We always look for revenue expansion before diving into any idea. Such an approach is the cornerstone of avoiding falling knives (stocks that look like value but yet keep falling). For Coach (COH), we were modeling in a very difficult 2015 and 2016, but we thought 2017 and 2018 would be brighter for the handbag maker as it annualizes weak comparable sales and gets North America back on track. We also thought the firm’s ~3.8% dividend yield would act as support for the firm’s shares. Though most of this may still be true, the company’s calendar third-quarter results left much to be desired.
On a constant-currency basis, revenue fell 9% in the period, while net income for the quarter totaled $146 million, with earnings per share of $0.53, excluding transformation-related charges. On a non-GAAP basis, operating income totaled $217 million compared to $322 million in the year-ago period. Coach’s non-GAAP operating margin fell 7 percentage points. Though the results were better than feared, the company continues to be plagued by plunging comparable sales and a North American handbag business under significant pressure.
Coach’s North American sales decreased 19% with comparable stores sales down 24% in the region. International sales were a bright spot, up 6% on a constant currency basis thanks to strength in China (sales up 10%). Europe was “very strong” during the period, “growing at a double-digit pace,” but we can’t overlook economic headwinds in the region, even if Coach’s primary customer base may be somewhat immune to economic cycles there. Healthy growth from Asia and Europe are welcome news, but the company must turnaround North America for its price to fetch our intrinsic value estimate. There’s no two ways around it.
It’s too early to say whether the launch of Stuarts inaugural collection in September and the firm’s spring fashion will reignite the brand in North America, but a V-shaped bounce in fundamentals can almost be ruled out at this point. There are two things that we are watching closely: free cash flow and the firm’s balance sheet net cash. At this point, Coach’s practically debt-free balance sheet is a blessing (it has $170 million in short-term debt), and its $900+ million in cash offers significant flexibility. This lessens the need for the company to issue equity at dilutive prices or cancel the dividend.
Coach represents less than a 2% position in the Dividend Growth portfolio, and while we generally don’t like turnaround stories, the company’s yield pulled us in. We still believe the dividend is safe, though we’re watching cash flow and the balance sheet like a hawk.