Guess?, Inc (NYSE: GES) designs, markets, distributes and licenses branded apparel and accessories. The company has a range of distribution channels, include directly owned retail locations and e-commerce sites, as well as international licensees and a wholesale operation that services third parties, such as department stores and boutiques. In the last two years, the company generated an average of $250 million in free cash flow, which compares to a current market cap of $2.87 billion. The company also has $416 million in net cash, so on an ex-cash basis, the company is trading at a P/FCF of 9.8x. Though this is not the cheapest we’ve seen, recent market volatility has created significant opportunities on little notice, so it is worth researching companies that exhibit strong operating fundamentals now, and then wait for the right chance to pounce.
Let’s look first at the company’s historical returns.
Guess?, Inc - Historical Returns, 1999 - 2Q 2012
Here we see significant improvements in the company’s returns over the last eight years. I believe recent results are more indicative of future results, due to a shift in strategy that began mid-decade to focus on international growth. In 2005, the company purchased its biggest European licensee, and in 2008, the company began partnerships for expansion in Asia. This increased geographic diversification renders prior data somewhat less relevant as it signals a permanent shift. The following chart helps depict the growth.
Guess?, Inc - Revenues and Margins, 1996 - 2Q 2012
This shows the aggregate gains in revenue and improving margins. The bulk of the growth in revenue is due to the company’s international expansion. For example, the company’s combined North American segments (retail + wholesale) doubled in revenue from 2005 to 2011, resulting in a gain of around $600 million. Though impressive, it pales in comparison to the gains in Europe, which increased 21x, for a gain of $877 million. Further, while the North American retail segment required (cumulative) $332 million in capital expenditures to support this growth, the European division required just $135 million. Also, the greater amount of wholesale revenue in Europe allows GES to generate significantly higher operating margins (averaging 818bp over the last seven years).
It is clear that Europe has been an integral factor in GES’ growth. This is now acting as a storm cloud over the company’s valuation, as concerns over the European economy worried analysts and others. This is despite the fact that, even up to the most recent quarter, the company’s European operations are performing extremely well.
Our international businesses continue to drive our growth, with Europe and Asia combining to deliver 80% of this quarter’s revenue increase. …. Net revenue from the Company’s Europe segment increased 29.9% to $288.8 million in the second quarter of fiscal 2012, compared to $222.3 million in the prior-year period. In local currency, net revenue increased 14.1%.
Nevertheless, the company’s share price is down 36% year to date (as of the time of writing, 10/24), due apparently to macroeconomic concerns, since the company’s revenues, margins, returns and (as the following chart shows), cash flows are all at or close to their historical peak.
Guess?, Inc - Cash Flows, 1996 - 2Q 2012
Here we see that operating cash flows have grown largely in line with revenues. This is a good sign, signalling stability in working capital as a percentage of revenue. Capital expenditures are usually somewhat lumpy, and we see that this took a toll with free cash flows in fiscal 2011 slightly lower than the previous year.
Guess?, Inc - Capital Structure, 1996 - 2Q 2012
This chart illustrates the massive increase in the company’s cash balance and near elimination of debt and capital leases (though, it is worth pointing out that, for retailers, there is a significant off-balance sheet – for now – liability in the form of operating leases). Net cash now accounts for 15% of the company’s market cap.
So where does this leave us? GES has exhibited exceptional returns on a number of metrics, while experiencing dramatic growth. This is a growth company priced for value investors. However, unlike other growth companies that tend to sacrifice returns as they grow, this is not the case here. GES is operating essentially at its peak performance and also has close to the safest balance sheet in its history. Concerns over its European sales appear to be overblown (if recent performance tells us anything). From my valuation of GES, I believe the company is undervalued, though not quite at the level where I would be ready to buy. That said, as recently as three weeks ago (from the time of writing), the company was trading 15% lower at a level not seen since mid 2009 (when macro uncertainty was significantly higher and the company was operating well below current levels). For now, I will wait.
What do you think of Guess?
Disclosure: No position