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Coach Fails to Impress

Earnings jump 35% and top Wall Street's forecast, but the stock falls 4%.
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reported a 35% jump in third-quarter profits and beat Wall Street's expectations, but the stock traded lower Tuesday as news of future earnings deceleration ruffled investors.

The purveyor of fashionable handbags said it earned $108.8 million, or 28 cents a share, for the quarter ended April 1, up from the $80.9 million, or 21 cents a share, it reported in the same quarter last year. Analysts were expecting a profit of 27 cents a share, according to Thomson First Call.

The upside apparently wasn't big enough, as shares of Coach recently were trading down $1.48, or 4.2%, to $33.72.

For all of 2006, the company projected earnings of $1.25 a share, ahead of Wall Street's estimate by a penny. That would mark a 26% year-over-year increase. For 2007, Coach sees earnings of $1.50 a share, while analysts forecast earnings of $1.48 a share. Still, the forecast implies earnings-per-share deceleration next year to 20% growth.

"That's not enough to get growth investors excited," says Brad Stephens, an analyst with Morgan Keegan. "This is a company that's always put up very robust earnings growth. With the deceleration next year, it looks like we're entering a period here where the multiple compresses."

For its third quarter, Coach recorded a 20% sales gain to $497.9 million from last year's $416 million. Wall Street expected sales of $495.7million. Same-store sales, of sales at stores open at least one a year, surged 21.1% in the U.S. They were up in the high single digits in Japan.

"They're talking about more opportunities in Japan and China and other countries in the Pacific Rim, so it looks like they're positioning themselves for substantial international growth," says Stephens (he doesn't own shares of Coach, and his firm doesn't have an investment-banking position with the company). "In the meantime, there will be a lot of store remodels, and investors are concerned that selling costs will rise."

Coach's gross margin for the quarter rose to 78.3% from 78.1%, while selling costs as a portion of sales declined to 45.1% from 46.2%.

It plans to open 55 new stores by July, bringing its worldwide total store count to 525. In 2007, the company plans to open at least 85 stores.

Tuesday's selloff had the stock trading at roughly 23 times earnings estimates through 2007. Stephens says the valuation looks favorable.

"At these levels, you've got a stock that adds about a 4% in free cash flow yield while growing in excess of 20% every year," he says. "They almost always outperform expectations. They've got about $2 a share in cash, and it competes in the luxury segment, which usually commands a premium over other retailers. I think it's hard to argue there's a whole lot of downside here."