The Intelligent Investor

Coach Has Great Management Skills

Coach Has Great Management Skills

It is tough to like any retail stocks these days given the dour economic outlook around the world. It is just as tough to find any good Consumer Discretionary ETFs and mutual funds, which rank 7th out of ten sectors (more on sector rankings here).

One can hardly find any retail companies whose economic earnings and returns on invested capital (ROIC) are rising in the last fiscal year, except for Coach (COH).

For a retail business, Coach generates nearly unheard-of ROICs. Over the past five years, its ROIC has been over 45%. Compared to traditional retail businesses, COH is two to four times more profitable in terms of ROIC. The only peer that comes close is Lululemon Athletica Inc. (LULU) in its most recent fiscal year, when it achieved a 52% ROIC. Its average ROIC over the prior 5 years is 32%, with ROIC as low as 17% in 2008. So, LULU has a long way to go to be as consistent as COH. And its stock is much more expensive than COH.

Figure 1: Return On Invested Capital Averages 41% Since 2001

Sources: New Constructs, LLC and company filings

Even more impressive than COH’s high and rising ROIC is the achievement of that success while also growing the business at incredible rates, including 2012. See Figures 2 and 3.

Figure 2: Compounded Annual Growth Rates (CAGRs) Since 2001

Sources: New Constructs, LLC and company filings

Typically, the capex and expense of expansion takes a while (if ever) to earn a return and depresses ROICs in the near term. Not the case with COH.

Astute investors know it is easier to grow revenue than economic earnings. To grow economic earnings faster than revenue for over a decade is quite an accomplishment. Figure 3 speaks for itself.

Figure 3: Revenue and Economic Earnings Since 2001

Sources: New Constructs, LLC and company filings

A 40% CAGR in economic earnings over more than a decade is amazing. Only once since 2001 has Coach not increased its annual economic earnings. Rarely in business do we witness such high growth rates maintained for so long. Even more rare is a rise in ROIC over the same time frame.

A company does not generate increasing ROICs and 20% CAGRs in top line growth without excellent management. Indeed, consistent and high ROICs are the best indication of good management and a wide moat around a business.

In particular, I am impressed by Coach’s management’s strategy to target growth in the parts of Asia where spending on their high-end good was most likely to be strong and grow. Focusing on the wealthiest and fastest growing parts of Asia has, no doubt, been central to their success. An  the excellent execution of their strategy manifests in the growth in economic earnings.

Investor capital is in good hands with Coach’s management team.

However, looking at COH’s price-to-earnings ratio, it is easy to see that the company is cheap compared to peers despite its impressive growth and profitability. I think most investors are missing three key drivers for the future of this stock:

  1. Very few investors appreciate the high ROICs and growth rates of this company
  2. Economic earnings grew faster than accounting earnings and ROIC rose in 2012 despite the anemic economic environment
  3. Profit growth will be higher than the market expects once the global economic rebounds.

The valuation of the stock gives little to no credit to Coach’s impressive history and its capable management team. Trading at ~$56.50/share, the stock implies the company will achieve relatively little future growth in NOPAT or economic earnings.

My target price of $70 implies that Coach grow NOPAT at 8% for five years. That seems like a low hurdle for a company that generated 33% CAGR in NOPAT over the past 11 years.

COH gets my Attractive rating because of its rising profitability and cheap valuation. The risk/reward of this stock is also compelling because of its 2% dividend yield.

My regular readers know that I also cover 400+ ETFs and 7000+ mutual funds, and I like to point out the ETFs and mutual funds that allocate most to the stocks I recommend to buy or sell.

For COH, there are no mutual funds or ETFs that allocate significantly to COH and get an Attractive or better rating. This finding does not surprise me given that the Consumer Discretionary ETFs and Mutual Funds ranked seventh out of ten per my Sector Rankings for ETFs and Mutual Funds report. You can access all of my sector reports here.

Disclosure: I own COH. I receive no compensation to write about any specific stock or theme.

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David Trainer

Trainer brings insight and transparency to research on stocks, ETFs and mutual funds.
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