Investors should buy Coach shares because its acquisition of rival handbag maker Kate Spade will drive earnings higher from merger cost savings, according to Goldman Sachs, which raised its rating on the luxury goods firm to buy from neutral.
The company announced a definitive agreement to acquire Kate Spade for $2.4 billion in cash or $18.50 per share Monday.
"We upgrade COH … on the back of increased confidence in its strategic allocation of capital," Goldman's Lindsay Drucker Mann wrote in a note to clients Tuesday. "If successful, the proposed KATE merger agreement … could be a transformational moment for the business, with the potential to create substantial earnings accretion through cost synergies and favorable financing costs."
The analyst raised her Coach price target to $55 from $40, representing 22 percent upside from Tuesday's close.
Mann estimates the Coach and Kate Spade merger could save the company up to $115 million in costs, which will benefit earnings per share by 14 percent to 30 percent by fiscal 2019. She expects Coach will shrink Kate Spade's lower margin wholesale and promotional e-commerce business, which should help profitability in the coming years.
"We see COH as a relative winner in handbags, now gaining share and with limited exposure to department stores, and margin tailwinds," Mann wrote.
The analyst did not change her official Coach earnings forecasts from the proposed merger. She noted the company expects the Kate Spade acquisition to close by the third quarter this year.
— CNBC's Michael Bloom contributed to this story.