Fossil - Solid Earnings Report Could Send Shares To Fresh All-Time Highs

Aug. 7.13 | About: Fossil, Inc. (FOSL)

Shares of Fossil Group (NASDAQ:FOSL) are seeing a large jump upwards on Tuesday after the company reported a strong set of second quarter results.

With shares trading around all-time highs at the moment, I remain cautious despite the solid operating performance and the shareholder friendly strategy. The valuation is not compelling enough for me to pick up shares at the moment.

Second Quarter Results

Fossil generated second quarter revenues of $706.2 million, up 11.0% on the year before. Revenues came in ahead of consensus estimates of $691.2 million.

Net earnings rose by 18.5% to $67.7 million. Earnings per share rose by 25% on the back of share repurchases in recent time, and came in at $1.15 per share.

Second quarter earnings saw an $0.08 per share benefit as a result of a shift of marketing and systems-related expenses into the third quarter. Even when adjusting for this benefit, earnings comfortably beat consensus estimates of $0.93 per share.

CEO Kosta Kartsotis commented on the developments during the quarter, "We are pleased to continue our positive momentum and report record second quarter results that surpassed both our revenue and earnings expectations."

Looking Into The Results...

The solid revenue growth was slightly tempered by adverse currency movements which shaved off $2.3 million in second quarter revenues.

US wholesale revenues were up by 4.2%. Excluding the negative $15 million impact of sales being shifted into the first quarter, revenue growth would be quite impressive.

European revenues were up by 15.0% driven by strength in the UK and Germany. Asia-Pacific revenues rose by 17.7% while direct-to-consumer revenues rose by 16.1% driven by store openings and same-store sales growth.

Operating margins rose by 130 basis points to 15.1% on the back of a 190 basis point improvement in gross margins which topped at 57.9%. Gross margins rose on the back of an improved sales mix, and the acquisition of Skagen, among others.

...And The Remainder Of The Year

Third quarter sales are expected to increase between 12.5% and 13.5%. As such, revenues are expected to come in between $770 million and $776 million. Operating margins are expected to come in between 15.0% and 15.5%, while diluted earnings per share are expected to come in between $1.30 and $1.37 per share. This includes an $0.08 charge related to the shift from second quarter expenses.

The third quarter revenue guidance came in ahead of estimates of $761 million. The earnings guidance was a bit soft compared to consensus estimates of $1.46 per share.

Full-year sales are expected to increase between 11.0% and 12.0%. Operating margins are expected to come in between 16.75% and 17.25% resulting in diluted earnings per share between $6.15 and $6.35 per share.

Valuation

Fossil ended its second quarter with $313.3 million in cash and equivalents. The company operates with $341 million in total debt, for a rather flat net cash position.

Revenues for the first six months of the year came in at $1.39 billion, up 13% on the year before. Net income rose by 21% to $140 million, or $2.36 per share. Full-year revenues could come in around $3.2 billion while earnings could come in between $360 and $370 million.

Factoring in gains of 20% on the back of the earnings release, with shares exchanging hands around $127 per share, the market values Fossil at $7.4 billion. As such, operating assets are valued around 2.3 times annual revenues and 20 times annual earnings.

Fossil does not pay a dividend at the moment.

Some Historical Perspective

Long-term holders in Fossil have seen great returns over the past decade despite witnessing quite some volatility in recent years.

Shares fell from highs of $40 in 2007 to lows of $10 in 2009. Shares have risen to highs around $130 in 2011 and 2012 before they fall back a bit. The action following the strong earnings report suggests the stock will make a new attempt to set fresh all-time highs.

Between 2009 and 2012, Fossil has increased its annual revenues by a cumulative 85% to $2.9 billion. Net earnings advanced by 150% to $343 million.

Investment Thesis

Investors are impressed with Fossil's strong results over the past quarter and the solid outlook for the remainder of the year. As a result, Fossil raised its full-year earnings outlook to $6.15-$6.35 per share. This compares to consensus estimates of $6.17 per share.

The company's strategy to reposition low-priced jewelry with an "affordable luxury" image has boosted demand for Fossil's products, notably for its watches and handbags. Fossil sells popular brands including Diesel, DKNY, Emporio Armani and Michael Kors (NYSE:KORS).

The solid financial state of the company has allowed Fossil to rapidly grow across the globe, while repurchasing its own shares. The decision to spend $169 million to repurchase 1.7 million shares during the second quarter, has been a great investment as shares have risen almost 30% ever since. The remaining $843 million of shares being authorized for further repurchases allow the company to retire 11% of its outstanding share base at current prices.

Investors are applauding Fossil's management for a very strong operating performance accompanied by a shareholder-friendly financial strategy. After the large jump following the release of the earnings report, I see few reasons to pick up shares at this point in time. Despite the solid operating performance in recent years, the current valuation at 20 times this year's estimated earnings is not compelling enough for me to pick up shares around their all-time highs.

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.