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In this screen, we set out to find companies that appear undervalued despite recording solid earnings results over the past year. Since this is primarily a value screen, we made sure to include only those equities with a relative price-to-earnings ratio below 1.0. This simply means the stocks’ P/E ratios had to be less than the average equity found in The Value Line Investment Survey. Next, we made sure that the stocks were not trading at depressed P/E ratios because of poor earnings results by requiring that EPS growth exceed 20% for the prior year. Next, we wanted to include companies that were not burdened with hefty interest payments, so we only let through those with long-term debt-to-capital ratios of 10% or lower. Finally, to add additional appeal, we required a decent annual dividend yield of 2.0% and above. The screen netted 15 stocks (see the list below), of which, we have chosen to highlight Coach, Inc. (COH).

Coach, Inc.

Coach is a designer, producer, and marketer of high-quality modern American accessories. Its primary product offerings include handbags (65% of fiscal 2012 sales), women’s and men’s accessories (wallets, belts, cosmetic cases, etc. 28%), briefcases, luggage, leather outerwear, gloves, scarves, etc. (7%). Coach holds the number one position in the U.S. premium handbag and accessories market and the number two position within the Japanese imported luxury handbag and accessories market. The Direct-to-Consumer segment (89% of sales) consists of company-operated stores in North America (63%); Japan and China (18%); other Asia (2%) and on the Internet (6%). The Indirect segment represented approximately 11% of total net sales in fiscal 2012. It sells products in approximately 990 wholesale locations in the U.S. and Canada. Its most significant distribution partners are Macy’s (M), Dillard's (DDS), Nordstrom (JWN), Lord & Taylor, and Saks Fifth Avenue (SKS). The company’s customers generate relatively high household income, and more than half of them are college graduates. 

Coach is coming off a worse-than-expected holiday quarter where earnings per share grew 4% year over year, but fell 5% short of Wall Street’s consensus estimate. In general, the handbag industry has been growing at a 5% to 10% clip for the past several quarters. Meanwhile, the company’s primary competitor, Michael Kors (KORS), saw earnings rise over 200% in its most recent reporting period, thanks partly to “very,very, strong acceleration” of the handbag business. It should be noted that Coach is a much larger and more established company that competes in fewer categories so it is hardly an apples-to-apples comparison. Still, the two companies’ recent results are a clear indication that Coach is losing market share.

Management appears well aware of this dilemma and is taking the challenge head on, recently acknowledging that the KORS threat has reinvigorated its competitive spirit. The company cites its strong brand loyalty/relevance, established history, quality craftsmanship, and ability to innovate as differentiating factors for its business. It also brought up a prior instance in the late 1990s when it overcame increased competition from European brands such as Gucci, as well as new entrants like Kate Spade and value brands like Nine West.

Specifically, Coach looks to increase dwindling mall traffic by introducing more shoes into the product mix over the near term, and eventually offering a broader general merchandise assortment. Although footwear likely won’t make a substantial direct contribution to the bottom line anytime soon, it may well lure people in the door and provide a “halo” effect for the handbag business, i.e. encourage shoppers to make purchases of core products while increasing the brand’s relevance in the fashion world and getting women excited about its assortments.

Other potential growth drivers include revamped marketing, better merchandising and use of floor space, more fixtures, and the ability to offer customers information and completed transactions via mobile devices. Asian expansion should not only help the bottom line, but also lift the gross margin. Furthermore, the men’s business is on track to grow 50% this year, to $600 million or over 10% of sales. And, growth of the Internet platform is also a priority.

The company voiced its commitment to returning cash to shareholders, and currently pays a solid dividend that yields 2.4%. It will likely keep a lid on footprint expansion as it sees opportunity to use the selling space it has now more efficiently.

Although it may take several quarters until investors see evidence that the aforementioned turnaround strategies are taking hold, with the shares trading near their 52-week low and at a relative P/E ratio of .77, we think they present an attractive risk-and-reward scenario for patient investors.

  

Company

Ticker

Dividend  Yield

Apple Inc.

AAPL

2.34

bebe stores

BEBE

2.26

Insperity Inc.

NSP

2.41

Quality Systems

QSII

3.94

Questcor Pharmac.

QCOR

2.90

Sturm, Ruger & Co.

RGR

3.05

Coach Inc.

COH

2.41

Men's Wearhouse

MW

2.52

NVIDIA Corp.

NVDA

2.42

Pan Amer. Silver

PAAS

2.98

Cascade Corp.

CASC

2.16

Exxon Mobil Corp.

XOM

2.65

Foot Locker

FL

2.48

Chevron Corp.

CVX

2.99

East West Bancorp

EWBC

2.37

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.