Coach Inc.

Coach Inc. ( COH - Analyst Report ) has beaten the Zacks Consensus Estimate for 11 consecutive quarters and pays out a healthy dividend that quadrupled in a span of three years. The company, famous for women’s handbags, is a Zacks #2 Rank (Buy) and has a dividend yield of 2%.

Furthermore, management provided an optimistic outlook for sustained double-digit growth in both the top and bottom lines for fiscal 2012, which was well supported by strong third-quarter 2012 results.

Fabulous Third Quarter

On April 24, Coach announced third-quarter earnings per share of 77 cents, which topped the Zacks Consensus Estimate by a couple of cents and increased 24% from 62 cents in the prior-year quarter. Results were buoyed by strong top-line growth. The company has a long history of positive earnings surprises, averaging about 6.8% for the last 11 quarters.

Net sales of $1,109 million handily beat the Zacks Consensus Estimate of 1,101 million and increased 16.6% from the year-ago quarter.

Despite the sluggish recovery in the economy, Coach posted better-than-expected results on the back of healthy sales in North America and China. Strong brand image, geographical expansion, and new pricing and promotional policies in the North American factory business also supported the growth.

Gross profit increased 18% to $818.1 million, spurred by top-line growth, whereas gross profit margin increased 100 basis points to 73.8%. Operating income rose 21% to $337.5 million, whereas operating margin expanded 100 basis points to 30.4%.

Earnings Estimates Inch Higher

Over the past 60 days, the Zacks Consensus Estimate for fiscal 2012 rose 0.6% to $3.53 per share, implying a year-over-year growth of 20.9%. For fiscal 2013, the Zacks Consensus Estimate is $4.14 per share, exhibiting an increase of approximately 1% in the last 60 days and portraying a year-over-year growth of 17.3%.

The Zacks Consensus Estimates for this Zacks #2 Rank (Buy) stock shows a double-digit year-over-year growth rate, which is in sync with management’s guidance.

Dividend Portraying Strength

Coach has raised its dividend 3 times since paying its first quarterly dividend of 7.5 cents in fiscal 2009. Subsequently, it hiked its dividend by 100% to 15 cents in fiscal 2010, and then by 50% to 22.5 cents in fiscal 2011. The company last increased its dividend by 33.3% to 30 cents per share during its third-quarter 2012 results. The current dividend yield looks relatively decent at 2% based on the last closing market price of $59.79.

Coach’s commitment towards enhancing shareholders’ returns reflects its free cash flow generating capability, sound liquidity position and defined future prospects. The company generated free cash flow of $61 million during the third quarter.

Valuation Stretched, Yet Lucrative

Coach currently trades at a forward P/E of 17.0x, reflecting a 32% premium to the peer group average of 12.8x. Also, on a price-to-book basis, shares trade at 8.9x, compared with the peer group average of 2.9x. Given the long-term earnings growth projection of 14.8%, the PEG ratio comes in at 1.1, marginally above the benchmark of 1 for a fairly priced stock. The return on equity (ROE) looks very impressive. It has a trailing 12-month ROE of 54.7%, which is substantially above its peer group average of 20.3%.

A Look at the Chart

Given the earnings growth potential, a series of positive earnings surprises and the ability to sustain dividend increases, the stock has enough ingredients to lure investors. A quick look at the price and consensus chart reveals that the stock price line remains below the 2012 and 2013 earnings estimate lines, reflecting the fact that the stock is still undervalued.

The Bottom Line

Coach, which competes with Ralph Lauren Corporation (RL), boasts a proven strategy of investing in stores to enhance sales productivity through product innovation, compelling pricing strategy, new merchandise assortments and a cost-effective global sourcing model, which should drive comparable-store sales and operating margins in the long term. With robust sales and earnings growth projections as well as a solid dividend yield, Coach offers an attractive upside potential going forward even in the midst of an uneven economic recovery.

Founded in 1941 and headquartered in New York, Coach is the designer and marketer of fine accessories and gifts for women and men in the United States and internationally. The company offers lifestyle products, which include handbags, women’s and men’s accessories, footwear, jewelry, wearables, business cases, sunwear, travel bags, fragrances and watches.