Fossil: European Depression Sends Fashion Industry Lower

| About: Fossil, Inc. (FOSL)

Shares of fashion accessory producer Fossil (NASDAQ:FOSL) took an incredible plunge Tuesday after the company released its first quarter results. Shares fell some 38% closing around $78 after trading as low as $75 per share. The move erased its year to date gains.

First Quarter Results

The company reported a 9.8% sales increase to $589.5 million which badly missed the analysts consensus of $617.6 million. Gross margins fell 40 basis point to 55.8%. The company reported a 4% net income increase to $58.1 million. Diluted earnings per share rose 8% to $0.93, roughly in line with analysts expectations of $0.92

The results were largely in line while revenues were a bit soft. The crucial sentence in the earnings release was the comment of CFO Mike Kovar who stated that "a softening macro environment toward the end of the first quarter and changes in our merchandising and assortment strategies negatively impact wholesale and retail sales in the region".

North America

Sales for the North American wholesale business increased 9.3% to $225.0 million driven by strong performance of watch sales, partially offset by a 25% decline in eyewear sales. Jewelry sales were strong as the company rolled out the Michael Kors jewelry line in its stores.


Sales for the European division increased a mere 1% to $152.8 million. Jewelry sales fell 12% as a result of a repositioning of the Fossil jewelry business, offset by stronger results at the watch and leather business. Same stores sales at the European business fell 5% on the year.


Asian sales increased by 19% to $76.7 million on the back of strong watch and leather sales, driven by new store openings. The company operated 215 stores at the end of the quarter as the company opened 38 net new stores over the last 12 months. Comparable sales fell unexpectedly by 1.1% as the Southern Korean economy was weaker than anticipated. South Korea is a prime region for Fossil in Asia.


For the second quarter of 2012 Fossil expects some 16% revenue growth, with a 6% growth contribution by Skagen which was recently acquired. Diluted earnings per share are expected to come in at $0.77-$0.79 driven by a $0.03 contribution of Skagen, offset by $0.07 transaction and integration costs.

For the entire year of 2012 the company expects revenues to increase by 16% as well. Diluted earnings per share are expected to come in at $5.30-$5.40 boosted by a traditional stronger third and fourth quarter. The net profit contribution of Skagen minus transaction and integration costs for the full year will amount to $0.07. Analysts expected the company to guide for full year revenue growth of 17% and earnings per share of $5.56


Fossil ended its first quarter with $261 million in cash and equivalents and $157 million in short and long term debt for a net cash position of roughly $104 million. Investors were not happy with the large build up in inventories which increased by more than $100 million to $512 million. The company even admitted that a part of the built up in inventories was related to disappointing sales, notably in Europe.

After Tuesday's decline the market values the firm at $4.9 billion, or $4.8 billion for the operating assets. This values the firm at 1.9 times annual sales and 17 times 2011's annual earnings. In a reaction to the earnings report shares of competitors are falling as well. Guess (NYSE:GES) fell 5.5%, Michael Kors (NYSE:KORS) 5.3%, Abercrombie & Fitch (NYSE:ANF) 4.7%, Ralph Lauren (NYSE:RL) 3.2% and Lululemon Athletica (NASDAQ:LULU) fell 3.0%.

Currently the company does not pay a dividend.

Investment Thesis

Shares in Fossil have seen a great long term run, just like many "high-flying" stocks in recent years. Shares in the fashion accessories company have multi-folded from lows of $12 in the beginning of 2009 to a peak of $139 in April 2012. In recent weeks shares have lost some 40% driven by Tuesday's losses from that point to $78 per share which erases the year to date performance to a loss of 1 percent.

Sales have more than doubled over the last five years and shares hit all time highs just a couple of weeks ago after the company acquired Skagen Designs for $232 million. The outlook implies that revenue growth which came in at 26% for the full year of 2011 will slow down to 16% for the entire year of 2012 while net margins will stabilize at 2011's levels.

Investors are worried for a justified reason. Sales growth have been slowing down for two subsequent years while margins have stabilized or even declined. Today's current valuation values the firm at 15 times 2012's earnings, which is a logical correction after stocks have more than ten-folded over the last couple of years. Despite the enormous correction today there are few drivers for a quick recovery and I will not pick up the shares anytime soon.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.