Don't Count Out This Handbag Maker Yet

Don't Count Out This Handbag Maker Yet

Shares of Coach have underperformed the market as the company has faced increased competition from the likes of Michael Kors Holdings and Vera Bradley . However, there are new changes happening at Coach, and the tide might be turning in the company's favor. I see better days ahead for Coach, as well as the accessible luxury category where all three companies operate. These three companies should continue to post sales gains regardless of how the overall economy fares.

Change is happening
The biggest change happening at Coach is Victor Luis becoming CEO and Stuart Vevers taking over as creative director. It is up to these two to reinvigorate the product line and grow the company. Their job is to help Coach regain lost market share in the accessible luxury category.

To do so, the company is looking to become more of a lifestyle brand for men and women. Besides handbags and leather goods, the company plans to improve its shoe line. By offering more products, it should get more customers into the doors and increase sales.

Coach also needs to focus on its international expansion. I was shocked to find out that Coach has only 20 stores in Europe. With the worst of Europe's troubles behind it, I think the region is a prime area for growth. Coach is planning to target that growth by opening 10 new stores by next spring.

Shares of Coach still look attractive because its forward P/E is only 12 and its EV/EBITDA is 7.6. Operating margin is strong at 30.9%. For dividend investors, the stock pays a nice dividend yield of 2.7%.

Coach's loss has been Michael Kors' gain
The primary beneficiary of Coach's stumbles has been Michael Kors. The performance of Michael Kors has been phenomenal. The good news is that international markets offer plenty of room for growth for companies in the accessible luxury category.

Michael Kors had several pieces of good news in October. For one, the company is joining the S&P 500 index. The stock got a 4% boost on this news because index funds will now need to include the stock in their portfolios. The second is that analysts are bullish on the company and see several items driving growth. Morgan Stanley said that channel checks show strong traffic patterns for this quarter. Canaccord Genuity sees Kors continuing to take market share from Coach. Piper Jaffray sees Michael Kors attracting teenagers into its stores and creating a new line of customers.

In looking at shares of Michael Kors, I see that it trades at a premium to Coach. While the company is not as cheap as Coach, its premium valuation is warranted because the company continues to grow and gain market share. Kors trades at a forward P/E of 22 and has an EV/EBITDA multiple of 19. Its operating margin is slightly lower than Coach's at 29.7%. While Michael Kors does not yet pay a dividend, the company has a strong balance sheet with $639 million in cash and no debt.

In the midst of a turnaround
Vera Bradley, like Coach, has struggled over the past few quarters as it too lost market share to Michael Kors. This happened partially because the company over-assorted and had too many styles and patterns in its handbag lines. I see things picking up and getting better heading into the holiday shopping season and early next year.

What I really like about Vera Bradley is that management is admitting its missteps. Outgoing CEO Michael Ray blamed soft sales on the company's product offering and its overall assortment and how it's showcased. The first step is to identify the problem and then work to fix it. Vera Bradley is doing that by reassessing its patterns and finding patterns that better connect with its customers.

Second, with Michael Ray retiring as CEO the company can now look to bring a retail-minded CEO on board. The company is looking for a CEO who has extensive retail and brand management experience. I think this will be great for the company as the new CEO can correct some of the mistakes of the past and guide the company forward.

In looking at Vera Bradley's valuation, it's similar to Coach with a forward P/E of 13 and EV/EBITDA multiple of 7.29. The company doesn't have the operating margin of Michael Kors or Coach though. Its current operating margin is only 19.4%, it has no debt, but it only has $9.3 million in cash.

Foolish assessment
As a value investor, I think the best bet is Coach. The company will have a new CEO and creative director in place in the new year. While the next quarter may be bumpy because the company is still losing market share to Kors, I think the company is cheap enough to attract some long-term investors.

It's tough to argue with the success Michael Kors has had, but it looks a little pricey to me. For Vera Bradley, I'll feel much better once I know who will be the next CEO. Whoever it is will have their work cut out for them, but the company has plenty of potential because it is in a strong category and it has name recognition. Overall, the best bet looks to be Coach in terms of valuation and turnaround potential.

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Mark Yagalla has no position in any stocks mentioned. The Motley Fool recommends Coach. The Motley Fool owns shares of Coach. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published