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INITIATING COVERAGE REPORT

William C. Dunkelberg Owl Fund September 18, 2013

Coach Inc.
Exchange: NYSE
Peter Blicharz Lead Analyst pblicharz@theowlfund.com

RECOMMENDATION
COH

BUY
$54.63 $68.17 27.28%

Ticker: COH
Bryan Murray Associate Analyst bmurray@theowlfund.com

Target Price: $68.17


Maxime Berin Associate Analyst maxime.berin@theowlfund.com

Target Price Projected Return

Market Data
52 week trading range Shares Outstanding ($mm) Market Capitalization ($mm) Enterprise Value ($mm) 45.87-63.13 281.33M 15.26B 13.80B

COMPANY OVERVIEW
Coach, Inc. designs and markets bags, accessories, business cases, footwear, wearables, jewelry, sunwear, travel bags, watches, and fragrances for women and men in the United States and internationally The company also offers fragrances comprising of perfume spray, toilette spray, purse spray, body lotion, and body splashes for women; and fragrances for men. Coach, Inc. markets its products to consumers through a network of companyoperated stores in North America, Japan, Hong Kong, Macau, Mainland China, Taiwan, Malaysia, Korea, and Singapore, as well as through Internet, department stores, and specialty stores. The company sells its products to wholesale customers and distributors in approximately 25 countries. As of June 29, 2013, COH operated 351 retail and 193 factory leased stores located in North America; 191 coach-operated department store shop-in-shops, retail stores, and factory stores in Japan; and 281 coach-operated department store shop-in-shops, retail stores, and factory stores in Hong Kong, Macau, Mainland China, Singapore, Taiwan, Malaysia, and Korea.

Financial Data
Cash & Equivalents Debt ($mm) 1.13B 985.00K

Revenue (mm)
$8,000 $6,000 $4,000 $2,000 $11 12 13 14E15E16E
Earnings History
Earnings Date FY13 Q4 FY13 Q3 EPS .89 .84 1.23 .77 Revenue $1.22B $1.19B $1.50B $1.16B Price -7.87% 9.8% -16.36% 7.35%

INVESTMENT THESIS
From its IPO in 2001 until 2007, COH traded as the hot new handbag company. However, going into 2008, the company lost its level of inelasticity with the higher end customer. Through this loss of market share in their largest segment, they have begun trading at a discount to their handbag and luxury competitors half way through 2012. However, thanks to their industry leading margins, COH is able to begin their transition to a lifestyle brand thanks to their expansion into mens products, high end leather offerings, and international expansion. COH will also be trading at a multiple that mirrors their lifestyle brand competitors moving forward. Therefore, entering a position in COH at this price marks a significant opportunity for the fund considering the companys industry leading margins, transition from a premium apparel, accessories & luxury goods to a Lifestyle brand and their expansion into international markets of Europe and Asia.

Consumer Discretionary/Staples

INDUSTRY TRENDS Apparel, accessories & luxury goods


Fundamental outlook for the apparel, accessories and luxury goods sub-industry is neutral. But with established brands such as COH that have 30% market share, there is still room for sustainable mature growth. Throughout the industry, the biggest trend to overcome is maturity. The newest an d hottest companies always tap into the more maturing companys market share, which happens to be Coach. COHs trend for North America has also shifted from same store sales to online sales due to the change of consumer preference during the past few years. Moreover, during 2013, a lot of consumers cut back on their apparel purchases, more specifically, over the last 3 years there has been 5-10% growth in the handbag industry. Realizing these trends, COH is revamping all of their product categories and transitioning into a lifestyle brand to diversify their product selection and revenues. As for personal luxury goods, the overall outlook is positive despite global macroeconomic headwinds which COH still maintains a leadership position in. Worldwide sales of personal luxury goods grew by 10% in 2012, led by an estimated 16% increase in leather goods with which COH plans to grow in FY14 with the help of Stuart Vevers. Specifically, Asia-Pacific grew by 18%, Americas by 13%, Japan by 8% and Europe by 5%. Moving forward, luxury goods will grow at a steady 5%-6% annually through 2015. Overall out of that growth, China holds 27% worldwide luxury consumption and is expected to expand to 35% by 2015. The demand will come across all markets, especially U.S., Europe, Japan and China followed by emerging markets which COH has plans to heavily expand on in FY14 . Moreover, Coach is entering these new markets successfully by pricing their products lower on average 50% to 75% lower than luxury brands like Louis Vuitton or Gucci. Lastly, due to expected lower cotton prices and supply chain improvements, gross margin expansion for apparel and accessories brands in 2013 will be almost inevitable. Year to date (through August 16) the S&P Apparel, Accessories and Luxury Good Index advanced 20.4%.

FY13 Q2 FY13 Q1

Analyst Consensus Estimates


Earnings Date FY13 Q4 FY13 Q3 FY13 Q2 FY13 Q1 EPS .89 .80 1.285 .754 Revenue $1.239B $1.179B $1.602B $1.160B

All prices current at end of previous trading sessions from date of report. Data is sourced from local exchanges via CapIQ, Bloomberg and other vendors. The William C. Dunkelberg Owl fund does and seeks to do business with companies covered in its research reports. Thus, investors should be aware of possible conflicts of interest that could affect the objectivity of this report.

COACH INC. Fall 2013


Positives
Multi-channel distribution strategy Increasing online sales o 74 million visits in FY13 with more sales by 10% than 76 Million in FY12. o Redesign of website o Increased mobile traffic through tablets and mobile devices o Double digit consistent growth Consistent revenue and profit growth o Mens bags and accessories increased 50% in North America in FY13 which accounts for 11% of rev. o Between womens and mens premium market rose 15% in FY13 to $11B w/direct channels posting 6% gains YoY, making combined market share of about 30%. Strong focus on the handbags category in International markets o 80-85% of factory handbags will be new and revamped. Transition to Lifestyle brand o Footwear went up to 12% YoY of business immediately due to relaunch. o Footwear category alone is $20B globally, o Launch of Capsule o Re-launch of Madison Reed Krakoff sale o Close in FY14 Q1 Dividend o Quarterly increase of 13% o Since 2010, we can see that Coach has increased their dividends by more than 350%

Strengths
Expanding presence in China o FY13 sales rose 40% (11% of Rev.) o 25% growth for FY14 o Customer intent to repurchase remains at a minimum of 80%. o 6% market share as of FY13 North America o 20 new stores in FY14, including 2 full priced locations and minimum of 15 factory outlets with 1 free standing mens store in addition to their 351 retail and 193 factory leased stores already; that account for $3334.48M of rev. o Beyond FY14, COH plans to have 500 stores in N.A. and 30 in Canada Japan o FY14, 5-10 net new locations which would equal square footage growth to increase by a minimum of 3% and expanding revenue. o Japan is responsible for 15% of revenue in FY13. o 17% market share = 2nd highest market share in the country Joint ventures with international partners in Europe o At the moment, 20 locations in U.K., France, Ireland, Spain, and Portugal account for $40 million in annual sales as of FY13. o Meant to increase their exposure to department stores and increasing their indirect sales. o 80-100 Coach specific stores openings planned for FY14: 70 wholesale and 10 retail locations. o Possibility of 20% of global category sales if COH penetrates the market successfully.

Drag Factors

Revenue Breakdown
Japan 15% Other Internati onal 19%

United States 66%

Sales shortfalls due to a sharp decline in global consumer spending Increased competition in core markets o Missing trends o Fashion Risks Counterfeiting Currency fluctuations may result in a gain or drag upon conversion to US Dollars. o Mid-single digit sales growth in constant currency. o Assuming Yen to close to 100 Dependence on independent manufacturers for procuring merchandise Sourcing activity is a key point for Coach as 69% of their sales are generates by new products.

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COACH INC. Fall 2013


Peer Group Identification
Ralph Lauren (RL) Ralph Lauren Corporation designs, markets, and distributes lifestyle and apparel products, including a range of mens and womens apparel, accessories, footwear, and leather goods, such as handbags and luggage. Fossil (FOSL) Fossil Group, Inc., designs, develops, markets, and distributes consumer fashion accessories worldwide including men's and women's watches; handbags, belts, small leather goods, jewelry, and sunglasses. V.F. Corporation V.F Corp is a lifestyle brand that has products including womens and mens accessories, apparel, footwear. They design, manufacture, and source from independent contractors, various apparel and footwear products.

Target Price
To arrive at our relative value fair price we first computed the NTM P/E values for each of the companies in our comp group. Although our median P/E multiple came out to be 19.4x, we decided to stay conservative and use the mean multiple of 17.8x with COHs NTM EPS of 3.83 to arrive at our target price of $68.17. Peer Analysis Target Price= $47-$73 Relative Valuation Target Price=$68.17 Relative Target Multiple= 17.8 NTM Forecasted EPS= 3.83

Target Multiple Comp LOW NTM P/e 17.8x

NTM EPS Est. 3.83

Target Price $68.17

Company Name Comparables Analysis


($ in millions except per share)
Revenue Market Company Cap ($mm) P/E Multiple LTM NFY Price per sales Growth NTM EBIT Margin LTM NI Margin LTM Gross Margin LTM Debt/ Equity MRQ

VF Corp. (VFC) Fossil Group, Inc.(FOSL) Ralph Lauren Corp. (RL) Coach, Inc (COH) Median Mean

$21,489.20 $ 6,562.30 $15,051.10 $15,402.10

19.40 19.00 21.00 15.10 19.4 19.8

17.24 17.75 18.54 14.70 17.8 17.8

1.94 2.30 2.16 1.88 2.16 2.13

6.33 11.84 1.14 4.53 6.3 6.4

14.30 17.50 16.20 31.10 16.2 16.0

10.21 12.18 10.54 20.38 10.5 11.0

47.60 56.60 59.50 73.00 56.6 54.6

35.99 6.28 7.04 0.04 7.0 16.4

Company

Market Cap ($mm)

P/E Multiple LTM NFY

3-yr Avg Ratio

Implied P/E

Revenue Growth NTM

EBIT Margin LTM

NI Margin LTM

Gross Margin LTM

Tiffany and Co. (TIF) Vera Bradley (VRA) Michael Kors (KORS) Coach, Inc (COH) Median Mean

$10,101.30 $ 816.60 $15,031.70 $15,402.10

23.40 12.20 33.10 15.10 23.4 22.9

20.75 13.36 25.62 14.70 20.8 19.9

0.91 0.9 0.43 1.00 0.7

21.294 10.98 14.233

5.76 -0.15 36.40 4.53

23.20 19.50 29.80 31.10 23.2 24.2

13.46 12.20 18.85 20.38 13.5 14.8

57.00 57.30 60.30 73.00 57.3 58.2

15.5

5.8 14.0

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COACH INC. Fall 2013


Growth Strategy
Growing business in North America and globally by transforming into a global lifestyle brand. o With new management, specifically Stuart Vevers, COH hopes to leverage his background in luxury leather goods to add to the bottom line and top line. o Plans to increase overall North American square footage by 10%. Leveraging the global opportunity by aggressively growing international business. o For FY13 China and other Asia sales accounted for 11% of sales. For FY14, China revenues are expected to grow about 25% to at least $530M. o 30 new stores in China in addition to 126 locations which spread across 47 cities. o FY13 alone there was an increase of 20 net new location equaling 33% sq. footage increase. o China alone represents about a $3.2B opportunity. Tapping into the large and growing mens accessory category. o In Asia, there is a $12B market for mens premium handbags and accessories. o Coach is targeting upper middle class (income range of $16,000-$34,000) which plans to grow from 14% in 2012 to 54% by 2022 of the overall Chinese population. o 64% of the upper middle class are confident in their income growth and 46% remain loyal to brands they purchase.

FINANCIAL ANALYSIS Sales: Revenues in FY13 increased by 7%. Coachs sales in China exceeded $430 million, which is up 40%, ending the year with about 126 locations including over 100 on the Mainland. Mens business grew almost 50% in FY13 to about $600 million. And online sales grew strongly with double digits. FY13 sales came in at $5.08B which resembles a 7% increase YoY. North America sales were $3.334B, while international markets brought in approximately $978M in sales and Japan $760M in sales. Looking forward, COHs strategy is to increase sales of their mens business to $1B in the next three years as they achieved $600M this past year. Keeping in mind, COH posted a 4% increase in local currency in Japan despite the top compare, white dollar sales which declined 15% reflecting the weaker Yen. With the re-launch of Madison in FY14 Q1, the company is expecting a steady growth in sales similar to last years and moving forward into the holiday season. Balance Sheet FCF: Cash flow continues to be something Coach is able to strive with. Thanks to an industry leading 7% FCF yield, The Company was able to grow their cash balance another 23% in F13 to just over $1.1B. The company is looking to use this cash balance to continue their expansion of new stores in Europe and Asia. Dividend: COHs cash balance also allows them to continue to pay out 2.5% dividend which is significant in comparison to their competitors and the rest of the discretionary industry. Coach has also made extended efforts to grow their dividend 40% over the last 3 years. Considering the significant cash balance and no other mention of cash usage besides growing their current stores, the growing dividend trend should continue.

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COACH INC. Fall 2013


Debt: Thanks to a significant cash balance that continues to grow and to their 7% free cash flow yield, Coach has been able to maintain an almost completely debt free balance sheet. While they may take on a small amount of debt in the near future to support their expansion efforts, their cash balance has historically lead these efforts. Valuation: Knowing that Coach is moving from their status as a high-end luxury bag maker to a lifestyle and apparel brand, there had to be consideration of how they previously traded. The first comparison considered was with luxury brands, Tiffany, Vera Bradley, and Michael Kors. While COH has traded at a discount to these companies over the last three years, we were able to take their discount level and find an implied P/E to these competitors of 15.5x. Taking this multiple by expected F2014 earnings ($3.83) left us with a price of $59.37. While this is slightly above their current price, it does not reflect the future growth into lifestyle brands. To consider their new multiple expansion, we added another comp group of primarily lifestyle brands where our target price is based. This includes Ralph Lauren, Fossil Group, and VF Corp. All three of these companies have well-known brands and a model for those brands that Coach, with its well-known brand, look to replicate as a part of their new lifestyle brand business model. While COH is entering into a smaller margin business with more of their sales dependent on the performance of their wholesaling efforts into other non-Coach stores, their consistent gross margin around 73% will assist in this fundamental change. Lifestyle: FOSL, ANN, RL, V.F. Corp. Luxury: TIF, JWN, VRA, KORS, EL, RDEN,

Margin Analysis Once again, Coachs old operations and their new directions must be considered. In both comparisons, they have a considerable advantage to that of their competitors. First, in the luxury segment, their 73% Gross Margin does not see other competitors reaching anything close. The closest competitor is Michael Kors at a 60% margin. This also continues across net Income margin (200 bps advantage) and EBIT margin (150 bps advantage). The trend then carries over in comparison to their new lifestyle brand comparisons. In Gross Margin, the next closest competitor is Ralph Lauren at a margin of 59.5%. But Coach also keeps considerable advantages in Net Income Margin (800 bps advantage) and EBIT margin (roughly 14% advantage). While Coachs margins may be adversely affected going into a lifestyle business that could end up having lower price points than the company is used to, the vast and efficient distribution network that Coach has in place should allow a shift that does not squeeze margins to any considerable degree.

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COACH INC. Fall 2013


3 Year Average

3 Year Average against Apparel, Accessories Benchmark

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COACH INC. Fall 2013


3 Year Average against the Luxury Goods Sub Industry

3 year Average against Comp Group (Individual companies)

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COACH INC. Fall 2013


3 year Average against the Lifestyle Brands

3 year Aver against their old market (accessories, apparel)

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COACH INC. Fall 2013

DISCLAIMER
This report is prepared strictly for educational purposes and should not be used as an actual investment guide. The forward looking statements contained within are simply the authors opinions. The writer does not own any of the Coach Inc., company stock.

TUIA STATEMENT
Established in honor of Professor William C. Dunkelberg, former Dean of the Fox School of Business, for his tireless dedication to educating students in real -world principles of economics and business, the William C. Dunkelberg (WCD) Owl Fund will ensure that future generations of students have exposure to a challenging, practical learning experience. Managed by Fox School of Business graduate and undergraduate students with oversight from its Board of Directors, the WCD Owl Funds goals are threefold: Provide students with hands-on investment management experience Enable students to work in a team-based setting in consultation with investment professionals. Connect student participants with nationally recognized money managers and financial institutions

Earnings from the fund will be reinvested net of fund expenses, which are primarily trading and auditing costs and partial scholarships for student participants.

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