Coach (COH): A fashionable buy

by Geoffrey Seiler, editor BullMarket.com

Coach (NYSE: COH) is primarily known for its luxury handbags. The company also sells leathergoods, business cases, travel accessories, footwear, watches, outerwear, scarves, sunwear, jewelry, fragrance, and related accessories.

At the end of 2009, Coach had 343 retail stores and 118 factory stores in North America. It also had 163 shops in Japan and 37 in China.

Coach reported fiscal Q2 earning in January, posting a profit of $241 million, or 75 cents per share, up 11% from $216.9 million, or 67 cents per share, a year earlier. That topped analyst EPS estimates of 72 cents. Revenue rose 12% to $1.07 billion from $960 million.

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Direct-to-consumer sales jumped 14% to $934 million. North American comparable-store sales for the quarter rose 3.2%. It was the first same-store increase in five quarters. Sales in Japan rose 7%, but fell -2% on a constant-currency basis. China same-store sales rose by a double-digit rate.

Indirect sales fell -8% to $131 million, due to lower shipments to U.S. department stores as Coach manages inventory in that channel. Sales to consumers at department stores dropped -22%.

Coach's bag and accessory sales rose about 3% across all channels in North America, and 18% at its own stores.    It estimated that the overall U.S. handbag and accessory category fell an estimated 0% and -5% during the same period.

"Building on the success of our price rebalancing strategy, which rolled out in July, we offered more handbag choices in the $200 to $300 range in our retail stores," Michael Tucci, president of North America Retail said on the conference call.

"This resulted in increased penetration of handbags to 54% of full-price store sales, from 51% last year. Additionally, we saw a further improvement in average store handbag unit sales during Q2, driven by gains in conversion rates over last year. We believe the conversion improvement this quarter is a strong indicator that our product, pricing, and service efforts are taking hold with our consumers."

Operating margin in the quarter was 35.8% compared to 36.3% in the year-earlier period. Gross margin increased 30 basis points to 72.4% from 72.1%, helped by the re-engineering of its product collections that resulted in lower average costs. Looking forward, CEO Lew Frankfort was optimistic about the second-half of its fiscal year.

While Coach sold off after its earnings report, it was a very solid showing, and the stock has started to bounce back. Impressively, Coach has successfully dropped the price point of its luxury bags, but at the same time increased gross margins.

Meanwhile, same-store continued to improve each month in the quarter and the solid trends extended into January, showing the brand continues to resonate with consumers. While China is still a small part of Coach's business, the early trends also look very promising.

Coach is currently trading at just above 15x FY 2011 (ending in June) EPS estimates, and it has over $1 billion in net cash, or about $3.50 per share. Given its premier brand and solid operational performance, we'd place a price target of around $42 on the stock. As such, we'd accumulate the stock on any weakness under $34.

Learn more about this financial newsletter at Goffrey Seiler's BullMarket.com.