Why Coach Inc Is a Top Dividend Stock: A Stylish 3.6% Yield

Coach Inc stock

Coach Inc (NYSE:COH) is finally gaining some positive momentum. After plummeting sharply over the latter half of 2016, COH stock has already bounced 10% in 2017 and is up about 15% from its 52-week lows set in December. The luxury handbag maker has struggled over the past several years amid intensifying competition and general retail fashion malaise, but the recent pop might be a signal that things are starting to get better.

As regular readers know, I’m constantly on the hunt for dividend-paying companies that have been beaten down, but what I really love is when those same companies are also showing some signs of life. Trying to catch a falling knife can be hazardous to your wealth, so it makes sense to make sure—to the best of your abilities, of course—that the knife has firmly hit the ground before picking it up.

Judging from the latest results, Coach’s business seems to have stabilized to a point where the dividend is worth grabbing. Let’s take a closer look.

Bagged by Rivals

In the company’s second-quarter results released last month, earnings per share increased 11% to $0.75 as revenue bumped up 3.9% to $1.32 billion.

While that isn’t spectacular growth by any means, it was definitely a stark improvement over the declines that investors gotten used to. In fact, the company’s earnings and revenue have dropped at an average rate of four percent and 23%, respectively, over just the past three years. Ouch.

As I touched on earlier, Coach has lost significant market share to increasingly popular brands like Michael Kors Holdings Ltd (NYSE:KORS) and Kate Spade & Co (NYSE:KATE) in recent years, while aggressive discounting and overexpansion has hurt the “luxuriousness” of its own brand. So not only have revenue and earnings fallen of late, but the company’s operating margins have basically been slashed in half over the past five years or so. Extra-ouch.

Throw in the fashion and retail space’s own overall slowdown, and it’s no surprise that Coach’s financials and stock price have experienced serious strain.

Coach’s competitive pressures underline why I stay clear of luxury retail stocks when they’re skyrocketing. The fashion space is notoriously fickle, and it’s only a matter of time when consumer tastes and preferences change in favor of names that are more on-trend. Now, that doesn’t render a brand like Coach’s worthless, nor does it mean that management can’t do things to revive its appeal. It only means that investors need to pay extra-careful attention to price when delving into the sector.

In fact, management is making solid progress in its efforts to make the Coach brand great again.

Fashionable Bounce

So what drove the top- and bottom-line increase last quarter? Well, the company has been trying several things to revitalize the brand for quite some time, including shutting down underperforming stores, restructuring the North American wholesale channel, and adjusting pricing. But only now are those initiatives really starting to bear fruit.

For example, total North American Coach brand sales increased two percent year-over-year, with comparable-store sales rising roughly four percent. Although that doesn’t seem like much of an increase, being able to clearly improve same-store sales in the weak-demand, discount-flooded North American market should be applauded.

Moreover, gross margin expanded 120 basis points year-over-year to 68.6%, suggesting that the Coach brand is regaining some much-needed pricing muscle. Specifically, Coach is steadily regaining market share for high-end handbags, with the $400.00and-above price point now accounting for over half of the company’s handbag sales, up significantly from 30% last year.

Given this “premium” positioning and concerted effort to limit discounting, I fully expect gross margins to rise above 70% over the next few years and extend the gap over Coach’s peers. So while we’re still a long way from the glory days when gross margins hit the high-70s, the important thing is that the Coach brand still maintains industry-topping pricing power and should gain even more.

“We are both pleased and proud of our performance this holiday season, particularly in light of the challenging and volatile global retail environment,” said CEO Victor Luis. “Our team delivered top-line growth in each of our reportable segments, highlighted by positive comparable store sales in North America and overall gross margin expansion.” (Source: “Coach, Inc. Reports Fiscal 2017 Second Quarter Results; Drives Double-Digit Earnings Growth,” Coach Inc, January 31, 2017.)

Dividends by Design

More importantly for dividend investors, though, is that Coach’s revenue and margin improvements are adding to the company’s already-strong cash flows. As I always tell our readers, cash is what counts.

In the second quarter, operating cash flow grew a solid 21% year-over-year to $366.0 million. And over the past 12 months, Coach generated $777.0 million in operating cash flow, versus dividends of just $376.0 million.

Although management hasn’t stressed dividend growth over the past several years, investors can take comfort in the fact that Coach has distributed a well-covered quarterly dividend of $0.34 per share since mid-2013. Given Coach’s stable cash flows, improving long-term trajectory, and ample cash balance of about $1.3 billion, the company might even get back to growing the dividend sooner rather than later.

“We are committed to our dividend, expect our dividend to grow at least in line with prior year’s operational net income growth as our transformation gains further momentum,” said Interim CFO Andrea Resnick in a conference call with analysts. “As always, underpinning all of these priorities are our guardrails for allocating capital effectively, maintaining strategic flexibility, strong liquidity and access to the capital markets.” (Source: “Coach’s (COH) CEO Victor Luis on Q2 2017 Results – Earnings Call Transcript,” Seeking Alpha, January 31, 2017.)

Luxurious Value

So all in all, COH stock’s recent run-up is pretty rational, given the company’s recovering top line and expanding margins. But is there room left to run?

Well, considering that Coach’s relatively stable dividend yield of 3.5% easily tops that of the luxury goods industry (2.5%), as well as the S&P 500 (2.5%), I’d say there’s still some decent upside left. Moreover, COH stock is still down a whopping 50% from its five-year highs set in 2012, suggesting that there’s plenty of operational improvement left to be had. And while the stock’s forward price-to-earnings margin of 18 isn’t cheap by any means, it’s still roughly in line with the broader market.

So although COH stock isn’t at bargain basement levels, its risk/reward trade-off remains highly favorable.

The Bottom Line on COH Stock

COH stock is definitely worth considering, even after the recent bounce. While competition remains intensely fierce, Coach’s improving margins and comparable-store sales suggest that the brand is steadily regaining its pricing power.

When you couple Coach’s long runway for further improvement with a stable dividend and above-average yield, COH stock’s total return potential is quite attractive.

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