Saturday, November 27, 2010

Rule #1 Analysis Blitz #4: Coach (COH)


If you have any ladies in the house, you'll likely have heard of the name, Coach.  No, it has nothing to do with Greyhound, Megabus, or the like.  It has everything to do with what your wife, mother, sister, or girlfriend (or you) carries with her wherever she goes.  Yep, it's her handbag, and Coach makes very many, very expensive (ok, not as expensive as Louis Vuitton or Prada, but still, not your typical Walmart bags), and most importantly, very popular ones.  Between my wife, my mother and her mother, they probably own around 10-15 Coach bags or wallets (no exaggeration)!  Whenever I travel to the US for work and am anywhere near an Outlet mall, I usually pick one up for them (at discount prices, of course).  And it's not just them...my brother's wife, cousin's wife, cousins all like Coach too.  If you also happen to live in the US or Canada and visit any of the more popular outlet malls, you'll find that there is always a line up going into the store on the weekends.  I'm absolutely serious, Coach is a hot brand!  Let's see if the stock is as hot as the product!

Moat
You can download the completed Rule #1 spreadsheet here.

Coach is another Rule #1 company by Big 5 standards.  There are only a few reds and yellows in its 10-year history, and they occurred within the past 2 years, during the Great Recession.  It is entirely forgivable.  Looking at the 5-year and 9-year averages, it's all green and growth is pretty astounding.  It also has no debt at all.  After looking at RIM, Apple, and now Coach, you're starting to get the idea of what a Rule #1 company looks like...a sea of green.

As I have mentioned above, everyone seems to love Coach.  Its products are priced nicely such that they are affordable by the masses, but expensive enough to make for awesome margin for the company.  I don't think Coach has much of a competitor.  If you go to Yahoo Finance, you can see who its competitors are.  The three listed are all private companies: Dooney & Bourke, Kate Spade, and Michael Kors.  I will confess...I'm not a fashion expert...but aside from Michael Kors, I have not heard of the other two companies.  This alone tells you that at least the females of my family do not really particularly like these brands.  I checked out the websites of these companies and I must admit, Kate Spade has some pretty nice handbags, too.  But the story is similar to the Coke-Pepsi story.  Pepsi may have the better tasting drink, but Coke has the brand moat.  So, Coach definitely has the brand moat that can give it the upper hand.

Coach gets a score of 9 for Moat.

Moat Score: 9 / 10

Figure 1: Rule #1 Analysis of Coach (COH)

Margin of Safety
For calculation of the Sticker Price, I used growth rate of 15% and PE ratio of 20.  Coach now has its eyes on Asia and Europe for expansion.  So, this 15% growth number could be higher if Coach is successful there.  From Coach's history, its execution has been fairly flawless. So, I wouldn't be too concerned if you wanted to use a few percentage points higher.  And given that all the lovely ladies I mentioned above are Chinese, I wouldn't be surprised if Coach dominated the Chinese market!

Coach's sticker price is calculated as $50.40, which means the entry price is $25.20.  With the stock price currently at $55.90, the stock is too expensive for us even to start considering!  It is a slightly overpriced stock.  If we were to crank up the growth rate to 20%, the entry price is still only $38.57.  If we had ran this in the summer, the stock would have been in the mid $30s and it may have been a good buying opportunity.  But since then, Coach has had a good quarter and the stock has skyrocketed from $33 to $55.90 in less than 4 months!

The payback time for Coach is 9.8 years, when calculated using a 15% growth rate.  It's close to the upper limit of 10 years.  Coupled with its slightly elevated stock price, I would not recommend stockpiling this stock at its current price.

Therefore, Coach gets a score of 4 for Margin of Safety.

Margin of Safety Score: 4 / 10

Management
Lew Frankfort is the CEO of Coach.  He has been at the helm of the company since 1995, before its spin-off from Sara Lee and before its IPO.  He's brought the company from a relatively unknown brand to what it is today.  Coach is now a bigger company than Sara Lee Corporation by market capitalization, and I think that speaks volumes to Frankfort's leadership.  With his long history and success at Coach, he's already won my vote...but let's continue.

Yahoo Finance shows that Frankfort owns 2.7 million shares of Coach.  That's about $150 million!  If I had to make a hunch, I would probably bet that Frankfort has some interest in running the company well, because if the stock drops to $30, his fortune would shrink to $81 million.  Another vote from me.

Frankfort recently sold about a million shares of company stock in November.  As I mentioned, the stock had a huge run up in the last few months.  So, I don't blame Frankfort for pocketing some profits.  He's probably not a stupid investor either.  He knows, just as we do, that Coach's share price is probably a little overpriced now.  So, Frankfort selling his stock does not necessarily make it a bad thing.  However, keep your eyes open for any future action.  Once Frankfort opens his wallet to buy shares again, you may want in too.  If he sells more, then you may want to reconsider.

I think Coach has solid management in Frankfort based on his long and successful history at Coach.  His large  ownership of company stock is also a plus.  Coach gets an 9 for management.

Management Score: 9 / 10

Meaning
If you are female or have females in the house, then Coach may have a meaning to you.  I've been to a number of Coach outlets and I like what I see.  The handbags, even to me, a fashion sense-less person, are stylish and attractive.  If you can appreciate the handbag business, then look no further and do some more research.

I've tried to dig up some dirt regarding Coach but couldn't find anything substantial. Coach does not manufacture its own products but uses contract manufacturers, mainly in Asia.  In its annual report, it does talk about its business practices, that it performs audits of the manufacturers.  However, we are not privy to seeing what those standards are exactly.  So, even though Coach claims to be a responsible corporate citizen, we don't actually know what that means.  But since there are not many complaints found online, I will take that as a good sign.

Now, I'm just going to split hairs.  One ethical issue I can think of is the use of leather.  As we know, leather comes from cows, and if you're concerned about the killing of cows, then you may want to have a closer look.  I remember seeing a documentary in which the treatment of cows, used as a source of leather, was shown.  Cows were treated very cruelly when they were brought to be slaughtered.  Moreover, in India, where cows are sacred, manufacturers would engage in unethical purchase of cows from poor families.  I don't know if these apply to the manufacturers used by Coach, but it would not be outrageous to assume that they probably do in some cases, maybe unknowingly.

I think Coach is likely an ethical company.  I would not have too much trouble putting my money in this company.  Its products improve the lives of our beloved wives, mothers, sisters, girlfriends, and in turn, that improves our lives.  Coach gets a score of 8 for meaning.

Meaning Score: 8 / 10

Summary
Moat Score: 9 / 10
Margin of Safety Score: 4 / 10
Management Score: 9 / 10
Meaning Score: 8 / 10
OVERALL (not an average): 6 / 10

Coach is a great company to invest in. The only issue is its current high price.  If the stock pulls back, then it'd be your chance to get in!