Is It Time to Buy Coach Stock?

Coach (NYSE: COH  ) earns a pretty penny for each handbag it sells, but its shareholders haven't shared in the profits as of late. The luxury handbag maker's stock price has declined 33% since the start of the year. Things obviously haven't been going the company's way lately, but that likely won't stop investors from making money buying its stock. In fact, this out-of-fashion stock could be a terrific investment for investors willing to buck the trend. Let's investigate further to find out whether it's time to buy Coach's stock.

There's a bargain in the premium aisle
In investing, it rarely pays to buy what's already in fashion. While Michael Kors (NYSE: KORS  ) and Kate Spade (NYSE: KATE  ) trade at 24 times earnings, Coach is on sale for just 11 times earnings. Although Coach's stock is out of style, it represents a compelling bargain for long-term investors. Michael Kors and Kate Spade together generate the same amount of revenue as Coach, yet their combined enterprise value is twice the latter's enterprise value.

Photo: Coach.

Granted, Michael Kors is growing much more quickly than Coach and Kate Spade has significant upside potential, but Coach remains the market leader in women's handbags. If Coach's brand maintains its market position, the stock could be a bargain.

The competition is heating up
Not everyone believes that Coach's earning power will remain intact. Coach tripled revenue from 2005 to 2013 -- a 15% compound annual growth rate. The market's low earnings multiple shows that many investors believe that Coach's best days are behind it. Although the company is unlikely to triple revenue again within a decade, the market's concerns may be overdone.

To begin with, women's handbags are extremely profitable for established brands. Although it doesn't break out gross profit by product line, Coach's overall gross profit is just under 70% of sales. That's incredible for any retailer -- and it's also why Michael Kors, Kate Spade, and other competitors are so eager to expand their handbag offerings.

Increased competition for luxury handbags will result in lower sales growth, but not necessarily lower profit margins. Although price can be a factor in the purchase decision, designer handbags are expensive across the board and Coach could ride buyers' attraction to its style to success.  

Coach's issue is more of a top-line problem than a margin contraction problem and Coach can ease top-line pressure by expanding its offering. For instance, its men's segment is growing annually by double digits, accounting for 14% of last year's sales. Expanding its men's and women's offering in the U.S. and abroad could provide the necessary support to maintain its earning power.

Low expectations set the stage for a higher stock price
The time to buy a retailer is exactly when everyone else has left it for dead. At 11 times trailing earnings, Coach is priced at a level that suggests its ubiquitous luxury brand is going to lose out to lesser-known brands. Although retail is hard to predict, it seems unlikely that Coach's brand equity has deteriorated so much and so quickly. If same-store sales start to flatten out, investors may wish they had bought Coach at its current price.

Like any fashion retailer, Coach is subject to the whims of fashion. However, unlike most other retailers, Coach's brand is known throughout the world as a standard in designer handbags. Unless that standard is passed to another brand, Coach is probably a good buy at just 11 times earnings.

Leaked: Apple's next smart device (warning -- it may shock you)
Apple recently recruited a secret-development "dream team" to guarantee that its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming that its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts that 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

In Big M&A Year, More Transactions Flop

An increase in mergers & acquisitions has been one of the leading investment themes so far this year. This week, 2014 became known for failed transactions, too. The week also brought potential trouble for tax inversions, which have been a growing part of the M&A boom. 

Some $2.5 trillion of deals have been announced in 2014, according to Thomson Reuters. And $428 billion of deals have been withdrawn. Both numbers represent the briskest pace since 2007.

On Tuesday, $126 billion worth of proposed mergers were cancelled. First, 21st Century Fox dropped its $94 billion offer for Time Warner. Then Sprint abandoned its pursuit of T-Mobile in what would have been a $32 billion transaction.

Next, Walgreen Co. announced it will spend $15 billion to acquire the 55% of Switzerland-based pharmacy chain Alliance Boots that it doesn’t already own. But Walgreen won’t move its tax base overseas in a tax inversion deal.

In a tax inversion, a company buys a foreign enterprise and then changes its tax domicile to that of the acquired company in order to take advantage of lower tax rates. This has been an increasingly popular tactic for U.S. companies in recent years because our high corporate tax rate.

Walgreen’s announcement came after the Obama administration said it’s considering ways to block inversion deals without awaiting congressional action to change the tax laws.

Walgreen said that its option to buy the rest of Alliance Boots wouldn’t have qualified for inversion treatment. And the company was unable to find another structure it was confident could withstand IRS review.

Walgreen also noted that it was "mindful of the ongoing public reaction to a potential inversion … with a major portion of its revenues derived from government-funded reimbursement programs." By one estimate, Walgreen derives $17 billion a year in revenue from Medicar! e and Medicaid.

Three of the biggest withdrawn merger & acquisitions deals ever have occurred in just the last four months: AstraZeneca by Pfizer ($122 billion), Time Warner by Fox and Time Warner Cable by Charter Communications ($62 billion). All three were hostile takeover attempts, and Pfizer’s pursuit of Britain-based AstraZeneca would have been a tax inversion.

This week’s inversion developments have led to declines in the share prices of Shire PLC and Covidien. Both are foreign companies that have agreed to be bought by U.S. companies—AbbVie and Medtronic, respectively. Neither deal has closed yet, making each potentially vulnerable to any inversion rule changes. AstraZeneca shares also weakened because an inversion crackdown would make another Pfizer attempt less likely.

Some observers contend that this week’s broken deals and pressure on inversions signal a peak in the M&A wave. But history indicates that such tops occur with the completion of blockbuster deals and/or the inability to finance them. Neither is the case here.

What’s more, companies have huge amounts of cash available for acquisitions, and borrowing costs are extremely low. For example, the benchmark U.S. Treasury 10-year note yield yesterday touched a new 15-month low of 2.3 percent.

In addition, the bull market has pushed up share prices. While this boosts the cost of acquisitions, it also gives buyers a strong “currency” if they use their own shares to pay for some or all of the purchase. It’s often cheaper and always quicker to buy a business instead of launching a new one. And in a lackluster economy, acquisitions are a way to boost earnings growth through more revenues and/or increased efficiencies from economies of scale.

Improved job growth and other reports have led to projections of faster U.S. economic growth, such as a 3%-plus annual rate for the second half of this year. How long such an improvement could last is debatable. ! But at le! ast there’s little current evidence of a new recession or financial crisis on the horizon. If the economy indeed is improving, prudent acquisitions could provide a big benefit.

Either way, it’s been a positive sign that shares of companies announcing acquisitions  generally have risen, in contrast to the typical historical pattern in which the buyer’s shares decline.