Why Coach Is a Great Investment

The market could be severely misunderstanding the situation of luxury leather goods company Coach . In the past two years, the company increased its revenue 12%. More importantly, the company's net income grew 8%. However, its shares have performed terribly since 2011, and they have lost more than 8% of their value year-to-date.

Investors are clearly more optimistic about rivals Michael Kors and Fifth & Pacific-owned Kate Spade. Michael Kors has risen 55% year-to-date, while Fifth & Pacific is up a mind boggling 140%. However, a careful look at Coach's fundamentals reveals that the company may offer great value in the long term. Several patient investors, including buy-side analyst Justin Braiker, have called the company a Buffett stock. What makes Coach a great investment?

COH Revenue (TTM) Chart

Source: YCharts

Coach offers cheap valuation and healthy growth prospects
Despite operating in a highly volatile industry that is subject to various macroeconomic risks, Coach has been able to build a strong business model, which is reflected in the company's healthy fundamentals. As Justin Braiker points out, Coach's gross margin is consistently above 70%, with its operating margin above 30%. Furthermore, the company's return on invested capital of 40%-50% is among the highest in the industry.

These are features that value investors such as Warren Buffett, who has made billions through his investing philosophy, simply love. Looking at Coach's amazing figures and surprisingly low market valuation, Morningstar called this company 'one of the best cash-generating consumer companies' in its entire coverage list. How did Coach manage to build a strong business model in a highly competitive and volatile industry?

It's all about competitive advantages
Coach focused on building a strong brand and improving capital efficiency, which is why the company operates some of the most profitable stores in the entire retail space. According to Bloomberg, the company boasts the third-highest sales per square foot among North American retailers, behind only Apple and Tiffany & Co.

Despite its strong brand, the company has recently experienced weak sales in North America, whereas Michael Kors and Fifth & Pacific are quickly gaining customers. According to the latest earnings call, Coach saw a 6.8% decline in same-store sales in North America.

The good news is that the company still has plenty of growth opportunities abroad. From focusing on on men's business to expanding square footage in China, Japan, and Latin America, there are plenty of growth catalysts available.

International expansion looks particularly promising. The North American region accounts for two-thirds of Coach's total sales. As the company continues to diversify its revenue, this proportion should get smaller. At the same time, Coach has experienced great reception in emerging economies. For example, sales in China were up by 40% annually in the second quarter of 2013. 

Is Michael Kors the new Coach?
Coach faces a strong competitor in Michael Kors, which has managed to grow its revenue between 58% and 67% in the past three years. The company was founded and is still managed by one of the most famous fashion designers in the world. Michael Kors was among the first retailers to target people with money to spend but who aren't rich yet, a fast-growing segment. From high heels to accessories, the company's product portfolio is well diversified, with no more than 30% of revenue coming from a single segment.

Kate Spade is also experiencing fast sales growth. Its comp sales rose 27% in the second quarter of 2013, with organic revenue increasing 43%. The brand is actively using digital media and e-commerce to build a truly global brand. Luxury research firm L2 has ranked the brand second in its third annual Digital IQ index in the fashion category, only behind Burberry.

Final Foolish takeaway
Despite operating in a fiercely competitive industry that's highly exposed to macroeconomic changes, Coach has built a strong brand, is consistently profitable, and has several growth catalysts ahead. Although strong competitors such as Michael Kors or Kate Spade do represent threats, Coach's current market valuation may be too cheap to be ignored, as the company's fundamentals suggest a higher fair price.

Would Warren Buffett buy Coach?
Want to know more about value investing? Warren Buffett has made billions through his investing and he wants you to be able to invest like him. Through the years, Buffett has offered up investing tips to shareholders of Berkshire Hathaway. Now you can tap into the best of Warren Buffett's wisdom in a new special report from The Motley Fool. Click here now for a free copy of this invaluable report.

The article Why Coach Is a Great Investment originally appeared on Fool.com.

Adrian Campos 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.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story