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Coach, Inc. (COH) Is a Good Pick Now

Coach, Inc. (NYSE:COH)An investment opportunity arises when a beaten down stock begins to pick up due to an improvement in its business. A stock might be beaten down because of various reasons: deteriorating fundamental performance, heavy insider selling, weak overall industry performance, earnings miss, etc. However, when those temporary problems are corrected and the business improves, it might be the time for opportunistic investors to come in.

That happened with retailer Coach, Inc. (NYSE:COH). On Jan. 23, Coach’s second quarter EPS came in at $1.23, missing analysts estimate of $1.26. Right after that, the market sent its shares down as much as 13%.  However, in the third quarter, its business seems to have improved. Moreover, Coach, Inc. (NYSE:COH) announced that it would also raise the dividend. Coach’s share price has rallied after its third-quarter earnings results. Is Coach a buy now? Let’s find out.

Business snapshot

Coach is a leading American retailer of fine accessories and gifts for both women and men. The company sells diverse fashionable products including handbags, accessories, wearables, jewelry, sunwear, fragrance, and watches. Most of its revenue, around 65% of the total, comes from men’s and women’s handbags, while accessories accounted for around 28% of total sales in 2012.

Coach, Inc. (NYSE:COH) has two main business segments: Direct-to-Consumer and Indirect. Most of Coach’s revenue, $4.23 billion, or nearly 89% of total revenue, was generated from the Direct-to-Consumer segment while the Indirect segment contributed only $531.5 million in revenue.

In the third quarter, Coach’s operating performance improved. Coach, Inc. (NYSE:COH) recorded nearly $1.19 billion in revenue, 8.2% higher than last year. Its net income came in at $238.9 million, or $0.84 per diluted share, nearly 6.2% higher than net income of $225 million, or $0.77 per diluted share. The company also announced that it would raise its annual dividend by 13% to $1.35 per share.

Three reasons to buy Coach

There are three reasons that make Coach, Inc. (NYSE:COH) a stock to hold for the long run. First is its superb balance sheet. As of March 2012, it had more than $2.24 billion in total stockholders’ equity, $928.5 million in cash, and only $22.6 million in short and long-term debt. The biggest item in Coach, Inc. (NYSE:COH)’s liabilities is “other liabilities” booked at nearly $413.2 million. Other liabilities include deferred lease incentives, non-current tax liabilities, and tax-related deferred credit.

Michael Kors Holdings Ltd (NYSE:KORS), another leading retailer of branded women’s apparel and accessories under MICHAEL KORS brand, and Vera Bradley, Inc. (NASDAQ:VRA), the retailer of Vera Bradley, Inc. (NASDAQ:VRA) products, also have fortress-like balance sheets with very little leverage.

Historically, Coach has generated high return on invested capital. In the past ten years, its return on invested capital has fluctuated in the range of 38.65% to 56.88%. Trailing twelve months, its ROIC stayed at 52.56%. Michael Kors Holdings Ltd (NYSE:KORS) and Vera Bradley had a lower TTM ROIC, at 36.80% and 38.18%.

Last but not least, Coach, Inc. (NYSE:COH) is a cash cow, generating consistent operating cash flow and free cash flow. Its operating cash flow increased from $222 million in 2003 to $1.22 billion in 2012, while free cash flow grew from $165 million to more than $1 billion during the same period.

At the current trading price of $59 per share, Coach is worth around $16.5 billion on the market. The market values Coach at around 8.9 times EV/EBITDA and its FCF yield is 6%.

Vera Bradley and Michael Kors are more expensive

In 2012, Vera Bradley, Inc. (NASDAQ:VRA) generated only $16 million in free cash flow. The company is trading at around $22 per share, with a total market cap of only $898 million. It is valued at a lower multiple of 7.5 times EV/EBITDA. However, because of the low FCF, its FCF yield is much lower at 1.78%.

In the past twelve months, the free cash flow of Michael Kors Holdings Ltd (NYSE:KORS) was $137 million. At $53 per share, the company is worth $10.6 billion on the market. It is valued expensively at 16.9 times EV/EBITDA. With FCF of $137 million, its FCF yield of 1.3% is the lowest.

Coach, Inc. (NYSE:COH) seems to be the most attractive stock for income investors with the highest dividend yield of 2.3%, while neither Michael Kors nor Vera Bradley pay dividends to their shareholders.

My Foolish take

Coach seems to be a much better buy than Michael Kors and Vera Bradley at its current price due to its decent dividend yield, the highest return on invested capital, low leverage and a reasonable valuation.

The article This Fashionable Company Is a Good Pick Now originally appeared on Fool.com and is written by Anh Hoang.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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