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Coach on Sale

You can get a better deal on the company's stock than its luxury handbags these days.

Some days, there's nothing you can say to please people. Clearly, April 22 was one of those days for Coach Inc., the luxury handbag and accessory company.

It wasn't enough that earnings for the quarter that ended March 29, released before the market opened, rose 19% from the same quarter last year. Or that they beat analysts' expectations by a penny a share. Or that sales also jumped 19%, to $745 million. Or that sales at North American stores open at least a year rose 9% -- not as good as the 20% jump recorded in the same quarter a year ago, but up from 7% in the quarter that ended last December 29.

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How many retailers can report that kind of progress these days?

No matter that Coach was still finding takers for its high-end bags, with those selling for more than $400 accounting for 22% of handbag sales in the March quarter, up from 13% a year ago. Chief executive Lew Frankfort even allowed as how he was particularly pleased with the success of the Francine Satchel, introduced in March and retailing for a cool $800.

Whatever Coach was saying, Wall Street just wasn't buying. The stock (symbol COH) closed at $31.70, down 2.5%, after trading as low as $29.95 early in the morning. The shares are down 40% from where they traded a year ago. "Right now, the negatives outweigh the positives," said Morgan Keegan analyst Brad Stephens.

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The biggest negative was what the company didn't say. Frankfort refused to give analysts a heads-up on what the company expects for the upcoming fiscal year, which begins in July. "Due to the continued uncertainty in the economic backdrop, we believe that it's prudent to wait until our fourth-quarter report to offer guidance for the upcoming fiscal year," he said in a statement.

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Talk about waiting for a stinky shoe to drop.

Even more disappointing was a decision to stop reporting separate sales figures for Coach's 287 swanky full-price boutiques and its 101 factory outlet stores. The old way made it easy for number-crunchers to tell how much of the company's sales were hard-won in the bargain bins.

But, Frankfort said, consolidating the numbers better reflects the operational flexibility of the company, which may sometimes tilt toward piquing the fashion whims of high-spenders and at other times offer affordable luxury to sale-seeking outlet shoppers. At the moment, Coach is full bore on both strategies, Frankfort said later in a conference call, adding that he expected a "rough go throughout the entire calendar year on a macro basis."

News that gross profit margins (sales minus the cost of goods sold, divided by sales) fell 2.8 percentage points, to 75%, didn't help the mood any. However, 1.9 percentage points of the drop was attributed to a rise in the yen against the dollar, making inventories in Japan, where Coach operates 147 stores, more expensive. Factoring out the currency impact, margins came in better than expected, in fact.

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Patricia Edwards, a portfolio manager at San Francisco-based money manager Wentworth, Hauser and Violich, says investors blinded by near-term shortcomings may be missing an opportunity. "I understand why people don't want to own the stock -- it's retail and retail has cooties right now," she says. "I think the stock is incredibly cheap, frankly. Once you get through the downturn, you can see something like this take off to the races."

Coach has been off to the races before. After being spun off from Sara Lee in 2000, the company logged earnings growth on the order of 25% to 30% a year and commanded a premium price-earnings multiple in the mid-20s. "Coach doesn't deserve that any more," says Needham & Co. analyst Christine Chen, who nonetheless still recommends the stock. "It's still a growth stock, just not a hyper-growth stock."

Chen, for one, says Coach can double its store base in the U.S. over the next four to five years while boosting its market share in Japan and China. She says the stock should trade for at least $35, applying a P/E ratio of 13.5 -- about the average in the retail sector -- to her calendar 2009 profit estimate of $2.60 a share.

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If Coach can sustain annualized growth in the 18% to 20% range, investors will likely award a multiple more along the lines of 15 to 18 times expected earnings, some analysts say. "I think the thing is worth at least 45 bucks a share 18 months out," says money manager Edwards.

First, though, investors will need more clarity on the state of the economy, and consumers' appetite for luxury leather goods. Until then, the stock may well be stuck in a trading range. "I like the stock here, but it's turned into a show-me story," says Morgan Keegan's Stephens.

By the way, if you're waiting for some big sales or a cut-rate deal on a classy Coach bag for Mother's Day, or for the new grad in your life, you may be disappointed. Here's what CEO Frankfort had to say about resorting to the mark-down pen: "We don't think that's going to be necessary at all. We expect promotional activities to remain at this level or decline over the next few quarters." So if you're sale-minded, you just may have to consider the stock instead.

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