Streetwise

Lauren Rudd

Sunday, August 29, 2010

Wall Street is not Las Vegas Dressed in Pin Stripes

You often hear the comment that Wall Street is Las Vegas dressed in pin stripped suits. Needless to say, I adamantly disagree with that statement. While speculation could be viewed as sophisticated gambling, investing certainly is not.

Unfortunately, many of you have been tempted to fold your investment hands, due to the recent volatility on Wall Street. Before you take such a step, remember that the market’s performance is that of the market and not individual stocks.

Yes, there are companies that will manage to push ahead despite a less than an ideal economic environment. One good example is Coach, (COH), a company famous for its leather hand bags and one that I have talked about several times in the past.

Here is a company that maintains its panache because many women regard its products with a near religious fervor. Although Coach is unquestionably a “high end” retailer that you would expect to feel the brunt of the recessionary pullback in consumer retail spending, it has nonetheless surprised it critics with its resiliency and market strategy.

To the latter point, the company’s management recognized the need for new price points within its product line and took appropriate action with a well planned and executed line of attack, as opposed to a series of panic induced moves.

When I last talked about the company a year ago, the shares were selling for $29.85. My earnings estimate for fiscal 2010 was $2.08 per share with a 12-month target price on the shares of $35 for an estimated gain of 17 percent. There was also a 1 percent dividend yield.

So how did the stock perform? The shares recently closed at $37.24, while earnings for the year came in at $2.33 per share, netting a one-year gain on the shares of 28 percent.

Looking at the performance in more detail, for the 2010 fourth-quarter that ended July 3, net income increased 34 percent to $0.64 per share. Revenues increased 22 percent to $950.5 million. And the company cut prices about 10 percent as consumers cut their spending during the weak economy.

According to its CEO Lew Frankfort, selling handbags in the new "sweet spot" of $200 to $300 helped to send quarterly revenue upwards by 6.3 percent in North American stores open at least a year. Lower prices have been "clearly resonating with consumers," Frankfort said.

For the full year, net income rose 18 percent to $2.33 per share, while revenues increased 12 percent to $3.61 billion. Frankfort said he expects full-year net income and revenue to rise "at a double-digit pace" in fiscal 2011.

Frankfort also said the company will begin a major expansion of its men's lines in fiscal 2011. The company expects men's leather bags, wallets and other accessories to account for as much as 10 percent of its revenue in coming years, up from 3 percent to 4 percent.

Coach hopes to increase its share of the $4 billion men's global premium bag and small leather goods market, which is about 15 percent of the total premium market.

It plans to open 10 men's outlet stores in North America in fiscal 2011. In Japan, where Coach says men are "more brand- and fashion-oriented," full-price men's stores will play a larger role. Meanwhile, Coach is stepping up its growth in China, where revenue from stores open at least a year doubled for the quarter. It plans to open 30 stores in fiscal 2011, up from 13 in 2010.

At the same time, Coach expects its costs for raw material and for labor in China to rise in the second half of the year, and it is therefore expanding production in Vietnam, India and other areas in response.

The intrinsic value of the shares using a discounted earnings model, with a conservative earnings growth rate of 14 percent and a 15 percent discount rate, is $61 per share. The more conservative free cash flow to the firm model produces an intrinsic value of $52 per share.