A stock with margin growth
First in our list is luxury brand Coach, Inc. (NYSE:COH), a pretty interesting case. Although the stock had been down for a few months, it has been showing considerable signs of recovery in the past days. After the announcement of stronger-than-expected third quarter results on April 22, the stock was up by almost 10% within a day and continued to escalate. However, the stock still offers a relatively low P/E ratio, since it trades at 15.27 times P/E, less than half the ratio offered by its main competitor, Michael Kors Holdings Ltd (NYSE:KORS), which trades at 31.35 times P/E. This stock looks even cheaper compared to its peers, when its forward P/E of 13.8 times and PEG ratio of 1.4 are taken into account.
Several reasons lead me to believe that Coach is a good long-term investment. Coach, Inc. (NYSE:COH) is an established fashion (mainly handbag and accessories) brand, ranked by Forbes as the 51st most powerful brand in 2012. Its fame for high-quality products that compete with Louis Vuitton or Chanel attracts an oncoming public, willing to pay a premium for the company´s creations. Expansion of its worldwide distribution model, while penetrating under-exploited markets, combined with innovative products and persuasive prices, should drive comps and margins growth in the long-run. The recently-announced Q3 results arrived better than expected, portraying an optimistic outlook for Coach. Sales increased by 17% to $1.11 billion and EPS by 24%, year-over-year, reaching $0.84 per share. In addition, the board passed a 13% increase in dividends, now paying $1.35 per share annually. The company now yields 2.3% in earnings, almost doubling the 1.2% industry average.
Focus on overseas markets, like China, relieves considerable pressure exerted by the situation in the U.S. Comps grew nearly 60% in China during Q3, while expected sales for the full year amounts to $300 million, at least. Substantial double-digit upsurges were also registered in Taiwan, Singapore, and Japan. Current gross margin of 73.8% widely surpasses other companies’ like Ralph Lauren and Michael Kors Holdings Ltd (NYSE:KORS), both offering margins under 60%. Operating margin is also considerably high, reported at 30.4% last quarter, close to the 10-year high of 38%, and way above most of its competitors that average an 8.3% margin.
As other analysts, I believe that the upside on Coach, Inc. (NYSE:COH) beats the risk it carries. Trading at bargain prices, this is definitely a stock to consider adding to your portfolio.
A leading brand
Coach, Inc. (NYSE:COH)´s number one competitor, Michael Kors Holdings Ltd (NYSE:KORS), also deserves a look. Last quarter’s results were also considerably strong, driving the stock to a 52-week high of $64.84 after the earnings were announced in February. The price is now down by about 12%, trading at $56.26 (Apr. 29). Exchanging at 31.58 times its earnings, doubling the industry 16.6 times P/E average, Kors seems a little overvalued. However, there are several reasons why I like this business and would recommend buying now, despite its valuation.
For starters, Michael Kors Holdings Ltd (NYSE:KORS) is an established, actually leading, brand worldwide, currently stronger than ever. People know the name and are willing to pay a premium for its goods. This advantage is certainly reflected in its financials, as gross margin reached 60.2% during the last reported quarter. This leads us to a second reason to believe that this company will grow further: its balance sheet. Last quarter, maintaining a five-year growth trend, the firm reported a 41.1% increase in comparable-store sales (YoY) and an expected 20%-25% extra growth in the fourth quarter, to be announced early June. Revenue grew 70% (YoY) to $637 million, principally in account of Kors’ luxury business. Earnings reached $0.64 per share, rising 220% from last year’s same quarter and surpassing consensus estimates of $0.41 by 56%. Full year expected results also look quite encouraging, as the firm’s management expects EPS of $1.80-$1.82, up about 130% from last fiscal year’s. Revenue is also projected to rise by 61%, up to $2.1 billion.
Kors’ financials are strong. This is most likely a reflection, asides from the brand name, of effective management. CEO, John Idol, has an impressive track record in the segment, having previously worked for Ralph Lauren and Donna Karan. His five-year expansion plan for the company includes the opening of 100 stores in China, the fastest growing luxury market, which is expected to provide 20% of this segment’s customer base by 2015. Already in motion, the enlargement plan signified a 28% increase in the number of shops over the past 52-weeks (now attaining a total of 297 stores).
Finally, as stated by investorplace.com’s editors, Kors also “expects to implement several drivers to increase margins over the medium to long term: (1) shifting the mix of retail/wholesale from its current 50/50 distribution to a 75/25 mix, (2) increasing the category mix of accessories from 75% to 80% of total sales over the next six to 18 months, boosting both gross and operating margins, and (3) bringing the ecommerce business in-house to become Michael Kors Holdings Ltd (NYSE:KORS)’ highest-margin business.
So while it is natural to assume that their blistering pace of sales growth must decelerate, KORS believes it still has fuel to burn.”
A brand in recovery
Although Urban Outfitters, Inc. (NASDAQ:URBN) has undergone some hard times since 2009, several signs now point to a recovery. Although I would not give a strong “buy” recommendation, I would certainly consider overweighting the stock, as suggested by Barclays. The main reasons to bet on the company’s future performance are:
Just like the previously-analyzed brands, Urban Outfitters, Inc. (NASDAQ:URBN) enjoys considerable fame, allowing it to use high initial markup rates. This generates substantial gross margins that now reach 36.9%, and operating margins of 13.4% (TTM), considerably above the 9.3% industry average. Urban Outfitters’ multiple brands create opportunities for flexible merchandising strategies, oriented to increase sales volumes and presence both in the U.S. and overseas.
Its “edgy and electric” product offering, added to a compelling pricing strategy, has helped the firm create a loyal customer base. Its highly differential retail model (called “experimental retailing” by some) creates a unique store environment and shopping experience that encourages customers to spend more time exploring the shops. Its roughly 475 stores provide plenty of space for further expansion, as several market segments remain to be penetrated.
Its expansion is targeted, rather than just aggressive. It seeks to expand in under-penetrated markets worldwide in order to attain higher revenue per square foot. Analysts expect solid quarterly results. Urban Outfitters, Inc. (NASDAQ:URBN) “is expected to see 26% growth in earnings along with 15% growth in revenue. Both rates are very strong for growth, and recent results from the company show strength.” (seekingalpha) Its healthy balance sheet presents no debt and $245.3 million in cash and cash equivalents.
Bottom line
All of these companies provide quite compelling investment prospects, as they all seem poised to grow both in the short and long-term. Although its forward P/E of 25.2 times does not make it exactly cheap, Michael Kors Holdings Ltd (NYSE:KORS)’ long-term earnings potential is one of the retail segment´s best. I will agree with Goldman Sachs and recommend buying this stock.
Trading cheaper, but not offering as much potential upside as Kors, is Urban Outfitters, Inc. (NASDAQ:URBN). I would consider buying this stock, but be aware of the various risks implied. Finally, there’s Coach, Inc. (NYSE:COH), which offers a great outlook at an attractive valuation. I would risk to say this last one is my stock of choice for a purchase, although all three of them look promising.
The article 3 Leaders In The Luxury Segment originally appeared on Fool.com and is written by Victor Selva.
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