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.