision, designer handbags are expensive across the board and Coach could ride buyers' attraction to its style to success.
Coach's issue is more of a top-line problem than a margin contraction problem and Coach can ease top-line pressure by expanding its offering. For instance, its men's segment is growing annually by double digits, accounting for 14% of last year's sales. Expanding its men's and women's offering in the U.S. and abroad could provide the necessary support to maintain its earning power.
Low expectations set the stage for a higher stock price
The time to buy a retailer is exactly when everyone else has left it for dead. At 11 times trailing earnings, Coach is priced at a level that suggests its ubiquitous luxury brand is going to lose out to lesser-known brands. Although retail is hard to predict, it seems unlikely that Coach's brand equity has deteriorated so much and so quickly. If same-store sales start to flatten out, investors may wish they had bought Coach at its current price.
Like any fashion retailer, Coach is subject to the whims of fashion. However, unlike most other retailers, Coach's brand is known throughout the world as a standard in designer handbags. Unless that standard is passed to another brand, Coach is probably a good buy at just 11 times earnings.
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