Coach (COH) delivered earnings results yesterday that were in-line with expectations, but Coach stock still got hammered down nearly 8% on the day.
COH stock is now sitting on double-digits losses year-to-date and is 36% off its all-time highs set early last year.
From watching the Coach stock price action, you would think that COH a company facing financial distress … or at the very least that Coach stock was trading at an unrealistically high valuation.
What’s Going On With COH?
Click to EnlargeCOH is a nearly debt-free company with (the current quarter notwithstanding) growing sales. And Coach stock currently trades for just 11 times forward earnings. Meanwhile, its highest valuation of the past five years never exceeded 25 times trailing earnings, as seen in the chart to the right.
A multiple of 25 isn’t cheap by any stretch of the imagination, of course. But considering COH has a return on equity of nearly 50%, it’s by no means outlandish.
So what gives? Why are investors punishing Coach stock?
Two words: Michael Kors (KORS).
Coach is positioned as an entry-level, inspirational luxury brand. Its bags are pricey, but far more affordable than, say, handbags by LMVH’s (LVMUY) Louis Vuitton. Michael Kors, meanwhile, has pushed aggressively into the core COH customer base with fantastic success. In fact, KORS has established itself as the hottest name in aspirational luxury.
That’s taken a toll an Coach’s American sales. Per the Coach earnings release, total North American sales fell 1% to $778 million from the same quarter last year, and comparable-store sales dropped 6.8%.
International sales, by comparison, are looking great. On a constant currency basis, international sales jumped approximately 9%, and Chinese sales were particularly strong for COH. Total Chinese sales surged over 35% with a double-digit rate increase in comparable-store sales.
And the other avenue for COH growth — men’s “man-purses” and accessories — also had a great quarter and was up 25%.
The problem, and the reason for the punishment of Coach stock, was its lackluster performance in its core market: American women.
See, the American aspirational luxury market is in bad shape as it is. Wealthy consumers are doing just fine, as sales of ultra-high-end brands have never been better. This was part of my rationale for recommending Daimler (DDAIF), the maker of Mercedes-Benz autos, in InvestorPlace’s Best Stocks of 2013 contest.
But those aspirational buyers — the middle and working class consumers who like to treat themselves to that occasional luxury — are still suffering from high unemployment, slow wage growth and a generally drab economy. So, demand is weak for COH, even as an aggressive new competitor in Michael Kors has entered the fray.
The good news for Coach stock is that the economy is improving already, as evidenced by everything from rising housing starts to retail sales. But hiring tends to be a lagging indicator that follow suit fairly late in the cycle; companies don’t like to hire aggressively until they are sure the economy is strong enough to justify it.
What does this mean for Coach stock?
The core domestic market for COH will likely stay weak for the next several quarters. But this does not necessarily mean that Coach stock should be avoided. COH is very modestly priced for a company of its profitability, and it’s become a strong dividend raiser in recent years. Coach now yields 2.7% — more than the 10-year Treasury note — and it’s more than doubled its payout in just the past two years.
I would wait for the current spate of selling to be exhausted before I aggressively bought any new shares of Coach stock. But I do consider COH an attractive dividend-paying value play that Wall Street has largely abandoned, and one that happens to have great growth prospects in China and other promising emerging markets.
Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he was long LVMUY. Click here to receive his FREE 8-part investing series that will not only show you which sectors will soar but also which stocks will deliver the highest returns. The series starts November 5 and includes a FREE copy of his 2014 Macro Trend Profit Report.
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