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Dividend Class Warfare: Burberry vs. Coach

It’s Thursday, which means it’s time for the next matchup in our special Dividend Class Warfare series. This go-round, we’re pitting two big name accessory retailers against each other – Burberry (BRBY.L) and Coach (COH).

If you’ve been with us since the start, you know the drill. If you’re a newbie, or you just need a quick refresher, use these links to check out the rules of engagement and our seven guiding principles of income investing.

Without further ado, it’s time for the battle to begin. Two will enter, but only one will emerge victorious as the best income investment.

~Round 1: Simple Business

As I’ve said before, when you’re looking for a simple business model, it doesn’t get much simpler than retail. Both of these companies sell accessories, from watches and wallets to belts, scarves and overcoats.

Burberry directly targets the luxury consumer, while Coach markets a slightly more universally affordable product (for the consumer who wants a taste of champagne even though they’re on a beer budget).

Advantage: Draw

~Round 2: Steady Demand

Retail is a cyclical industry – meaning that it experiences certain times each year when revenue and profits are much higher than others. Right now, we’re in one of the boom quarters for such companies. The holiday shopping season is always good for retailers. But due to the current income inequality between the upper and lower economic classes, one company emerges as the clear winner of this round.

Advantage: Burberry

~Round 3: Cash Flow Positive

Over the past year, both companies have produced a large amount of cash, but, again, a clear winner emerges. Burberry has been able to generate enough free cash flow over the past year to pay about half a year’s worth of dividends to its investors.

Doesn’t seem too shabby. That is, until you see that Coach has enough free cash from the past year to make more than three years’ worth of dividend payments.

Advantage: Coach

~Round 4: High Cash Balance

Again, both companies meet our criteria for solid income investments, sitting on enough cash to cover more than two quarters’ worth of dividend payments.

But again, one company is clearly stronger.

While Burberry has enough cash stockpiled to pay for a little less than three full quarters, Coach boasts enough dry powder in its armory to cover dividend payments for seven and a half quarters.

Advantage: Coach

~Round 5: Minimal Need for Credit

The industry debt-to-equity (D/E) ratio checks in at a microscopic 0.03, well below the 0.13 D/E ratio for Burberry. While Burberry is in no real danger of defaulting on its loan payments (0.13 is still a very low ratio), Coach wins this round by a landslide with a D/E ratio of 0.0005.

In other words, the company practically has zero debt. In turn, there’s almost no chance of its dividend getting zapped because of cumbersome debt payments.

Advantage: Coach

~Round 6: Earnings Buffer

As I’ve said before, we look for a dividend payout ratio (DPR) of 80% or less of earnings when selecting a strong income investment. And both of these retailers fall well below that threshold.

Burberry checks in with a respectable DPR of 65%. Coach, however, takes yet another round with an extremely impressive DPR of only 35% of earnings. So not only can Coach afford its current dividend payments, it can easily increase its dividend, as well.

Advantage: Coach

~Round 7: Dividend Yield and Growth

Both of our competitors clock in with a solid dividend yield. With Coach at 2.40%, it’s slightly ahead of Burberry’s 2.23%. As I’ve said before, though, we value dividend growth more than high yields. On such merits, one company has a much stronger record of growing dividends year in and year out.

While Coach has raised its dividend an average of 49% a year over the past four years, averages can be deceiving. The company actually doubled it back in 2010 and has raised it only a fraction of that amount ever since. Burberry, on the other hand, has a lower average (19.30% per year over the past five years), but has a longer and more consistent history of dividend hikes. And slow and steady wins the race…

Advantage: Burberry

~Round 8: Valuation

Last, but certainly not least, on our list of key fundamentals is valuation.

In order to frame our analysis, it’s important to know that the average stock in the S&P 500 Index currently trades at a price-to-earnings (P/E) ratio of 17.9 and a forward P/E ratio of 16.5.

Against that backdrop, Coach clearly represents the best bargain. It’s actually trading at a discount to the market on both measures, whereas Burberry is trading at a premium to both.

Sorry. Burberry might sell premium goods. But that doesn’t mean we need to pay a premium price for the stock, too.

Advantage: Coach

And the Winner Is…

It’s time to go to the scorecard to see who has emerged victorious following eight grueling rounds of head-to-head battle:

Thanks to its strong cash flow generation, equally strong cash reserves, minuscule debt, a solid earnings buffer and impressive valuation, Coach, like Wal-Mart, overcame the decreased demand of a still-recovering economy to topple Burberry in the fight for accessory dominance.

Don’t forget to check in next week when we’ll be broadcasting the results of our final Dividend Class Warfare matchup. We’re pitting jeweler against jeweler to see who’s got the best bling for our Dividends and Income Portfolio.

Also, don’t forget to join the conversation on our Facebook page, or tweet your thoughts to @WallStDaily.

Stay tuned for matchup No. 4: Tiffany & Co (TIF) versus Signet Jewelers (SIG).

Until then…

Safe (and high-yield) investing,

Louis Basenese