As a value investor, I often get very excited when I can spot a cash cow business that has wide margins and delivers a great return on invested capital. This business I am going to tell you about today enjoys more than a 30% operating margin, delivers more than a 56% return on invested capital and pays a 2.2% dividend yield. For the last 10 years, it has grown its earnings and cash flows at the annualized rate of more than 24%. Should we get excited? Let’s dig deeper.
It is Coach (NYSE: COH), a leading American marketer of premium and fine accessories and gifts for men and women including bags, business cases, footwear, jewelry, watches and fragrance. Its mainstream product is handbags, which accounted for 65-66% of total revenue. It has two main segments: Direct-to-Consumer and Indirect. The Direct-to-Consumer segment is the company’s owned stores in several countries globally. This segment contributed around 89% of total sales in fiscal 2012. And it is interesting to note that 71% of COH’s net sales in fiscal 2012 were from newly introduced products. The products are seasonal and should be held in stores for a short time only. The business expects to have higher sales and income in the second quarter of its fiscal year, which is the last quarter of the calendar year.
We will have a quick look at several key operating figures to see how the business is currently performing.
Operating margin (%)
Net margin (%)
COH enjoys quite a high operating margin and net margin, and a great return on invested capital while employing very little debt. Its P/E is only 15.9x, quite lower than the industry average of 18.9x and equivalent to S&P 500 valuation of 15.3x. Nevertheless, its Cash Conversion Cycle of more than 100 days seems a bit high. It was due to high days of inventory. But the good thing is it was trending down for the last 10 years, from 163 days in fiscal 2003 to only 104 days.
Cash Cow Business
COH has proved itself to be a cash cow business. For the last 10 years, it has grown its operating cash flow and free cash flow consistently at a very high rate.
The operating cash flow and the free cash flow experienced astonishing cumulative growth of 700% and 881%, respectively in a 10-year period.
COH has several contractual obligations such as purchase obligations and leases. Even COH has no debt in its balance sheet, but like any other retailers with its own operated stores, it will have operating leases. It means that COH doesn’t capitalize its leases on its balance sheet, rather an operating lease is an off-balance sheet item.
With more than $1 billion in annual operating cash flow, I think that COH can comfortably fulfill its contractual obligations.
Other luxury retailers
Other publicly traded luxury retailers include Ralph Lauren , Saks (NYSE: SKS) andTiffany(NYSE: TIF).
Operating margin (%)
Comparing Coach to other luxury retailers, Coach is the most outstanding. Its operating margin is much higher than those of the other three, while employing no debt, whereas Ralph Lauren has the highest D/E of nearly 21%. Its return on invested capital is top-notch, more than double that of Ralph Lauren, 4 times higher than that of Tiffany and more than 10 times higher than Saks. Interestingly enough, it is the cheapest among the four, selling for only nearly 16x earnings whereas others are selling for 18-27x.
My Foolish Take
With 2.2% dividend yield, little leverage, high return on invested capital and a cheap valuation compared to its peers, Coach is clearly a choice for long-term value investors.