Coach May Carry Too Much Baggage

People show off their prosperity in countless ways. Since 1941, one subtle yet effective ploy for the well-to-do, and those aspiring, has been to carry a purse or briefcase by Coach. Their distinctive little leather tags have come to suggest something valuable inside. Now, with shares in Coach coming public, I wondered if a few shares might do something for a portfolio, too.

That will depend on how cheaply you can get the stock after an initial public offering to be led by Goldman Sachs. Sara Lee bought Coach in 1985. Now amid a corporate makeover, it aims to spin Coach off in two steps. In an IPO this fall, it plans to sell up to 19.5% of Coach for an estimated $127 million. It then intends to distribute the rest of its Coach shares within 18 months. For Sara Lee, the timing is perfect: Sales of Coach handbags and dozens of its other leather goods, home furnishings, watches, and even sunglasses are up, and profits are soaring (table).

Just the same, if this is a good time for Sara Lee to sell Coach, it's not the best time for you to buy. Along with Coach's buoyant results, the company's securities filing discloses several signs that life may not be so lush for a future investor.

The first is the simple fact that, until recently, Coach wasn't growing. Just last summer, the company finished its second consecutive fiscal year of dwindling sales. They sank to $508 million from 1997's $540 million. Net income in that time shrank by nearly half, to $16.7 million from $32 million. Now, even though net profit in the fiscal year ended July 1 rebounded to $38.6 million, that's still shy of the nearly $43 million Coach netted back in fiscal 1996.

FASHION VICTIM. Coach execs are keeping mum ahead of the IPO, but the filing lays the trouble on both weaker demand in Asia and Coach's misreading of fashion trends. "These declines," it says, "were primarily the result of changes in consumer preferences from leather to mixed material and non-leather products, which some of our competitors offered." Coach has since added new lines, such as purses of microfiber and mohair, but its future is bound to keep swaying with fashion's vagaries.

To complicate matters, the market for handbags in the $150 to $350 range, where Coach gets 56% of its sales, is as crowded as the Hamptons in July. Check department store displays. You might find, as I did recently, that purses from longtime rival Dooney & Bourke enjoy the biggest display. Others getting in on the action include Perlina, aimed at well-off techies, Longchamp from Paris, and Australia's Oroton, to which a saleslady steered me.

To build sales, Coach aims to keep expanding rapidly. It plans to add 50 stores to its current retail network of 106 within the next three years, while renovating or expanding the rest. It also aims to remodel 78 of its leading department store displays by the end of 2002.

All this should burnish the Coach brand. Yet it also takes cash, a resource that grew scarcer in fiscal 2000. Even as sales rose and earnings surged, cash flow from operations actually shrank 14%, to $84 million. Nor can Coach count on cash from the IPO. Every penny of that is pledged to repay part of a $190 million note it will owe Sara Lee as a result of the spin-off. The debt must be paid by September, 2002, and its terms demand that excess cash flow go to prepayments. Can Coach fund its ambitious expansion and thrive? Perhaps, but only as it also services Sara Lee.

Coach estimates it will go public at $15 a share. At that, its market value could top $650 million, or 7.7 times the past year's cash flow and 18 times profit. Compare that with Polo Ralph Lauren, which has a similar clientele. It's bigger, more diversified, and its sales are growing faster. Yet its shares cost seven times cash flow and 13 times net. What does that tell me? At 15, Coach is fully priced. Bargain hunters must wait.

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