Streetwise for September 22

Streetwise for Sunday, September 22, 2013

 

 

Streetwise

 

Lauren Rudd

 

Sunday, September 22, 2013

 

 

Expectations are the Coin of the Realm

 

Expectations are the "coin of the realm" on Wall Street despite the fact that those expectations often include a large dollop of hope, some dreaming and maybe a prayer or two. It is not until expectations are bathed in the harsh light of reality that we see the true picture of where we are and how we got there, which then leads to a new round of expectations.

 

Too often we try to mold our view of reality to meet our expectations when we should be doing exactly the opposite. While it is always nice to dream of a utopian corporate world, in actuality corporations have to deal with many factors well beyond their control. It is the knee jerk reaction of Wall Street to those exogenous factors that often creates bargains for the astute investor.

 

In other words, relying on short-term fluctuations of a company’s share price to predict the future of that company is a mistake. Keep in mind that share price data at a particular point in time is merely an indication of Wall Street’s arbitrary opinion of a company’s performance at that moment. An opinion that is again generally more emotional than logical.

 

At the same time, a company's prior and potential future accomplishments, fundamental financial data and dividend policy are ascertainable with complete certainty. From there, the problem becomes relatively straightforward. By combining the results of your research with the temporary underperformance of a company’s share price, you can potentially realize substantial capital gains going forward.

 

One good example is Coach (COH). Over the years, this Company has performed well for investors. Unfortunately, recent earnings news has degraded its share price performance. Nonetheless, I am still willing to allow Coach some additional leeway to demonstrate that it can regain Wall Street’s confidence.

 

When I last wrote about the Company a year ago, my earnings estimate for 2013 (Coach’s fiscal year closes at the end of June) was $3.90, with a 12-month target price on the shares of $66. Earnings for the year came in at $3.73 and the shares recently closed at $55.39. The first reaction of many is to abandon the shares to the dustbin. Not so fast, let’s analyze the situation.

 

Although North American sales saw a 1.7 percent decline in volume, Coach did well overseas. However, as a result the uncertainty and weakness in much our economy, customers here are now more price sensitive than in the past.

 

For the 2013 fiscal year, net sales rose 7 percent to $5.08 billion, up from $4.76 billion the year prior, while net income, excluding unusual items, increased 3 percent to $1.07 billion from $1.04 billion. On a constant currency basis sales rose 8 percent for the year. In addition, earnings per share were $3.61, up from $3.53. On a non-GAAP basis earnings rose 6 percent to $3.73.

 

Operating income for the year totaled $1.52 billion, while the Company’s operating margin was 30.0 percent, as compared to $1.51 billion and 31.7 percent for the same period a year prior. Gross profit was $3.70 billion, while the Company’s gross margin was 72.9 percent.

 

And fiscal 2013 had a number of milestones, including the acquisition of the Company’s retail businesses in Malaysia and Korea and the transition of Coach Europe to a directly operated business just after the close of the year. During fiscal 2013, the Company’s men’s line grew nearly 50 percent to over $600 million at retail. In China sales grew 40 percent, totaling about $430 million.

 

At the moment, the stock is trading well below its 52 weeks high of $63.24. Within its industry, Coach has one of the lowest price-to-earnings ratios. The intrinsic value of the shares using a discounted earnings model with a consensus 5-year average earnings growth rate of 10.96 percent and a discount rate of 15 percent, is $76. The more conservative free cash flow to the firm model produces an intrinsic value of $98.

 

My earnings estimate for fiscal 2014 is $3.85 with a 12-month projected share price of $63 for a 15 percent capital gain. There is also an indicated dividend yield of 2.5 percent.