COH Hold Coach Troup Fall07 (2)

FIN 57311/30/07Danielle Troup

Company: Coach Inc (COH) PSFA Purchase Price: $33.93Current Price: $37.14 DA Davidson Purchase Price: $35.2452-Week Range: $30.52-$54.00 Target Price: $67.01PSFA Shares: 170 Market Cap: $13.67BDA Davidson Shares: 200 Recommendation: Strong Hold

Company Overview & Business Description

Company Background

Coach, Inc. (COH) designs and markets high-quality accessories targeted towards middle and upper income consumers. It is the number one luxury accessories brand in the US and also holds the number two spot within Japan.1 As of June 2007, it operated through 254 retail stores and 93 factory stores in the US, five retail stores in Canada and 137 department store shops, retail stores and factory stores in Japan.2 Coach, Inc. was founded in 1941 and is headquartered in New York, New York. The strength and endurance of the Coach brand has grown significantly over the six and a half years it has been a public company marked by 22 consecutive quarters of annul sales growth exceeding 20%.

Company Management

Coach benefits from a strong industry experienced and seasoned management team. On both the design and financial side of the business management has built a solid track record.

Below is a brief introduction to key executives within the company:

Lew Frankfort, Chairman and CEO: Lew Frankfort has been involved with the Coach business for more than 25 years. He has served as Chairman and CEO since November 1995 and held a number of executive positions within the company prior. Before joining Coach in 1979, Mr. Frankfort served as President and CEO of the accessories division of Sara Lee Corporation for almost six years.

Keith Monda, President, COO, and Director: Keith Monda was appointed COO in June of 1998. Prior to joining Coach, Mr. Monda served in executive roles for Timberland Company and J. Crew, Inc.

1 “Coach Inc.: Stock Report.” 29 September, 2007. Standard & Poor’s. 4 October 2007 <http://www2.standardandpoors.com>.

2 Coach Inc. 2007 Annual Report: 61.

Michael Devine, CFO: Michael Devine has served as CFO since December 2001. Before coming to Coach, Mr. Devine served as CFO for Mothers Work, Inc. and prior for Strategic Distribution, Inc.

Janet Carr, SVP Consumer Insights and Strategic Planning: Janet Carr joined Coach in 2005 from Gap Inc., where she held the same position for Gap International. Before this role she was VP of Strategy and Business development for Banana Republic.

Reed Krakoff, President, Executive Creative Director: Reed Krakoff has served as Executive Creative Director for Coach since 2001. Mr. Krakoff brings over 13 years of senior design experience to the company. Prior to his involvement at Coach he served in critical design roles for Tommy Hilfiger USA and Polo/Ralph Lauren. Mr. Krakoff has been recognized twice by the Council of Fashion Designers of America and awarded the coveted American Fashion Award for Accessories Designer of the Year for 2001 and 2004.

Managements combined experience and focused dedication should help the company continue to experience strong growth and weather any tough conditions ahead.

Industry Setting

Specialty Retail

Coach operates within the specialty segment of the retailing industry. The specialty retailing industry encompasses a broad range of sub-industries and product classifications. Unlike general retailers, specialty retailers focus on either a single category of merchandise, or carry a few closely related products. Specialty product categories range from big ticket items such as automobiles and luxury goods, to less expensive products including books and pet supplies. Figures presented by the US Census Bureau show that each year retailing firms generate close to $3.8 trillion in annual sales with specialty retail making up a substantial portion of those sales.3 During the first four months of 2007, specialty retail provided approximately 86% of the $1.26 trillion in U.S. retail sales. 4

Products sold at specialty retail stores can be broken down into two main categories of merchandise: basic and fashion. Basic merchandise includes staple and non-seasonal products such as T-shirts, underwear, and jeans. These items are typically unchanging in style and stable in demand due to their everyday use. Fashion merchandise consists of trendy or seasonal items. Much fashion merchandise is subject to consumers fleeting taste and demand exists for shortened times as fashion goes in and out of style. Due to great diversity within specialty retailing, rapid expansion of specialty shops and heightened competition from mass merchandisers and department stores, specialty retailers must

3 Yeo, Shirley Siew Lin. Mergent: The North American Retailing Sectors June 2007: 10.

4 DeFoe, Jeannine and Michael Souers. Standard & Poor’s Industry Survey: Retailing: Specialty 2 August 2007: 8.

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constantly work to differentiate themselves in the eyes of the consumer. In the specialty retailing industry, having a strong and recognizable brand image is pertinent to success.

The Luxury Market

Coach has positioned itself within the luxury market of specialty retailing. The global luxury market has doubled in the past decade to almost $220 billion a year in retail value and industry analysts predict that the market will continue growing at an annual rate of 8-10%.5 The largest luxury markets include the United States, Japan and China respectively.6

The term “luxury” used to be defined as hideously expensive and unashamedly elitist. However, today’s luxury defies this notion. For the most part, luxury is no longer reserved for the spoiled rich. Increasingly the global middle class is prepared to pay a premium for the “thrill of owning something that makes them feel special.”7 Luxury houses such as Dior, Cartier, and Chanel have tapped into this market by extending their product lines to cater to such aspirations.

Likewise, Coach has built its company on a similar strategy. Coach’s luxury products are offered at multiple price points allowing the brand to reach a wider demographic than most comparable luxury retailers. This has resulted in what the company has called an “accessible luxury” offering.

Target consumers within the luxury market fall into three brackets:

The Near Affluent: Household incomes of $75,000 to $99,999 who occasionally trade up to luxury.

The Affluent: Household incomes of $100,000 to $149,999. The Super Affluent: Household incomes of $150,000 and above.

Increasingly there is a shift in the luxury market towards experience based purchasing. Pam Danzinger explains in the Luxury Report 2006, that “Today’s luxury market is less about ostentation and materialism and more about a search for meaning and emotional fulfillment.”8

5 Gumbel, Peter, and Eugenia Levenson. “Mass vs. Class.” EBSCOhost. 11 October 2007 < http://www.ebscohost.com/ >.

6 Rein, Shaun. “Growth in China’s Luxury Goods Market to be Fueled by 2nd Tier Cities.” Seeking Alpha.com. 2 November 2007 <http://seekingalpha.com>.

7 Ibid.

8 “Research and Markets: This important new study of the US Luxury Market provides the results of a four year longitudinal research study of the luxury market.” BNet Research Center. 2 November 2007 <http://findarticles.com>.

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The key to luxury today lies in creating an emotional connection between the consumer and the product.

Life Cycle

According to Hooke in Security Analysis on Wall Street, “mature industries produce “average” results” and the retailing industry as a whole operates within this setting.9 However, the specialty retailing market is one of greater breadth and dynamics. As such, specialty retailing waivers in the life cycle between the growth and mature stage, depending upon the specific retailer. The luxury market continues to operate within the growth cycle and Coach finds itself in this same cycle. The company has experienced strong sales increases in all distribution channels, averaging revenue CAGR of 28.6% over the past five years.

Products & Markets

Product Offerings

The Coach philosophy is to develop and deliver “accessories functionally appropriate for contemporary dress”.10 Coach’s product offerings include handbags, women’s and men’s accessories, footwear, outerwear, business cases, sunglasses, watches, travel bags, jewelry and fragrance. Coach’s leather products, which make up the bulk of company sales, are very well made using high quality leather and sturdy hardware. With proper care Coach’s leather goods often last 15 years or more.11

Coach’s 2007 $2.6 billion product sales mix by product category were as follows:

Handbags – 64% Women’s Accessories – 28% Men’s Accessories, Watches, Footwear, Eyewear, Business, and Travel – 1% to 2%

each.

Coach has become the status symbol of US “accessible luxury”. The company places unwavering focus on providing affordable luxury lifestyle accessories that are extremely well-made, fashionable and functional at a very attractive price.12 The company’s ability to integrate all of these key elements into its products is what differentiates them from other luxury accessories retailers. Each key selling season the company reinvents itself through new lifestyle

9 Hooke, Jeffery C. Security Analysis on Wall Street. A Comprehensive Guide to Today’s Valuation Methods. New York: John Wiley & Sons, Inc., 84.

10 "Coach (company)." Wikipedia: The Free Encyclopedia. 12 October 2007. 13 October 2007 <http://en.wikipedia.org/wiki/Coach_%28company%29>.

11 Ibid.

12 Coach, Inc. 2006 Annual Report: 4.

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platforms showcasing the newest styles and quality driving new and repeat purchases.13 Additionally Coach, Inc. strives to offer superior and innovative customer service. The company is passionate about empowering its employees to do the right thing for its customers and believes that “great service builds loyalty, and loyalty drives sales.”14

Coach’s strong iconic brand image and fresh, relevant, functional and innovative products offered at multiple price points draws a diverse crowd of customers. This strategy diminishes the impact that the loss of any one customer base may have upon operations.

Target Market

Coach targets the top 20% of U.S. households and attracts an additional 20% below the top 20% percent.15 The company believes that its incremental business is split about equally from three different sources: those trading “down” from higher priced brands, those trading “up” from lower priced brands, and those that shop similarly priced brands.16 The average household income of the lowest quarter of the company’s shoppers is $60,000 a year.17

Many consumers who are in the top one to three percent in income buy Coach. However they might, for example, buy a Coach accessory which they place in their European luxury handbag. Coach is effectively working to draw a larger share of these consumers accessory wardrobe by offering higher-end products. Increased products within the $400-plus category, particularly for many of its limited edition bags, has garnered increased interest and sales amongst its top purchasers. In the fourth quarter 2006, sales of handbags priced over $400 grew sharply from a year ago to 17% of handbag sales in Coach retail stores.18

Competitors

The luxury handbag and accessories industry is highly competitive. Over the last several years the category has grown rapidly, encouraging the entry of new competitors as well as increasing the competition from existing competitors. Coach primarily competes with European luxury



15 Geller, Martinne. “Coach’s Frankfort talks about holiday season, consumers.” Reuters.com. 2 November 2007 <www.reuters.com>.

16 “Coach (COH)” Wikinvest. 29 October 2007. 14 November 2007 <http://www.wikinvest.com/stock/Coach_(COH)>.

17 “Will Coach be hurt by economic woes?” BloggingStocks.com. 7 November 2007 <www.bloggingstocks.com>.

18 Much, Marilyn. “Coach’s Win Streak Continues as Consumers Snap up Handbags.” Yahoo! Finance.com. 23 November 2007 <http://biz.yahoo.com>.

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brands such as Louis Vuitton, Prada, and Chanel. Additionally, Coach’s business model of “affordable luxury” reaches a larger demographic as compared to the company’s higher priced competitors. Thus, the company also competes against private label retailers and lower-priced brands such as Liz Claiborne, Fossil Inc, and Tandy Brand Accessories.

Distribution, Manufacturing & Sourcing

Coach operates its business in two segments: The Direct-to-Consumer segment, which includes company-operated stores in North America and Japan, its online store and its catalogs. The Indirect segment includes department store locations in the US, international department stores, freestanding retail locations and specialty retailers. This multi-pronged international distribution model sets the company apart from its competitors and allows the company to reach a broader customer base and offer its products at multiple price points. Additionally, the company’s success does not depend solely upon the performance of a single channel or geography.

Coach plans to expand its distribution channels greatly over the next three years. The company aims to almost double its North American retail locations, bringing the total to over 300 stores. In Japan, its number two market, Coach is implementing a multi-channel model similar to that of the US and hopes to add over 70 retail locations. Additionally, the company continues to focus on driving growth in Hong Kong as the gateway to greater China.

All of Coach’s products are manufactured by independent manufacturers which allows for a broader mix of product types, materials, and seasonal influx of new, fashion oriented styles. Unlike many other luxury retailers, Coach also utilizes lower-cost production facilities in developing countries such as China and the Dominican Republic. No one vendor provides more that 13% of Coach’s total production.19

All product sources, including independent manufacturers and licensing partners, must undergo continuous quality and business practice standards audits and meet minimum guidelines in order to partner with Coach. The company maintains sourcing offices in Hong Kong, China, South Korea, and Italy that work closely with its independent manufacturers. This broad-based, multi-country manufacturing strategy is designed to optimize the mix of cost, lead times and construction capabilities.

Design and Merchandising

Coach’s New York design team, led by its Executive Creative Director, conceptualizes and designs all of Coach products. Coach designers are closely supported by the merchandising team that analyzes sales, market trends and consumer preferences in order to identify business opportunities that help guide each season’s design process. The design and merchandising team also work closely with all licensing partners to ensure that licensed products (watches, footwear and eyewear) convey properly the Coach brand.

Research, Development, & Marketing


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The importance of planning, buying, and controlling merchandise levels is critical for retailers. The process of getting the right inventory in place at the right time involves a great level of research and preparation. Factors including fashion trends, demographic changes, and weather forecasts must be constantly observed and reacted upon. Coach devotes considerable resources towards researching market trends and surveying its consumer base. The company reportedly spends $4-5 million per year surveying consumers to find out more about their preferences.20 Analyst Liz Dunn of Thomas Weisel Partners states, “Management identifies different types of customers and attempts to meet all its customers’ needs at all times with continued newness and innovation.” and also states, “They’ve been spot on in terms of fashion.”21 In any given year, Coach gets between 60-70% of its business from new products.

New product line introductions often go through a pilot program in the company’s home of New York City before being rolled out across the entire market. This is done in an effort to test consumer acceptance and popularity. Coach’s CEO, Frankfort asserts, “It’s in our backyard, making it easier for us to micromanage, which we like to do in a pilot environment. We’ll use that as a laboratory for us. Based on our learning, we’ll decide how to expand beyond that.” Coach is methodical and cautious around the product line expansion of its business.

Coach’s marketing strategy revolves around delivering a consistent message each time the consumer comes in contact with the Coach brand. Advertising costs, which make up approximately 12% of SG&A expense, include expenses related to direct marketing activities as well as media and production costs. Coach’s direct marketing activities include catalogs, brochures and email contacts. In fiscal 2007, over 114 million consumer contacts were made.22 Coach has not only an impeccable focus on keeping with current trends but also on creating & driving trends. As a testament, the company through its website, www.coach.com, puts out a monthly online magazine, Coach Clique, that “delivers hip style trends, news and fun facts” to keep their customers in the “in crowd.”23 During fiscal 2007, Coach’s internet business generated net sales of $82 million, up 51% from the prior year. This growth was primarily driven by advertising and email contacts.24

Capital Expenditures

Coach’s major capital expenditures consist of new store development, store expansions and remodels, information systems hardware and software, and fixture purchases. Coach typically

20 “Coach (COH)” Wikinvest. 29 October 2007. 14 November 2007 <http://www.wikinvest.com/stock/Coach_(COH)>.

21 Much, Marilyn. “Coach’s Win Streak Continues as Consumers Snap up Handbags.” Yahoo! Finance.com. 23 November 2007 <http://biz.yahoo.com>.


23 Coach.com 29 October 2007 < http://www.coach.com/CoachClique/default.aspx>.


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http://www.coach.com/

funds its growth through internally-generated funds. The company’s long term debt consists primarily of operating leases and accounts for only .01% of liabilities.

Company Strategy & Competitive Environment

Coach is pursuing two key strategies to drive sales and increase its market presence: increase global distribution throughout the Asian markets and improve productivity. To increase productivity the company plans to market merchandise as a year-round gift resource, develop under penetrated categories, emphasize new usage occasions, and enhance store service levels.25

SWOT Analysis

Strengths:

Strong Brand Image. Coach is the leading premium luxury accessories retailer in the US. Coach’s share of the US market has increased over 9% in the past five years.26 It is also one of the fastest growing import brands in Japan. In 2007, the company spent 2.3% of net sales on advertising, marketing, and design.27 The Coach product has been in existence since the early 50s and the company maintains a very loyal customer base. Retail stores manage client relationships through private product showings and maintain client books in which they use to call on customers when product enters the store that meets stated preferences. The company has a very strong product guarantee policy, provides free home shipping, and all product purchases come wrapped in ribbon and a special Coach box. The Coach Brand image encompasses more than just the product.

Multi-Tiered Pricing Strategy. Coach wants all consumers to experience its brand. A Coach product, like a trendy key fob, can be purchased for as little as $28 or one can pay up to $1200 for a special request handbag made with exotic materials such as snake skin or ostrich feathers. There are many products offered at prices between the two mentioned and it is through this strategy the company is able to reach a much wider demographic than that of its competitors.

Multi-Channel Distribution Network. Coach’s widespread shopping venues has allowed to company to target a greater range of customer segments and gain economies of scale. The company’s products are sold in about 900 US locations, including such retailers such as Federated Department Stores, Dillard’s, Nordstrom and Saks. Overseas, the company’s wholesale customers include the DFS Group, Lotte Group, Shilla Group, Tasa Meng Corporation and Imaginex.28



27 Datamonitor: Coach, Inc. 24 Aug 2007: 6.

28 Ibid., 5.

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Weaknesses:

Geographic Concentration. Coach derives the majority of its revenues from the US market making the company vulnerable to US economic risks. In 2006, 75% of revenues came from sales in the US. In contrast, competitor LMVH derived 27% of total revenues from the US, 35% from Europe, 31% in Asia and the remaining from other markets.29

Opportunities:

New Store Openings, Expansion & Renovation. Coach’s brand recognition has grown considerably over the past few years. As such opening new stores will increase the companies’ presence which in turn will lead to an increase in sales. The company plans to open at least 100 new stand alone retail locations by 2009. Coach also plans to increase the footage in its most productive stores and enhance their appearances with proprietary Coach fixtures.

Product Expansion. Coach recently expanded into two new product categories, fragrance and jewelry. Launched nationally on August 28, 2007 the incremental revenues from these product lines should begin to increase earnings. Coach plans to further expand these product categories dependent upon their continued success.

Growing Retail Market in Asia. The Japanese handbag market is estimated to be twice that of the US. Additionally, Japanese women are very fashion conscious and will pay up to 60% more for luxury goods than that of US women. The workforce of the Japanese has grown from 49% in 1980 to 71% in 2004 leading to an increase in discretionary income to indulge in luxury goods. 30 Greater China and Korea with their expanding economies could also be of vast potential for luxury retailers as these markets tend to value luxury items highly as well.

Threats:

Strong Competition. Competition within the luxury goods market continues to grow. Deregulation has resulted in increased infiltration of foreign retailers into the US. In addition, large global retailers whom yield immense buyer power have been expanding their operations of designer goods. This increasing competition could lead to price wars and put greater pressures on the company’s margins.

Counterfeit Goods. The rise in counterfeit designer goods is hurting original branded

retailers. The Global Congress on Combating Counterfeiting reports that fake goods comprise 9% of all world trade.31 Even of more concern is that similar goods are finding

29 Ibid., 6.

30 Ibid., 7.

31 Ibid., 8.

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their way into organized retail shops. Fendi has sued Wal-Mart for allegedly selling counterfeits of its handbags at its Sam’s Club stores and Coach itself was recently in litigation with Target over a handbag that resembled too closely one of the company’s most popular designs. The increase in counterfeit items could damage luxury brand images.

. Brand Cache. As the company grows in popularity and through increased product

expansion there is growing concern that the perception of its products may change. Specifically, that its products are too “pedestrian” and could turn off customers attracted to its higher priced luxury handbags. To mitigate this risk the company is increasingly focused on drawing in its top consumers. The introduction of pricier handbags, limited edition offerings, private product showings, and Coach by special request - in which the customer may order handbags in exotic leathers and colors - are expected to maintain these customers’ loyalty to the brand. It will be pertinent that Coach is able to preserve its appeal to consumers in the higher end market.

Slowdown in US economy. The current slowdown in the US economy is depressing the purchasing power of retail consumers. The housing slump, rises in gas prices, increases in borrowing rates, and slow employment growth are all contributing to decreases in consumer spending. As Coach derives the majority of its revenues from the US, this is an area that could be of growing concern if consumer spending continues to slow.

Financial Strength

Market Share

Market share for the company has grown from 16% in 2000, to just over 25% in 2005 outpacing that of US industry growth for luxury accessories.32


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Figure 1: Coach US Handbag Market Share Source: www.wikinvest.com.

Coach is placing considerable focus on increasing its market share in Japan through increased distribution and marketing as it holds second place with a 9% market share to competitor Louis Vuitton. Coach also is moving to create a dominant presence in other Asian markets such as China and S. Korea.

Stock Performance

Coach has experienced remarkable growth in both top and bottom line earnings, and hence stock price, since its incorporation in 2000 as seen in the following figure, Figure 2:

Figure 2: Coach Stock Chart: 2000-2007 Source: Yahoo Finance.

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http://www.wikinvest.com/

Additionally, Coach has far exceeded the stock performance of its US competitors as seen in Figure 3:

Figure 3: Coach Stock Chart vs. Competitors: 2000-2007 Source: Google Finance.

The recent downturn in the price performance of Coach came amidst news of weakening consumer store traffic as mentioned during the company’s Q1 conference call October 23rd, 2007. Despite a 28% increase in revenue and 34% increase in margin, the fear of continued weakening in the US market due to uncertainty in the credit markets, falling home prices, and all time high crude oil prices, drove the stock downwards.

However, it is not just Coach who has suffered from these economic conditions. Other accessible luxury retailers such as Tiffany & Co., Saks Inc., and Nordstom Inc., have posted similar declines in stock performance. Coach continues to achieve increases in all channels of distribution and is not suffering due to company specific issues. It appears Coach has been taken down by the “good stock in a bad market” phenomenon but price is expected to rise back up as market conditions settle.

Ratio Analysis

Profitability

Coach continues to drive not only top line growth but has been able since its inception to push that growth to the bottom line. As seen in Figure 3, sales for 2007 rose 28.4% and coupled with better SG&A expense management the company enjoyed an operating margin of 38%. Diluted EPS increased over 65% for the period 2006-2007.

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Figure 4: Coach 2007 Financial Highlights Source: Coach Inc.: Annual Report, 2007.

Coach surpasses its competition on a number of profitability metrics. The company nearly doubles the industry average ROE of 20.7% and exceeds its primary competitors almost threefold in terms of ROA. Margins are also considerably higher than the industry average of approximately 10%.

COH Profitability Ratios Jun-03 Jul-04 Jul-05 Jul-06 Jun-07Return on Equity (%) 34.3% 33.5% 37.6% 41.6% 33.3%Return on Assets (%) 23.7% 25.5% 28.9% 30.4% 26.0%Net Profit Margin (%) 15.4% 19.8% 22.7% 23.4% 25.4%

Figure 5: Profitability RatiosSource: COH DCF Worksheet, Appendix C.

Liquidity & Solvency

Coach boasts healthy cash flow and very low levels of debt borrowing. Both the Quick Ratio and Current Ratio are quite high as there is a considerable amount of cash sitting on the balance sheet. This is also reflected in the low debt management ratios. It is the company’s objective to conserve cash within the company for further expansion.

COH Liquidity Indicators Jun-03 Jul-04 Jul-05 Jul-06 Jun-07Quick Ratio 1.64 2.69 1.69 1.82 3.17Current Ratio 2.78 3.88 2.67 2.85 4.27Working Capital/Total Assets 0.46 0.51 0.33 0.39 0.54 COH Debt Management Current Liabilities/Equity 0.38 0.23 0.26 0.29 0.21Total Debt to Equity 0.01 0 0 0 0Long Term Debt to Assets 0.01 0 0 0 0

Figure 6: Liquidity Indicators & Debt ManagementSource: COH DCF Worksheet, Appendix C.Asset Management

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The company manages its assets very effectively and most notably it’s inventory. As demonstrated by the inventory turnover ratio, Coach is able to turn its inventory almost every month. As the company’s product collections are seasonal and planned to be sold in stores for short durations, the production quantities are typically limited lessening its exposure to excess and obsolete inventory.

COH Asset Management Jun-03 Jul-04 Jul-05 Jul-06 Jun-07Revenues/Total Assets 1.54 1.28 1.27 1.3 1.07Revenues/Inventory 6.63 8.16 9.27 9.04 8.97Revenues/Working Capital 3.32 2.52 3.86 3.34 1.96Interest Coverage 353.26 555.03 - - -

Figure 7: Asset ManagementSource: COH DCF Worksheet, Appendix C.

Industry Specific Ratios

Store space is considered to be a productive asset and key to profitability. Successful retailers generate as much sales volume as possible out of each square foot of store space. Coach has increased its sales per square foot over 146% since 2003.

Comparable store sales growth, also referred to as comps, evaluates sales in stores that have been open for a year or more. This measurement allows the comparison of what proportion of new sales have come from sales growth compared to the opening of new stores. Coach continues to drive increases in its comps through its constant introduction of seasonally inspired merchandise and new product line offerings.

It is impressive that Coach nearly doubles the industry in terms of both sales per square foot and comparable store sales growth.

COH Industry Specific Ratios Jun-03 Jul-04 Jul-05 Jul-06 Jun-07Sales per Square Foot $1,364.77 $1,688.83 $1,890.31 $2,032.80 $2,134.41Comparable Store Sales Growth 16.9% 18.20% 22.3% 27.1%

Figure 8: Industry Specific RatiosSource: COH DCF Worksheet, Appendix C.

Company Valuation

Relative Valuation

A quick relative valuation based on P/E reveals that Coach is slightly undervalued as compared to its exchange traded competitors and the Apparel Footwear and Accessories Industry as a whole. Coach has the highest ROA, ROE, and EPS for those firms compared as seen in figure 9:

Company Ticker Market P/E ROA ROE EPS

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Cap (ttm) (ttm)Jaclyn, Inc. JLN 15.25M 28.61 6.73% 2.80% 0.22Fossil, Inc. FOSL 3.01B 28.82 10.81% 16.59% 1.50Apparel Footwear & Accessories Industry n/a 56.18 B 21.50 n/a 20.70% n/aCoach, Inc. COH 13.67B 20.31 30.18% 42.28% 1.83Liz Claiborne, Inc. LIZ 2.50B 18.88 6.44% 7.29% 1.33Tandy Leather Factory, Inc. TLF 45.01 M 13.76 5.98% 8.70% 0.30Tandy Brands Accessories, Inc. TBAC 66.03M n/a -1.21% -1.63% -0.39

Figure 9: Relative ValuationSource: COH DCF Worksheet, Appendix B.

DFC Valuation

The consensus in the market is that the luxury retailing sector is poised to have consistent growth in the coming years both domestically and internationally. After analyzing Coach’s prior financial health, as well as their stated objectives and company position, they seem to be in line with the market to continue experiencing strong performance. The definitions for FCFF/FCFE as given in Aswath Damodoran’s 2ed. writing of Investment Valuation: Tools and Techniques for Determining the Value of Any Asset were used in determining the value of the company.

As Coach is currently in its growth cycle, increased growth is likely – especially within the Asian markets. FCF forecasts of the company’s revenues were broken down by geographical region (United States, Japan, & Other International) with growth projected accordingly based on historical performance and current qualitative factors. In the short run, revenues are slightly depressed for the US market due to the weak current economic conditions while Japan and Other International growth is strong due to increased freestanding store locations and distribution expansion. Growth continues to increase for all regions throughout the intermediate growth period and then slowly tapers off to reach a projected constant of 4% by 2019. Additional parameters, such as SG&A expense, effective tax rate, depreciation and amortization ect., were held relatively constant as historically the company has done a consistent job at maintaining such levels.

The company’s WACC was calculated to be 10.9%. Discounting the FCFF by this cost of capital gave an equilibrium price for the stock of $67.01. Comparing this to the current stock price as of 11/30/2007, the stock is found to be deeply undervalued by roughly 81% as seen in the following figure, Figure 10:

COH DCF Summary FCFF FCFE

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Cost of capital 10.9% 10.9%

Cash flow in 2021 3,622,388.04

3,632,901.55

Terminal value at 2021 $54,980,610 $54,701,283 Present value of Terminal Value $15,037,494 $14,868,039

Present value of intermediate CF 9,715,476 9,779,978

Total $24,752,970 $24,648,018 Add Cash 262,720 262,720 Subtract value of debt 94,714 Equity value $24,920,976 $24,910,738 Shares outstanding 371,890 371,890 Value per share $67.01 $66.98 Current Price $37.14 Over(under) valued ($29.87)

Figure 10: DCF ValuationSource: COH DCF Worksheet, Appendix A.

Investment Summary

Current Holdings

Coach was introduced into the CFASP portfolio November 9, 2005. Reasons for the purchase and target price are unknown. 170 shares were purchased at a price of $33.93. Currently, our holding in Coach, Inc. makes up 3.5% of the CFASP portfolio’s value. Up until mid October 2007 our holding of Coach yielded a return of 39.28% since its purchase. However, as mentioned earlier, due to cited weakening of US store traffic and weakening economic conditions, the stock has been negatively affected and as of 11/30/2007 has yielded 9.08%. Coach is also held in the DA Davidson portfolio, making up 15.5% of the portfolio’s value. 210 shares were purchased December 31, 2005 at $35.24. Subsequently, 10 shares at $33.40 were sold September 19, 2006. The reasons for the purchase and partial sale of Coach within the DA Davidson portfolio are unknown. Coach’s closing stock price 11/30/2007 was $37.14, trading at a P/E ratio of 20.31 with an industry P/E of 21.50.33

Recommendation

It is my opinion that we continue to hold Coach, Inc. in both portfolios if not increase our DA Davidson holding in the company if further class discussion around the options for the portfolio merit such. Coach is effectively growing and leveraging its brand awareness across the globe excelling at maintaining the delicate balance between fashion, quality, functionality and price. I believe Coach has substantial room for growth both domestically and internationally and with an ever increasing demand for luxury items, Coach is poised for further success. Coach’s continued ability to create new products and to sustain existing products by successfully anticipating and responding to consumer preferences and fashion trends will be critical for its future growth.

33 MSN Money PSUPortfolio Holdings. Retrieved 6 October 2007. <http://moneycentral.msn.com/stock_portfolio>.

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COH Hold Coach Troup Fall07 (2)

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