March 23, 2012

Coach Earnings Are of Designer Quality

by Sridharan Raman

It has been a great earnings season for most luxury retailers, a majority of which posted earnings that were stronger than those they reported a year earlier. Many also announced plans to expand their outlets and online presence to attract even more consumers. (To read more about same-store sales trends, see this previous article on AlphaNow.) One of these luxury retailers, Coach, Inc. (COH.N) has adroitly used social media to establish consumer loyalty, a factor that is likely to contribute still further to its already-robust earnings as it invests in a mobile platform. Coach’s fourth-quarter earnings were higher than those it reported a year ago; moreover, the company has succeeded in funneling some of its profits into expanding its store network (from 480 in 2007 to 739 last year) without denting same-store sales results. Based on analysts’ estimates, Thomson Reuters expects Coach to post a robust 5.9% SSS figure for the quarter, on the heels of strong gains last year. On top of all that good news, there is the fact that Coach has a high StarMine Earnings Quality (EQ) score of 99, indicating that the company’s profits seem to be coming from sustainable sources and may remain strong in the future.

StarMine uses computer-driven models to analyze the financial statements of thousands of publicly traded companies, and to calculate a proprietary StarMine Earnings Quality (EQ) scores for each of those businesses. Those companies recording the highest StarMine EQ scores are the most likely to be able to sustain their past earnings track record. (For a more detailed explanation of this model, please refer back to this recent article about the earnings quality of American Express.) This examination of Coach’s earnings is the final installment in this series of articles looking at the earnings quality of companies across North America that rank either especially low by our quantitative measure.

Coach saw its profits soar to record levels in the quarter that ended December 31,2011, when it reported net income of $347 million. The charts below show the two most common measures of cash flow: free cash flow (FCF) and cash flow from operations (CFFO). The green bars represent the amount by which the cash flow exceeds net income. As you can see, Coach also reported record FCF and CFFO for the quarter, of $572 million and $611 million respectively. Such strong cash flows are an encouraging sign for future earnings; the more robust the cash flows, the more sustainable a company’s profits tend to be.

Source: Thomson ONE / StarMine

Coach’s return on net operating assets (RNOA) in the last quarter of 154% (represented by the blue line in the chart below) was similarly outstanding; the figure was the highest the company had recorded in five years in spite of the fact that the company has opened so many new stores worldwide. The median RNOA for the industry, represented by the gold line in the chart below, was 24% for the last quarter. The extent to which Coach exceeds this industry measure speaks volumes about the premium prices that customers are willing to pay for the brand’s products. Another measure of operating efficiency is net operating asset turnover. Here, too, Coach has done well, boasting a level of 5 turns, the highest level in five years and double the industry median, indicating that Coach is using its assets to generate revenues effectively. This also shows that that Coach has been increasing its operating efficiency more successfully than its peers.

Source: Thomson ONE / StarMine

Coach has done a good job in capturing the interest of brand-conscious and affluent Chinese consumers, and has expanded its global product line to include men’s products, such as wallets and belts. In fact, in Coach’s most recent 10-Q, the retailer reported strong double digit growth in SSS in its Chinese operations.

Coach’s brand is as strong as it has ever been, judging by the sales and the willingness of customers to line up to buy coveted new products even before they hit the shelves. That is evident from the fact that the company recorded its lowest inventory level in two years (only 117 days) in the most recent quarter. That’s just the icing on the cake – or rather, the top-quality leather strap on the designer handbag – for Coach, whose fundamentals contribute to its strong StarMine EQ score of 99 and point to continued strong earnings in the coming year.

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