How Safe Is Coach Inc Stock and Its Dividend?

By Markets Fool.com

There used to be a day when Coach could do no wrong. Between going public in 2000 and its all-time highs in 2012, Coach shares soared 3,000% higher. It seemed like just about everyone wanted a designer bag or high-end scarf from the company.

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Accessories like this helped Coach post amazing results over the past decade. Source: Coach

But the company began to stumble in late 2012 as competition from the likes of Michael Kors began winning market share and margins tightened. Since then, investors have also had to contend with the retirement of founder and former CEO, Lew Frankfort.

With all this change, many are worried about Coach stock and its dividend. Is there really something to worry about? Read below to find out.

The most important metric for dividend investors
We'll start by looking at the dividend which is currently offering a tempting 3.7% yield. The most important metric to consider when deciding whether or not the Coach dividend is safe: free cash flow, or FCF.

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The FCF represents the amount of money a company is able to pocket at the end of the year, less any spending for capital expenditures. It is ultimately from FCF that dividends are paid out.

Here is how historical FCF for Coach looks going back to 2011 and how much the company has used for dividend payments.

Coach's FCF and Dividend Payout, in Millions

There are two key takeaways from this chart -- one positive and one negative.

The good news is that over the past twelve months, Coach has only used 50% of FCF to pay out its dividend. That is a very healthy number and tells investors that if the company is able to grow its FCF in the coming years, there should be plenty of room for the dividend to grow.

On the flip side, however, overall FCF has plummeted. FCF rang in at almost $1.2 billion during fiscal 2012. Since then, however, that figure has dropped 36%, reflecting the larger struggles the company has faced.

The message for investors: The Coach dividend is currently safe, but it will come under pressure if the company does not work to bolster its overall performance and FCF.

A turnaround story in the making?
As I mentioned above, competition from other designers like Michael Kors has Coach on the defensive with two key metrics trending downward.

The first is same store sales growth -- this tells investors if stores that have existed for more than a year are generating more or less revenue than they did in prior periods. This is an excellent indicator for how popular Coach products are in the current fashion market.

Below, we can compare same store sales growth for Coach and Michael Kors in North America -- Coach derives the majority of its retail sales from this region.

Same-Store Sales, North America, Coach & Michael Kors

While both companies have experienced slowing growth, same store sales have gone negative for Coach, a very bad sign for shareholders.

The second metric is profit margin. Coach has created a very strong brand over the past decade -- as the popular fashion item to own, the company could charge higher prices for its products, particularly its bags. However, that trend has actually reversed itself over the past three years when compared to Kors.

Profit Margins at Coach and Michael Kors

All in all, Coach shares are valued at just 13 times earnings with a safe dividend . . . for now. Investors should keep an eye on Stuart Vevers and the popularity of his new fashion line with shoppers. The company also needs to stabilize margins and improve foot traffic stores at its stores. If Coach is successful on these fronts, the low valuation could be an attractive opportunity.

The article How Safe Is Coach Inc Stock and Its Dividend? originally appeared on Fool.com.

Brian Stoffel has no position in any stocks mentioned. The Motley Fool recommends Coach and Michael Kors Holdings. The Motley Fool owns shares of Coach and Michael Kors Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.