Long Fossil Group: A Company With An Army Of Strong Brands

Jul.10.13 | About: Fossil, Inc. (FOSL)

Introduction

Fossil Group (NASDAQ:FOSL) is a global design house that focuses on consumer fashion accessories such as: fashion watches and jewelry, handbags, small leather goods, belts, sunglasses, soft accessories and clothing. Besides its primary brand "Fossil", Fossil group also has a diverse portfolio of globally recognized owned and licensed brand names under which their products are marketed. This includes Adidas, Armani Exchange, Burberry and more. With consumer sentiment now improving, this article seeks to convince you why Fossil is a great long term hold.

Business economics

1) A portfolio of strong brands

There is one thing that is constant about humans: change. With our preferences and needs always changing, fashion has constantly evolved together as well. In the 1950s, women loved to don A-line and pencil skirts; in the 1960s, mini dresses and maxi length skirts become popular; in the 1980s, longer skirts and dresses returned to the limelight, and so on and so forth- you get my gist.

With unending changes in preferences for fashion, brands often face the risk of losing favor from customers if they can't catch up with the latest trends or if their reputation is damaged due to an occurrence of an unexpected event. But, with a portfolio of strong brands under Fossil, Fossil is able to target many different market segments to mitigate this risk that they face. Customers may churn from one brand to another due to changes in preference, but as long as they churn within Fossil's portfolio of brands, Fossil's revenue stream remains relatively intact.

Also, the portfolio of brands under Fossil allows it to target many different price points which further shields its revenues from the swings in the economy.

Furthermore, most of the brands under Fossil are mainly incumbent brands which have dominated that particular market segment for a long time and are often exclusive only to Fossil. Therefore at the individual brand level, competitors will have to spend large amounts of time, effort and expenses on marketing if they were to establish a new brand to compete, deterring any potential entrants into the industry to vie for market share. Put together, the "Great wall of brands" keeps Fossil's revenues safe and sound.

This can be seen from Fossil's stable and increasing revenues from 2003 to 2012.

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2) Large global footprint

A strong brand is often determined by 4 primary factors: Quality, Design, Service and personality of the brand. Of the 4 primary factors, I believe that design and brand personality play the most important role in determining a purchase. To understand why design is important, one must be willing to embrace the fact that true brand loyalty does not exist. True loyalty is defined as purchasing a product from a brand without even bothering to look around at others. This, I believe almost never happens. More often than not, consumers will window shop around several reputable brands before purchasing a design they like the best.

I strongly believe that designs are mostly based on serendipity. Nonetheless, experience plays a part as well by increasing the probability of "meeting" serendipity through the understanding of the wants and needs of their target groups. If you too believe that design is a matter of probability, then being a large and prominent design house like Fossil yields the company many benefits on the design front.

First, by having a large number of designers in the creative team to cater to the various design demands around the world, Fossil is in fact increasing the probability of serendipity and resulting in designs of which will be loved by many.

Secondly, being large and reputable attracts many aspiring or seasoned designers with a diverse range of consumer insights to work for the company. These people like to associate themselves with these large design houses to boost their resume which they can use as leverage to start their own brands in the future or to negotiate for higher pay as they move from one brand to another. Henceforth, by being able to select the people with the best insights amongst the throngs of people who apply to be a designer at Fossil, Fossil is effectively increasing the probability of having good designs under its portfolio.

With more well-accepted designs, there will be fewer consumers who churn to other brands, while at the same time, the designs will attract more new consumers. With higher demand comes higher pricing power and hence larger margins. And best thing of all: this advantage expands as the company gets larger.

On the operational front, being a large design house like Fossil often gives them the power to pressure suppliers into giving them larger discounts so as to lower costs and further push margins.

3) Focus on the watch segment

Fossil's revenue comes largely from its watch segment, bringing in nearly 74.9% of the revenues in 2012. Although, through the annual reports, the management has kindly proposed to investors studying the company's prospects to divide the price points of their watch offerings into 4 segments, the better way to look at their watch offerings would be to divide it into Luxury and non-Luxury.

The non-luxury watches mainly involve those which are mainly sold on design and functionality. Design usually becomes the main differentiating factor as functionality is largely similar across all watches. Based on this premise, Fossil gains an upper hand through their size and portfolio of brands as explained in point 1 and 2 above.

As for the luxury watches segment, it is governed by a totally different set of economics. In this segment, the more expensive the product is, the more demand there is for the product. This segment is all about exclusivity. A very high price point brings about such feelings for the product and therefore creates more demand. This segment targets the ultra-wealthy who are seldom affected by the gyrations of the economy. (True, they may lose some money here and there, but unless they bet their entire fortune on one investment, these loses often do not amount to much when compared to their entire fortune.) With demand disconnected from the volatile economy and a willingness to pay even higher prices for these watches, it can be safe to say that Fossil will achieve high margins and stable revenues from this segment.

4) A $0 salary CEO

Even though this does not really qualify as business economics, it's worth bringing up here as it affects how the company is managed and subsequently, its business economics. The founder and current CEO of the company, Kosta Kartsotis, takes no salary, but holds nearly 30% of the company's shares. With most of his fortune tied to the company, the only way to make himself wealthier is to make sure the price of the company's shares appreciates over time; and the only way to achieve it: by making the company more and more profitable.

Business trends

1) Profitability trends

Increasing spending power

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Source: Forbes

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Source: Capgemini

Over the past few years and despite a global financial crisis in 2008, the world is currently witnessing an increase in spending power. According to Forbes, there were 1426 Billionaires in 2012, up from 1125 in 2007. And according to Capgemini, there were 11 million Millionaires in 2011, up from 10.1 million back in 2007.

In addition, China as well as many parts of Asia are experiencing a rapid middle income class expansion. This group of people can be labeled as the "Aspiring Rich" as they are still some ways off being classified as very wealthy, but are on their way there. Even so, these people often behave as though they already are and desire to be treated like one of the very rich. Therefore, they often like to be associated with reputable and well-known brands to flaunt their wealth and success to their peers. The "Aspiring rich" are often willing to pay high prices for watches, especially those in the lower end of the luxury segment, as they are traditionally seen as symbols of status. This plays well for Fossil, as watches make up a very large part of their revenues and many of their watch brands are very well known in Asia. You can see this trend reflected on the company's Asia pacific revenue growth rates in the table below:

2012

2011

2010

2009

2008

Asia Pac. Revenue (in Mils)

$ 361.50

$ 297.00

$ 220.80

$ 153.80

$ 161.80

Growth

21.72%

34.51%

43.56%

-4.94%

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The increasing number of ultra-wealthy, the expanding middle class and together with the restored consumer confidence due to the improving global outlook, has resulted in an increased capacity and willingness to pay for branded goods.

Opening of more emerging markets helped in lowering costs

In the past, China was the "go to" place when a manufacturer is looking for avenues to produce at a lower cost. As time passed, production costs started increasing in China due to the increment in wages, and producers are once again on the lookout for cheaper places to manufacture their goods. Now, with more markets in South East Asia such as Myanmar, Vietnam and Cambodia more open to international businesses, many businesses have moved their production lines into these countries to save costs.

2) Volume trends

Watches becoming fashion statements

Consumers all over the world are reflecting the wants for exciting lifestyle brands rather than local watch brands. With watches functioning more as fashion accessories, they will suffer from the same seasonal nature as many other types of apparel. Though now watch designs that are off season will be harder to sell, the good news is that purchase volumes can be expected to increase as consumers keep purchasing new watches to keep up with the latest trends at the change of every season. In contrast to the past where people would often invest in a good watch for very long extended periods of time, this trend has shifted competition from exclusivity and prestige to design- giving Fossil an edge against its competitors.

Men becoming more interested in fashion

Another booster to the Fossil's business volume is the interest men now show to fashion and personal grooming. Fossil has released a series of product lines for Men and has thus been garnering rather good responses.

The proliferation of mobile/online shopping

Finally, many consumers now prefer to shop wherever and whenever they want instead of making their way down to the mall which they might leave disappointed if they do not find anything of interest. An increased ease of shopping brings about higher shopping frequencies and thus higher business volumes

Financial ratios

Now let us discuss about the company's financial ratios.

03 to 07

08 to 12

Ave. ROE

16.98%

23.29%

Ave. Return on capital

23.14%

32.78%

Ave. Net margin

8.36%

11.38%

Ave. Asset Turnover

1.41

1.45

Ave. Debt to Equity

0.42

0.38

Annualized earnings growth

18.75%

21.84%

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To be honest, I have nothing but praises for Fossil's financial ratios. All average ratios have increased across the 2 periods while debt has been lowered.

Improvements in the net margins, asset turnover and consequently the return on equity have been fueled by the economics and trends as described above. Although one look at the earnings growth rate may induce one to question its sustainability, but I am sure it can be, with the trends discussed above.

Is FOSL a buy?

This table shows a summary of the investment merits of Fossil

Economics

Trends

A portfolio of strong brands

Increasing spending power after the 2008 crisis

Large global foot print

Opening of more emerging markets

Focus on the watch segment

Watches becoming fashion statements

CEO with $0 salary

Men becoming more interested in fashion

Proliferation of mobile/online shopping

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Based on the economics and trends described above, FOSL would be great long term hold. The value that I have calculated for Fossil is $120.15 VS a price $106.82 (as of 5th July 2013). So, now would be a good time for investors to buy Fossil's stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.