coh valuation

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Coach Inc.[NYSE: COH]------------------------------------------------------------------------------------------------------------------------------------------------------------

Recommendation Date: February 27, 2012

Closing

PriceTarget Price Recommendation Sector Industry

Stock

Type$76.05 $54.66 Sell

ConsumerCyclical

LuxuryGoods

Cyclical

Executive Summary

We issue a sell recommendation for Coach (COH)based on our analysis with a long term target price of $54.66

We believe Coach Inc. is currently overpriced based onperpetual long time horizon, even with our optimistic

estimation of sales growth of around $13.88% in the next 4

years, core profit margin of 20.68% and with a terminal growth rate of residual earnings of 3.6%

Core operating margin will continue to get less in the long run as the products reach marketsaturation, driving the terminal growth rate of residual earnings down to 3.6%

Since the products of Coach, Inc. are cyclical, it is highly dependent on long run economic growth rateand growth of middle & high income class around the world. A repeat of 2008 recession will surely

put Coach Inc, at risk and hence its stock price is quite vulnerable to macroeconomic issues (such as

Eurozone crisis and subsequent Eurozone breakdown)

Coach Share Price Summary Statistics for last 1 year

Coach Price History for last 1 year

52-Week Change: 40.04%

52-Week

Low (Aug

19, 2011):

$45.7052-Week High

(Mar 2, 2012):$77.30

S&P500 52-Week

Change:4.54%

50-Day

Moving

Average:

$71.47200-Day Moving

Average:$62.10

Tahsanul

Hoque

Email:

[email protected]

Ran YanEmail:

[email protected]

Haiyan ZhuEmail:

[email protected]

Michael

Bradley

Soper

Email:

[email protected]

Team Members:


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Table of Contents

Historical Analysis ......................................................................................................................................... 2

Company Background ............................................................................................................................... 2

Business Segments .................................................................................................................................... 2

Geographical Segments ............................................................................................................................ 3

Product Segments & Market Share .......................................................................................................... 5

SWOT Analysis........................................................................................................................................... 6

Comparison of Coach with some of its Key Competitors ......................................................................... 7

Trend Analysis of Ratios of Coach ............................................................................................................. 9

Conclusion of historical analysis ............................................................................................................. 13

Prospective Analysis .................................................................................................................................... 13Sales Growth Forecast ............................................................................................................................ 13

Asset Turnover forecast .......................................................................................................................... 16

Core Operating Margin & Income Forecast ............................................................................................ 16

Other operating income & unusual income ........................................................................................... 17

Terminal Growth Rate ............................................................................................................................. 17

Financial Income ..................................................................................................................................... 18

Dividend Payout Ratio ............................................................................................................................. 18

Tax Rates ................................................................................................................................................. 18

Discount Rate .......................................................................................................................................... 18

Multiples Analysis ................................................................................................................................... 19

Sensitivity Analysis .................................................................................................................................. 20

Risks to our investment recommendations ............................................................................................ 21

Exhibits ........................................................................................................................................................ 22
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Historical AnalysisCompany Background

Coach, Inc. (Coach), incorporated in June 2000, is a marketer of fine accessories and gifts for women and

men. Coachs product offerings include womens and mens bag, accessories, business cases, footwear,

wearables, jewelry, sunwear, travel bags, watches and fragrance. Coach was founded in 1941, in a loft in

New York City. Coach has grown from a family-run workshop in a Manhattan loft to a leading American

marketer of fine accessories and gifts for women and men. They utilize a flexible, cost-effective global

sourcing model, in which independent manufacturers supply their products, allowing them to bring broad

range of products to market rapidly and efficiently.

Business Segments

Direct-to-Consumer Segment

The Direct-to-Consumer segment consists of channels that provide the Company with immediate,

controlled access to consumers: Coach-operated stores in North America, Japan, Hong Kong, Macau and

mainland China, the Internet and the Coach catalog. This segment represented approximately 87% of

Coachs total net sales during the fiscal year ended July 2, 2011 (fiscal 2011), with North American stores

and the Internet, Coach Japan and Coach China contributing approximately 64%, 18% and 5% of total net

sales, respectively. Coach stores are located in regional shopping centers and metropolitan areas

throughout the United States and Canada. The retail stores carry an assortment of products. Its stores are

located in locations, such as New York, Chicago, San Francisco and Toronto.

Coachs factory stores serve as a means to sell manufactured-for-factory-store product, including factory

exclusives, as well as discontinued and irregular inventory outside the retail channel. These stores operate

under the Coach Factory name. Coachs factory store design, visual presentations and customer service

levels support. Coach views its Website as a key communications vehicle for the brand to promote traffic

in Coach retail stores and department store locations. Its online store provides a showcase environment

where consumers can browse through a selected offering of the latest styles and colors.


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Indirect Segment

The Indirect segment represented approximately 13% of total net sales in fiscal 2011, with U.S. Wholesale

and Coach International representing approximately 7% and 5% of total net sales, respectively. The

Indirect segment also includes royalties earned on licensed product. U.S. Wholesale channel offers access

to Coach products to consumers who prefer shopping at department stores. Coach products are also

available on macys.com, dillards.com and nordstrom.com. Coachs products are sold in approximately

970 wholesale locations in the United States and

Canada. Its U.S. wholesale customers are Macys

(including Bloomingdales), Dillards, Nordstrom,

Lord & Taylor, Carsons and Saks Fifth Avenue.

Coach International channel represents sales to

international wholesale distributors and

authorized retailers. Coach has developed relationships with a select group of distributors who sell Coach

products through department stores and freestanding retail locations in over 20 countries. Coachs

network of international distributors serves various markets: South Korea, Taiwan, Mexico, US &

Territories, Singapore, Australia, Malaysia, Saudi Arabia, France, Japan, Thailand, UAE, Hong Kong,

Spain, China, Indonesia, Bahamas, Bahrain, India, Macau, New Zealand, Portugal, United Kingdom and

Vietnam. Coachs international wholesale customers are the DFS Group, Shinsegae International, Tasa

Meng Corp, Lotte Group and Shilla Group.

Geographical Segments

Coach North America

North American Retail Stores

Fiscal Year Ended

July 2, July 3, June 27,

2011 2010 2009

Retail stores 345 342 330

Net increase vs. prior year 3 12 33

Percentage increase vs. prior year 0.9% 3.6% 11.1%


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Retail square footage 936,277 929,580 893,037

Net increase vs. prior year 6,697 36,543 97,811


Average square footage 2,714 2,718 2,706

North American Factory Stores

Fiscal Year Ended


2011 2010 2009

Factory stores 143 121 111



Factory square footage 649,094 548,797 477,724


Percentage increase vs. prior year 18.3% 14.9% 15.6%Average square footage 4,539 4,536 4,304

The growth trend in the North American market has been in the direction of the factory stores channel.

As indicated in the tables above, retail store growth has decreased from 11% to less than 1% from FY 2009

to FY 2011. Whereas, the number of factory stores opened in North America has increased from under 9%

to over 18% in same period. The factory store allows Coach to target value-oriented customers who would

not otherwise buy the Coach brand. Prices are generally discounted from 10% to 50% below full retail

prices. If this trend continues over time, Coachs superior brand that produces high gross margins (over

70%) may be diminished and the company would then have to increase their inventory turnover in order

to maintain their overall net profit margins (21% in FY 2011).

Coach China

The real growth opportunity moving forward will continue to be in the Asian markets, particularly in

China. The number of locations in China, 66 at the end of FY 2011, has more than double since 2009 and

is projected to continue to grow well into the future. The premium handbag and accessories market in

Asia is approximately $12 billion ($3.2 billion in China alone) compared to the United States which is

roughly $10 billion. Coach has identified over 120 cities in China with populations greater than 1 million

people. Coach currently has a market share of approximately 10% in China and generates about $320


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million in sales annually. Sales in China could reach $1.4 billion annually by 2015 if the market grows to

its projected $7 billion and Coach is able to increase its market share from 10% to 20%. Coach is able to

price its products in China at a 50% to 60% premium vs. the U.S. market which produces over an 80%

gross margin.

Fiscal Year Ended


2011 2010 2009

Coach China locations 66 41 28


Percentage increase vs.prior year

61.0% 46.4% 16.7%

Coach China square footage 127,550 78,887 52,671


Percentage increase vs.prior year

61.7% 49.8% 18.4%

Average square footage 1,933 1,924 1,881

Product Segments & Market Share

Coachs revenue stream can also be divided byproducts:

Handbags (63% of net sales): Thereare usually 3 - 4 collections per quarter and 4 - 7

styles per collection. These collections feature

classic and fashion designs.

Accessories (28% of net sales):These include small leather goods, novelty

accessories, and belts.

Other products (9% of net sales): These include footwear, business cases, jewelry, wearables,sunwear, travel bags, fragrance, and watches.

The following table illustrates the market share of Coach, Inc. Coach seems to have a good market share in

womens handbag and accessories. They have excellent women handbag & accessories market penetration
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in US & Japan. The main thing is they have lot of growth potential in mens handbag & accessories

market.

SWOT Analysis

Strengths: Strong brand equity Aspirational brands outperform the market in tough economic environment Multi-channel retail network Beating competitors price by 50% or more Monthly introductions of fresh new handbag designs

Strategic alliances to bring Coach brand of handbags into luxury categories such as: watches,

footwear, glasses, fragrances outerwear and mens

Weakness:

High geographic concentration in different states of USA Products generally inaccessible to most consumer segments as it is priced higher Factory outlet stores outperforming full-priced store Outerwear only accounting for 2% of sales Luggage only accounting for 1% of sales

Opportunity:

New store openings across Asia Pacific region


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Product expansion Growing demand of luxury goods in emerging global markets, such as China and India Increased wealth of consumers in global markets of Asia, Middle East, Australia, and Mexico

Threats:

Slowdown in consumer spending due to possible future recessions from Eurozone crisis Fashion trend changes Brand diffusion: Manufactures of the finest luxury goods launching diffusion lines to exploit

middle-income consumers.

Rising labor costs in outsourced factories Counterfeiting of luxury merchandise, totaling $500 billion worth of goods sold in countries

throughout the world in 2006.

Comparison of Coach with some of its Key Competitors

Listed below is a table of various financial ratios for Coach and their closest publically traded competitors.

Coachs most direct competition in the handbag and accessories market comes from the likes of Dooney &

Bourke, Kate Spade, and Michael Kors. Unfortunately each of the peer firms mentioned before are

privately held and not required to issue their financial statements to the public. Having access to these

firms financial statements would enhance our ability to assess Coachs performance relative to the

industry.

With that said, we chose to compare Coachs financial results to other high-end retail manufacturing and

distribution firms including Tiffany, Kenneth Cole and Ralph Lauren. From the ratios listed below it is

apparent that Coach is able to sell its products at a much higher gross margin than other firms within the

industry. It has a gross margin of over 72% compared to the average of 57% with a similar SG&A expense

ratio indicating they are able to command a premium due to the quality of their products and a strong

brand name with high customer loyalty. This pricing power ultimately translates to an above average


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return on assets and return on common equity, 29% ROA and 53% ROCE vs. and average ROA of 14% and

ROCE of 21%, which makes its financial performance better than the competitors.

However short term liquidity seems to be less than the competitors and it is a significant weakness and

certainly increases bankruptcy risk from daily operations.

Coach Tiffany KennethCole

Ralph Lauren

Ratios LTMDec-31-11

LTMOct-31-

11

LTMSep-30-11

LTMDec-31-11

Average

Profitability

Return on Assets % 29.4% 12.6% 1.5% 12.4% 14.0%

Return on Common Equity % 52.7% 20.5% (9.5%) 19.0% 20.7%

Margin Analysis

Gross Margin % 72.3% 59.2% 39.2% 58.3% 57.3%

SG&A Margin % 41.4% 38.1% 37.8% 42.4% 39.9%

EBIT Margin % 31.0% 21.1% 1.4% 15.4% 17.2%

Net Income Margin % 21.2% 12.4% (2.9%) 9.9% 10.2%

Asset Turnover

Total Asset Turnover 1.5x 1.0x 1.7x 1.3x 1.38x

Fixed Asset Turnover 7.9x 5.0x 10.0x 8.4x 7.83x

Acct Receivable Turnover 22.8x 20.3x 8.6x 17.1x 17.23x

Inventory Turnover 3.1x 0.8x 5.6x 3.5x 3.24x

Short Term Liquidity

Current Ratio 2.3x 5.3x 2.1x 2.9x 3.15x

Quick Ratio 1.6x 0.9x 1.4x 1.7x 1.39x

Avg. Days Sales Out. 15.9 17.9 42.3 21.3 24.35

Avg. Days Inventory Out. 117.0 67.6 65.7 104.2 88.61

Avg. Days Payable Out. 33.7 47.3 79.6 21.2 45.42

Avg. Cash Conversion Cycle 99.2 38.2 28.4 104.3 67.54

Long Term Solvency

Total Debt/Capital 1.3% 23.5% N A 7.0% 10.6%

EBIT / Interest Exp. N A 15.2x N A 43.0x 29.1x


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Trend Analysis of Ratios of Coach

The GAAP ratios have been presented in the table at the end of this section.

Profitability Ratios:ROA increased slightly from 2009 to 2011 to 32%. ROCE has increased to 56% for FY

2011. It is worth noting that profit margins were previously lower following the financial crisis of 2008.

The good news is the profit margins increased from 2009 to 2011 and projected to further increase as

consumer spending has steadily recovered since 2008.

Turnover Ratios: Turnover ratios seem to be mostly stable, expect for accounts receivable turnover which

increased to 33x. This is good news as the company is earning receivables from its customers quicker.

Liquidity ratios: Liquidity ratios are mixed over the years. Both current and quick ratio are decreasing

over the years (from 3 to 2.4 for current ratio and 2to 1.4 for quick ratio) but the cash conversion cycle has

decreased to 102 days in 2011 which is a good sign.

Solvency Ratios: Coach did not have any major debt outstanding in the last 3 years and hence its solvency

ratios are extremely good. (GAAP solvency ratios include short term liabilities)

Ratios12 months

Jun-27-200912 months

Jul-03-201012 months

Jul-02-2011Profitability

Return on Assets % 25.4% 28.6% 32.0%

Return on Common Equity % 39.1% 45.9% 56.5%

Margin Analysis

Gross Margin % 71.9% 73.0% 72.7%

SG&A Margin % 41.7% 41.1% 41.3%

EBIT Margin % 30.2% 31.9% 31.4%

Net Income Margin % 19.3% 20.4% 21.2%

Asset Turnover

Total Asset Turnover 1.3x 1.4x 1.6x

Fixed Asset Turnover 6.1x 6.3x 7.4x

Accounts Receivable Turnover 30.0x 33.1x 33.0xInventory Turnover 2.8x 2.8x 2.9x

Short Term Liquidity

Current Ratio 3.0x 2.5x 2.4x

Quick Ratio 2.0x 1.5x 1.4x

Avg. Days Sales Out. 12.1 11.2 11.0

Avg. Days Inventory Out. 129.2 131.3 125.9


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Avg. Days Payable Out. 47.3 38.3 34.2

Avg. Cash Conversion Cycle 94.1 104.2 102.7

Long Term Solvency

Total Debt/Capital 1.9% 1.6% 1.5%

Now lets compare the ratios from our reformulated statements. Detailed reformulated statements are

attached in the exhibits 1, 2 & 3 at the end of the report.

Both return on common equity and return on net assets are increasing over the years. Return on net

operating assets seems to be the major driver of ROCE instead of the financial leverage.

2009 2010 2011

ROCE 35.43% 49.06% 54.02%

RNOA 62.71% 84.27% 88.73%

FLEV -44.11% -42.16% -39.16%

NBC(RNFA) -0.87% -0.75% -0.10%

SPREAD 63.58% 85.02% 88.82%

From the profitability breakdown we see the return on common equity growing is due to return on net

operating assets (RNOA) growing from 62.71% to 88.73% from 2009 to 2011. Since the RNOA is indicator

of operating activities, these growing trends clearly tell us Coach is a continuing growing company.

We can see Coach has considerable financial assets, although slightly decreasing each year, giving it a

financial leverage that was negative almost -40%. The firms return on net financial assets was incredibly

small as only 0.1% in 2011, which also further proves that Coach is deriving most of its earnings from

operations rather than financing activities. Overall Coach has a favorable financial leverage and that is a

good thing.

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

2009 2010 2011

ROCE

RNOA


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The charts and table show a much clearer role of net operating assets in the firms overall balance sheet.

2009 2010 2011

Net Operating Assets 961,257 896,610 1,020,739

Net Financial Obligation(Assets) -758630 -653459 -657090Common Stockholders' Equity 1,719,887 1,550,069 1,677,829

The return on net operating on assets (RNOA) is further broken down and we can see the increasing

influence coming from return on operating assets (ROOA), which is growing from 35.24% on 2009 to

47.79% to 2011. We also see high operating liability leverage with average of 92% in recently three years,

and the operating spread is much bigger than short-term borrowing rate (assuming 3% as current market

rates). This large operating liability leverage means almost half of net operating assets of Coach is

financed by suppliers with low borrowing rate and we suspect this might decrease in the long run, even

though the trend in last 3 years show the opposite trend.

2009 2010 2011

RNOA=ROOA+(OLLEV*OLSPREAD) 62.71% 84.27% 88.73%

ROOA 35.24% 43.74% 47.79%

OLLEV 85.19% 99.50% 91.42%

OLSPREAD 32.24% 40.74% 44.79%

2009 2010 2011

RNOA = PM*ATO 62.71% 84.27% 88.73%

PM 18.66% 20.94% 21.78%

ATO 3.361 4.024 4.074

-

500,000

1,000,000

1,500,000

2,000,000

2009 2010 2011

Net Operating Assets

Net Financial Assets

Common Stockholders'

Equity


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The return on net operating assets growing also can be broken down to profit margin and assets turnover.

We can see both profit margin and assets turnover are growing from 2009 to 2011 and the profit margin is

the primary driver of RNOA instead of the asset turnover, which is quite logical since a luxury item sellers

like Coach will have lower turnover due to higher prices.

We can clearly see the growth of sales from 3,230,468 thousands in 2009 to 4,158,507 thousands as in

2011, almost 29% increase. The core operating income also grew from 616,772 thousands in 2009 to

883,086 thousands in 2011. Other figures are also seeing growth.

The following table also shows the percentage of growing of net sales, grow margin, core operating

income, operating income each year compare to previous year as 2010 and 2011.

2010 2011

Net sales 12% 15%

Cost of sales 7% 17%

Gross Margin 13% 15%

Selling, general and administrative expenses 10% 16%

Core Operating income (before tax) 18% 13%

Net salesCost of

sales

Gross

profit

SG&A

expenses

Operating

income

(before

tax)

Tax on

operating

income

Core

Operation

Income

2009 3,230,468 907,858 2,322,610 1,350,697 971,913 355,141 616,772

2010 3,607,636 973,945 2,633,691 1,483,520 1,150,171 420,135 730,036

2011 4,158,507 1,134,966 3,023,541 1,718,617 1,304,924 421,838 883,086

-

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

3,500,000

4,000,000

4,500,000

Thousands


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Tax on operating income 18% 0%

Core Operation Income(After Tax) 18% 21%

Operating income (after tax) 25% 20%

Comprehensive income 25% 19%

Conclusion of historical analysis

Overall the financial performance of last 3 years has been strong, except for the liquidity ratios. Operating

income grew both as absolute numbers as well as ratios. Financial income also grew and there has been

buildup of financial assets. Coach has also performed well when compared to competitors and hence the

overall performance is strong.

Prospective Analysis

Sales Growth Forecast

We believe sales forecast is the most important factor of all as the other assumptions are also related to

sales forecasts. We forecasted the sales using a multiple of mechanisms and then take an average number

from them. At first we will make projections based on historical trend in the numbers from 10K. We will

forecast sales from 2 main categories: business segment and geographical segment. But before going into

depth, lets look at the overall macroeconomic forecasts to predict the future sales pattern.

From Economist Intelligence Unit, we researched the following data of estimated historical and forecasted

future retail sales growth rate. Overall we are seeing that the world retail sales growth is forecasted to pick

up in the next few years. On average the world retail sales will grow by 4.10% over next few years.

Retail Sales Growth Estimates & Forecast

2008 2009 2010 2011 2012 2013 2014

North America -1.30% -4.60% 2.10% 1.20% 1.50% 2.70% 2.60%

Asia & Australasia 4.70% 5.60% 6.50% 6% 6.50% 6.30% 6.60%

Western Europe -0.80% -1.90% -0.50% 0.20% 0.80% 1.10% 1%

World 1.50% -0.40% 3.50% 3.20% 3.70% 4.20% 4.40%

*Source: Economist Intelligence Unit

If we also look at spending power increase in China, we see it is projected to increase in the future to $110

billion by 2025. Coach management is planning to open 30 new stores in China in 2012. Asia Pacific will

be the primary growth driver for Coach in the near future. JP Morgan estimates Chinese luxury goods


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market will grow to $1.4 billion by 2015. The consumer spending in US however is volatile but we are

seeing consumer confidence is increasing recently as well as many other US economic indicators are

showing positive trend, with 4Q 2011 GDP growth of 3% and unemployment rate decreasing to 8.3% in

February 2012. Coach will open 15 new stores in USA.

Now going back to historical data analysis, if we analyze the business segment, we clearly see that the

majority of growth is coming from director to consumer segment (existing store, new store sales etc), with

an average growth of around 12%. Indirect sale is also increasing but it is very volatile. On average, over

the next couple of years, sales will grow at 13% on average, similar to past trend, with a geometric mean

growth of 12.84%

Figure: Sales growth forecasting using historical revenue segmentation data

2008 2009 2010 2011 2012E 2013E 2014E

Direct to Consumer 2544 2727 3096 3624 4080 4668 5353

Growth 7.19% 13.55% 17.04% 12.59% 14.39% 14.67%

Indirect Sales 637 504 444 534 512 519 549

Growth-21% -12% 20% -4% 1% 6%

Total Revenue 3181 3231 3541 4158 4592 5186 5901

Growth 2% 10% 17% 10% 13% 14%

Average Growth 12.84%

*Ignoring 2009 growth rate since it is clearly an outlier because of 2008 Great Recession


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On the other hand, we also took a look at historical trend of sales from different geographical regions.

Bulk of sales volume is coming from USA with decent growth while the new extraordinary growth of sales

is mainly coming from international regions such as Asia Pacific countries, averaging around 40%. We

believe growth in Asia will cushion any lost sales in North America or Europe should a new recession

appear. Overall we forecasted an average yearly growth of 15% over the next few years and this gives us a

mean growth of 13.79%

Figure: Sales growth forecasting using historical geographic data

2008 2009 2010 2011 2012E 2013E 2014E

United States2,382.9

2,318.60 2,487 2,895 3097 3414 3797

Growth -2.70% 7.24% 16.42% 6.99% 10.22% 11.21%

Japan

605.5

670.1 707 758 817 872 936

Growth 10.66% 5.55% 7.13% 7.78% 6.82% 7.24%

OtherInternational 192.3

241.8 346 506 700 997 1419

Growth 25.72% 42.99% 46.26% 38.32% 42.53% 42.37%

Total Revenues 3,181 3,231 3,540 4,158 4,614 5,283 6,152Growth 1.56% 9.57% 17.48% 10.94% 14.52% 16.44%

Average Growth 13.79%

*Ignoring 2009 growth rate since it is clearly an outlier because of 2008 Great Recession

Aswanth Damodaran is forecasting an average yearly growth of 15% for Coach on his website.

Sales Forecast

Damodaran Historical Geographical Historical Business Segment

15% 13.79% 12.84%

Average 13.88%


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So we will use 13.88% sales growth on our model for the valuation. Based on latest 10Q, Coach has already

achieved 50% of its sales of about $2.4 billion for 2011-2012 year and so we think our projections are

achievable.

Asset Turnover forecast

We also carried out asset turnover forecast using historical data. We get the following information using

past trends.

2009 2010 2011 2012E 2013E 2014E

Asset Turnover 3.36 4.02 4.07 4.11 4.16 4.20Growth 19.64% 1.24% 1.00% 1.12% 1.06%

Geometric mean of asset turnover 3.98

Although our projected asset turnover is increasing over the years, we believe the average asset turnover

will be around 3.98 in the next few years. On the long run, asset turnover should slightly increase more as

world economic recovery picks up but we chose to be conservative.

Core Operating Margin & Income Forecast

Core operating income from sales will be static around 20.68%. The reasons for this are as follows:

1. As per Wall Street Journal article, Black Friday and Holiday 2011 sales were primarily driven bylarger discounts in items to lure consumers. The same trend is expected in 2012 also as the

consumers are cautious.

2. Coachs last one year 3 quarter results shows slightly decreasing gross margin trends. From Q4:11through Q2:12, gross margins fell 155bps, 137bps and now just 23bps

3. There is higher factory outlet sales & rising costs. In Q2 2011, Coachs profits increased 26% overQ1, but its margins fell as Coach relied more on its factory outlets channels that typically have

lower margins than full-priced stores. Rising labor costs in China are also weighing on the

company. This trend has been seen in entire 2011.

As a result, we believe gross margins will slightly fall in 2012 to 20.95% and the n rise slowly from 2013

onwards due to rising economic growth from USA and Asia after 2008 recession.


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2009 2010 2011 2012E 2013E 2014E

Core OperatingIncome

$616,772

$730,036

$880,164

$1,064,591

$1,291,671

$1,568,284

Core Profit Margin 19.09% 20.24% 21.17% 20.95% 21.33% 21.42%

Growth 5.99% 4.59% -1.00% 1.80% 0.40%

Mean Growth 20.68%

Other operating income & unusual income

For other operating income, we forecast it to be zero in the long run. Over the last few years, it has been

very volatile and hence this line item is very difficult to predict with such high deviations. So we are

assuming this line to be zero over long run.

2009 2010 2011Other OperatingIncome

-13944 25544 25516

Growth -283% -0.11%

We also forecast the unusual operating income to be zero over the long term. Historically over the last 3

years, there has been no unusual one time operating income item.

Terminal Growth Rate

For terminal growth rate, we used the World Bank forecast of world real GDP growth rate. We used 3.6%

as the terminal growth rate for Coach as we believe it is easily achievable for a fast growing company like

Coach in the long run. Plus recent US & Asian economic news are all positive (like US unemployment rate

is down to 8.3% and jobless claims are falling; Chinas manufacturing activity is rising) and hence long

run growth will continue to increase.


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Real GDP growth 2009 2010 2011 2012 2013

World -2.2 3.8 3.2 3.6 3.6

*World Bank estimates

Financial Income

We assumed financial assets will continue to grow, although the growth rate as per historical projections

is quite volatile. However financial income in dollar amount will still be a small part of the overall income

(around 0.1%) and hence it is not a significant factor in our model.

2009 2010 2011 2012E 2013E 2014E

Interest Income 6597 4904 636 657 1146 1792

Growth -25.66% -87.03% 3.30% 74.34% 56.39%

Dividend Payout Ratio

For dividend payout ratio, we assumed it will grow from present historical rates of 26% to around 30% in

the long run as the company matures and hence turns into a matured company from a growth company.

As the companys growth reaches saturation point in Asia, their reinvestment needs should decrease and

hence their dividend payout ratio should increase.

Tax Rates

We assumed tax rates will remain unchanged at 38%. Although there is proposal by Obama

Administration to reduce marginal tax rates, we believe it will not easily pass in the Senate & Congress

due to wide division between Democrats & Republicans.

Discount Rate

We took an average of current publicly available discount rates from Bloomberg, CapitalIQ and

Damodarans website and we also took an average of the discount rates for use in our model. We get an

average WACC of 11.45%, which is average for growth stocks like Coach

Cost of Capital

Capital IQ Bloomberg Damodaran

11.00% 12.50% 10.84%

Average 11.45%


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Valuation

For the valuation purpose, we used the residual income model. This model is most suitable with our

reformulated balance sheets and hence we preferred it. We achieved a fair value of $54.66 using our

model for the companys share price and around $15.7 billion total equity for the company in long run.

For detailed output of the model, please see Exhibit 4

Multiples Analysis

In addition, we use the multiples valuation approach to get a range of share price. We focus on three

multiples of Coachs peers: the P/E, P/B and P/S, and find the highest, lowest and mean value for each

multiple.

Comparable Companies

Company P/E P/B P/S

Kenneth Cole Productions,Inc.

21.32 2.09 0.52

Polo Ralph LaurenCorporation

20.9 4.5 2.38

Tiffany & Co. 16.52 3.56 2.32

Mean 19.58 3.38 1.74

Highest 21.32 4.5 2.38

Lowest 16.52 2.09 0.52

Coach 18.44x 11.70x 4.88x

The EPS, Book value per share and sales per share of Coach are shown below. The leading EPS is based on

our forecasted earnings for 2012. According to the highest, lowest and mean value of the three multiples

above, we get the share price range for Coach from $7.51 to $73.32. The prices based on P/B and P/S are

much higher than the prices given by P/E, because Coach has much higher P/B and P/S multiples than its

peers.

Forecasted EPS $3.44

Book Value/Share $6.50

Sales/Share $14.45


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P/E P/B P/S

Mean $60.44 $21.23 $20.03

High $73.32 $29.25 $34.39

Low $45.43 $13.59 $7.51

The intrinsic value per share of $54.66 from the residual earnings model is falling in this range. However,

the market price on February 27th of $76.05 is higher than the upper side of the range, suggesting that

probably the stock is overvalued.

Sensitivity Analysis

We conducted a sensitivity analysis using cost of capital and sales growth. We get the following results

below:

Sales Growth

9.00% 10.00% 11.00% 12.00% 13.00%

9% US$ 68.17 US$ 70.41 US$ 72.70 US$ 75.06 US$ 77.48

10% US$ 57.66 US$ 59.50 US$ 61.40 US$ 63.34 US$ 65.33

WACC 11% US$ 50.00 US$ 51.55 US$ 53.15 US$ 54.80 US$ 56.48

12% US$ 44.16 US$ 45.50 US$ 46.88 US$ 48.30 US$ 49.75

13% US$ 39.57 US$ 40.74 US$ 41.95 US$ 43.19 US$ 44.46

We highlighted a realistic range of share price estimates in the near future. We get a range between

$45.50 and $63.34 with the estimated share price at the middle and our forecast seem to be reasonable.

We also carried out a sensitivity analysis using terminal growth rate and wacc.

Terminal Growth Rate

2.00% 3.00% 4.00% 5.00% 6.00%

9% US$ 64.81 US$ 73.16 US$ 84.86 US$102.40 US$131.64

10% US$ 56.59 US$ 62.62 US$ 70.65 US$ 81.89 US$ 98.76

WACC 11% US$ 50.21 US$ 54.72 US$ 60.51 US$ 68.23 US$ 79.04

12% US$ 45.12 US$ 48.58 US$ 52.92 US$ 58.49 US$ 65.91

13% US$ 40.96 US$ 43.69 US$ 47.02 US$ 51.19 US$ 56.54


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With this table, we get an estimated range of $48.58 to $81.89 for the share price, which is also quite

reasonable.

Risks to our investment recommendations

Macroeconomic factors will have a huge effect on Coach Inc. as it is a cyclical stock. It seems thatfor now, economic growth in Asia and USA is stable and but severe recession may occur

worldwide if the Eurozone crisis spreads.

Primary growth of sales for Coach will come from international markets, particularly from AsiaPacific. These countries do not have strong counterfeit laws that might hamper Coach sales if

their products are being copied by generic brands.

Coach has better margins than competitors and it is unclear how it might be sustainable in thelong run, especially in the Asia Pacific region.

We do not have the data for many private company competitors and hence we believe our peercomparison analysis is not that detailed as we can hope to be.


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Exhibits

Exhibit 1 Reformulated Income Statement


Operating income: 2011 2010 2009

Net sales 4,158,507 3,607,636 3,230,468

Cost of sales 1,134,966 973,945 907,858

Gross profit 3,023,541 2,633,691 2,322,610

Selling, general and administrative expenses 1,718,617 1,483,520 1,350,697

Operating income (before tax) 1,304,924 1,150,171 971,913

Tax on operating income:Taxes as reported 420,419 423,192 359,323

Tax on net financial income (395) (3,057) (4,182)

Tax allocated to other expense 1,814 - -

Tax on operating income 421,838 420,135 355,141

Other expense (4,736) - -

Tax effect (at 38.3%) 1,814 - -

Other expense (after tax) (2,922) - -

Other operating items (after tax):

Unrealized gains (losses) on cash flow hedging derivatives 627 (1,757) (7,278)

Translation adjustments 24,351 27,464 (5,298)

Change in pension liability 538 (163) (1,368)

Operating income (after tax) 905,680 755,580 602,828

Financing income:Net interest income 1,031 7,961 10,779

Tax effect (at 38.3%, 38.4% & 38.8%) 395 3,057 4,182

Net financing income (after tax) 636 4,904 6,597

Comprehensive income 906,316$ 760,484$ 609,425$

COACH, INC.

CONSOLIDATED STATEMENTS OF INCOME

(amounts in thousands, except per share data)

Fiscal Year Ended


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Exhibit 2 Reformulated Balance Sheet

(1) Treated 0.5% of sales of Cash as operating assets (sale are $4,158,507, and $3,607,636, 3,230,468

thousands)

(2) Treated items labeled "other" as operating activities

(3)Subtracted dividend payable from accrued liabilities ($65,260, $ 44,776, $23,845 in thousands)


2011 2010 2009

Net Operating Assets:

Operating Assets

Cash and cash equivalents 20,793$ 18,038$ 16,152$

Trade accounts receivable 142,898 109,068 108,707

Inventories 421,831 363,285 326,148

Deferred income taxes 93,902 77,355 49,476

Prepaid expenses 38,203 30,375 48,342

Other current assets 53,516 26,160 63,374

Property and equipment, net 582,348 548,474 592,982

Goodwill 331,004 305,861 283,387Intangible assets 9,788 9,788 9,788

Deferred income taxes 103,657 156,465 159,092

Other assets 155,931 143,886 122,678

Total Operating Assets 1,953,871 1,788,755 1,780,126

Operating Liabilities

Accounts payable 118,612 105,569 103,029

Accrued liabilities (excluding dividends payable) 408,350 377,949 324,774

Revolving credit facilities - - 7,496

Other liabilities 406,170 408,627 383,570

Total Operating Liabilities 933,132 892,145 818,869

Net Operating Assets 1,020,739$ 896,610$ 961,257$

Net Financial Assets:Financial Assets

Cash and cash equivalents 678,989$ 578,432$ 784,210$

Short-term investments 2,256 99,928 -

Total Financial Assets 681,245 678,360 784,210

Financial Obligations

Current portion of long-term debt 795 742 508

Long-term debt 23,360 24,159 25,072

Preferred stock: (authorized 25,000,000 shares;

$0.01 par value) none issued - - -

Total Financial Obligations 24,155 24,901 25,580

Net Financial Obligation (657,090) (653,459) (758,630)

Common Stockholders' Equity 1,677,829$ 1,550,069$ 1,719,887$

Net Financial Obligation + Owner's Equity 1,020,739$ 896,610$ 961,257$

COACH, INC.

REFORMULATED BALANCE SHEET


Fiscal Year Ended


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Exhibit 3 Reformulated Statement of Owners Equity

Reformulated:

Adjusted beginning Balance:

Reported beginning balance 1,505,293$ 1,696,042$ 1,490,375$

Reported dividends payable 44,776 23,845 -

Adjusted beginning Balance 1,550,069$ 1,719,887$ 1,490,375$

Transactions with shareholders

Prior earnings restatements - - (161)

Stock issued for stock options 343,571 204,982 7,363

Stock option-based compensation 153,994 109,036 66,671Cash dividends (178,121) (94,322) -

Stock repurchased (1,098,000) (778,556) (1,149,998) (930,302) (453,786) (379,913)

Comprehensive income

Net income reported 880,800 734,940 623,369

Net translation gains and losses 24,351 27,464 (5,298)

Net hedging gains and losses 627 (1,757) (7,278)

Pension liability, net of tax 538 906,316 (163) 760,484 (1,368) 609,425

Adjusted Balance 1,677,829$ 1,550,069$ 1,719,887$

Reported Balance 1,612,569$ 1,505,293$ 1,696,042$

Reported dividends payable 65,260 44,776 23,845Adjusted balance 1,677,829$ 1,550,069$ 1,719,887$

COACH, INC.

STATEMENTS OF OWNER'S EQUITY


2010

June 27,

2009

Fiscal Year Ended

July 2,

2011

July 3,


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Exhibit 4 Valuation Model

Assumptions:

Sales growth 13.88%

Core PM 20.68%

ATO (based on beginning assets) 3.98Cost of debt -0.1%

WACC 11.45%

Dividends as a % of Net Income 30.0%

Perpetual Growth Rate 3.60%

Number of Shares 287,770

2011 2012E 2013E 2014E 2015E

Income Statement

Sales 4,158,507.00 4,735,707.77 5,393,024.01 6,141,575.74 6,994,026.46

Core operating expenses 3,252,827.13 3,756,363.40 4,277,746.64 4,871,497.88 5,547,661.78

Core operating income 905,679.87 979,344.37 1,115,277.37 1,270,077.86 1,446,364.67

Financial income (expense) 636.13 657.09 1,173.95 1,790.31 2,492.54

Earnings 906,316.00 980,001.46 1,116,451.32 1,271,868.18 1,448,857.22

Balance Sheet

Net operating assets 1,020,738.54 1,189,876.32 1,355,031.16 1,543,109.48 1,757,293.08

Net financial obligation (657,090.47) (1,173,953.70) (1,790,314.79) (2,492,544.19) (3,292,560.64)

Common equity 1,677,829.00 2,363,830.02 3,145,345.94 4,035,653.67 5,049,853.72

Cash Flow Statement

Operating Income 905,679.87 979,344.37 1,115,277.37 1,270,077.86 1,446,364.67

NOA 169,137.79 165,154.83 188,078.32 214,183.60

FCF 810,206.58 950,122.53 1,081,999.54 1,232,181.07

Required OI 116,874.56 136,240.84 155,151.07 176,686.04

Residual OI 862,469.80 979,036.53 1,114,926.80 1,269,678.64

FCF - 810,206.58 950,122.53 1,081,999.54 1,232,181.07

Dividend payout 294,000.44 334,935.40 381,560.45 434,657.16

Excess free cash flow 516,206.14 615,187.14 700,439.09 797,523.91

Growth in Res OI 13.52% 13.88% 13.88%

Growth in FCF 17.27% 13.88% 13.88%

Res OI Valuation:

NOA 1,020,738.54

PV of Years 1-4 Res OI $3,190,406.70

CV 10,860,845.09

Enterprise Value 15,071,990.33

Less NFO (657,090.47)

Equity Value 15,729,080.79

Value per Share $54.66

Coach Inc. Valuation

coh valuation

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