Fossil Group - No Big Surprises, Appeal Remains

| About: Fossil, Inc. (FOSL)


Fossil reports earnings which are in line with expectations.

The outlook for the rest of the year is comforting.

The fair valuation and strong term track record are comforting to me despite the difficult operating environment.

Investors in Fossil (NASDAQ:FOSL) hardly reacted to the company's second quarter results and outlook for the rest of the year which did not contain huge surprises.

As the company faces a difficult operational environment, it still manages to show growth and trades at a reasonably attractive multiple at a discount to the wider market given the strong long term track record of the business.

I continue to like the shares at current levels.

Second Quarter Results

Fossil posted second quarter sales of $773.8 million which is a 9.6% increase compared to the year before. Revenues came in marginally ahead of $770.7 million as expected by analysts.

Despite the growth in topline sales, net earnings were pressured amidst increase operating expenses in particular. Reported net earnings fell by 22.5% to $52.5 million.

Sizable share repurchases limited the fall in diluted earnings per share to 14.8% with earnings coming in at $0.98 per share on a GAAP basis. Reported earnings beat consensus estimates by two pennies.

Looking Into The Numbers

While a reported 9.6% growth in topline sales is impressive, this is mainly the result of new store openings rather than organic comparable store sales growth which requires much less capital. Organic growth furthermore does not add as many costs to the cost base of a company versus store openings.

Currency movements actually has a beneficial effect, especially on the European operations, as they added a combined $11.3 million in total sales.

Fossil ended the quarter with 558 stores across the world, a 13.2% increase compared to the year before, suggesting that average revenues per store were down by about 4%. This makes it much more understandable to see profits fall. The company stresses that direct-to-consumer sales were up by 12% compared to last year, outpacing overall sales growth.

Watches remain the most important sales category, with sales of $611.2 million being up by 11.7% compared to last year, thereby making up nearly 79% of total sales. Jewelry sales were doing fine as well as sales of leather dropped slightly to $87.3 million with other sales being stagnant as well.

Overall, gross margins came in at 57.5% of sales which is a very healthy number, although margins were down by about 40 basis points compared to last year. Greater sales through lower-margin channels were the reason behind the modest margin compression.

The real pain was in the increase in operating expenses, driven by store openings in part, but also by general costs increases. As a result, operating expenses jumped by 370 basis points to 46.5% of sales. The company furthermore stressed that investments to support growth, more advertising and a non-cash impairment charge were the driver behind the temporary increase in costs.

Combined this hurt operating earnings by 4.1% points to 11.0% of sales. Net earnings have been hurt by increased interest expenses to nearly $4 million for the quarter amidst the build up in debt.

Looking Into The Remainder Of The Year

For the current third quarter, Fossil anticipates sales to increase between 7.5% and 9% on an annual basis. Operating margins are anticipated to improve to 16.7-17.2%, a big improvement on a sequential basis. This should result in earnings of $1.77 to $1.84 per share for the upcoming quarter. The guidance looks quite favorable compared to last year's earnings of $1.58 per share. Analysts were looking for earnings of $1.84 per share based on expected revenue growth of 8%.

Full year sales are anticipated to grow between 8.75% and 10%. Full year diluted earnings of $6.95 to $7.35 per share are anticipated which compares to earnings of $6.63 as reported last year. Operational earnings pressure will be made up for by share repurchases this year.

The full year guidance is five cents higher than previously anticipated, a revision hardly worth mentioning. Analysts were looking for full year earnings of $7.13 per share on sales growth of 9.8%.

Included in the full year guidance is the option for potential charges related to the plans to improve the performance of North American retail stores. Charges of around $0.10 per share could be taken near the end of this fiscal year or in the first half of next year.


Fossil ended the quarter with nearly $273 million in cash and equivalents. Notably the firm's debt increased to roughly $547 million which in its turn is the result of sizable share repurchases in recent times. This has resulted in a net debt position of about $275 million at the moment.

These share repurchases have reduced the outstanding share base to 53.7 million shares which values equity in the business at $5.5 billion assuming a share price of $102 per share.

Given the outlook, the current valuation of equity values Fossil at roughly 1.6 times annual revenues and 14-15 times earnings while the debt position remains limited.

A History Of Continued Growth

Fossil has a history of growth over the past decade, having reported steady revenue growth in each sequential year with exception of the recession in 2009. Since 2004, the business has increased topline sales at an average growth rate at around 15%, as sales have grown from roughly a billion in 2004 to a guidance for $3.5 billion in sales for 2014.

Earnings growth has kept up pace as well, yet recently margins have been impacted to some extent. A sluggish retail environment and fierce competition from likes of Michael Kors (NYSE:KORS) have made a real impact.

Despite the very impressive growth, the company managed to retire roughly one in every four shares outstanding in the meantime thereby fueling earnings per share growth. While the company has traditionally managed to grow without the assumption of debt, the latest repurchases have resulted in a modest built up in debt. This is however not a great concern of mine.

The company still has $309 million remaining under its current share repurchase program. As such the net debt position could increase a bit further under the current authorization.

Final Takeaway

Fossil has quite a diversified operations in terms of geographies while it has a good exposure in the direct-to-consumer business as well. Wholesale revenues make up about 75% of total revenues, while the remainder is sold directly to consumers. Of the wholesale revenues nearly 50% are being generated in North America, a third in Europe and the remainder in Asia. The latter two continents are showing solid growth, amidst a stagnating performance in North America. The company is looking at initiatives to improve the performance going forwards in this area.

While the reported results look solid, the earnings beat is mostly driven by repurchases with the sales guidance was a bit soft amidst a poor performance in North America with poor mall traffic and a very competitive field. A good sign was the renewal of the license agreement with Italy's Giorgio Armani for another decade.

While the current environment is rough, revenues are still up while operating earnings are pressured to some degree. That being said, share repurchases allow for another year in earnings per share growth while the company trades at a roughly 15% discount compared to the general market. This discount is appealing in my eyes given the very strong long term track record in both operations and shareholder value creation.

I continue to like the shares around these levels.

Disclosure: The author is long FOSL. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.