Fossil Inc: Another Summer Value Play

| About: Fossil, Inc. (FOSL)

Investors in 13,000-employee watch maker Fossil Inc. (NASDAQ:FOSL) have been taken on a ride this year. After purchasing at $90 levels in November and selling to breakeven in early 2012 after a long stretch in the red, I missed out on the tremendous jump to $130 levels after Fossil's cash acquisition of Skagen Designs, Inc.. This news was embraced by the markets in the bull run early this year, and much anguish was felt over missed opportunities. However, more recently, I was vindicated as shares of FOSL fell 40% on May 8 in the biggest percentage drop in share price in the company's public history. Today, the stock is trading at $71 levels.

Among its peers and competitors, Fossil, Inc. has one of the lowest P/E ratios at 15.16: Tiffany & Co. (NYSE:TIF) has a P/E of 17.93; Signet Jewelers (NYSE:SIG) has a P/E of 12.24; Jarden Corp. (NYSE:JAH) has a P/E of 15.36; Movado Group Inc. (NYSE:MOV) has a P/E of 19.9; and Blue Nile, Inc. (NASDAQ:NILE) has a P/E of 48.38. In terms of market capitalization, FOSL is in a strong position with an approximate $4.4 billion valuation; however, this is half of the $8 billion+ peak value reached in January of this year. With customers across a wide range of styles and markets, including Neiman Marcus Group Inc., Nordstrom Inc. (NYSE:JWN), Target Corp. (NYSE:TGT), and Wal-Mart Stores (NYSE:WMT), along with standalone retail stores across the world, Fossil Inc. is in a powerful place in the consumer specialty retail world.

The early May decline in share price was precipitated by the last earnings announcement from management; the firm cited the weak European economy - especially in Italy and Spain - and a repositioning of products, "including the exiting of the optical-frames business in Europe and the pulling back of Fossil's eyewear products to U.S. department stores" as factors that impeded sales in Q1:

"During the first quarter, we were unfortunately not firing on all cylinders," Chief Executive Kosta Kartsotis said on a conference call.

Fossil, which has seen its annual revenue double over the past five years, posted a 4.2% rise in first-quarter earnings, provided second-quarter guidance below Wall Street expectations and lowered its full-year earnings projections. The outlook surprised investors because it included the company's recently completed acquisition of watch maker Skagen Designs in April for $231.7 million.

"Momentum slowed for Fossil as European economic dismay, negative comps for the key Korean market and the repositioning of the Fossil-branded jewelry led to lower-than-expected top-line result," said Eric Beder, retail analyst at Brean Murray Carret & Co.
The results and outlook sent shares plunging, with the stock falling $47.25, or 38%, to $78.52. The decline wiped out the stock's entire 2012 gain of $46.41, or 59%, before Tuesday.

Other retailers with either significant exposure to Europe or a luxury bent also fell. Guess Inc. (NYSE:GES) lost 5.5% to $26.50, Michael Kors Holdings Ltd. (NYSE:KORS) dropped 5.3% to $41.75, Saks Inc. (NYSE:SKS) declined 4.4% to $10.23, Ralph Lauren Corp. (NYSE:RL) lost 3.2% to $163.38, Coach Inc. (NYSE:COH) fell 1.8% to $70.80, and Tiffany & Co. retreated 1.5% to $64.75.

However, the worthwhile aspects of May 8 to examine for investors now are in regard to future share price movements. Though the company offered a weak outlook for Q2 2012 (expecting EPS of $0.77-$0.79 on 16% sales growth), the market is dramatically understating the value of the company, especially in the long term. This is demonstrated by the solid retail metrics reported in the Q1 earnings call but overshadowed by the above news - retail same-store sales rose 7.7%; direct-to-customer revenue increased 18%; and wholesale sales for FOSL were up 7.5%. Taking a closer look at Fossil's equity shares, we see that these positive business fundamentals translate well into FOSL's current metrics: forward P/E stands at 11.32, with PEG of 0.77, P/S of 1.66, P/B of 3.87, and P/FCF of 35.19. Fossil's current ratio is a healthy 3.9, and in terms of capital structure, debt/equity is very low at 0.02. Potential shareholders can be assured by the fact that insiders own nearly 10% of the company. As if that all weren't enough, ROA stands at 20.7%; ROE at 27.66%; and ROI at 26.09%.

As far as the variant view goes, downside risk on FOSL certainly does exist. The potential for further slowing of German and Korean sales exists, as does a negative adjustment in Asian sales growth in the upcoming Q2 earnings call. As European sales comprise about 30% of the company's sales and Asian sales make up 20%, such potential declines would necessarily preclude positive earnings growth for investors into future quarters of this year and the holiday season. However, FOSL isn't the only company exposed to these risks. All the competitors mentioned above, as well as Calvin Klein/Tommy Hilfiger holding company PVH Corp. (NYSE:PVH), Warnaco Group Inc. (WRC), Timberland/North Face group VF Corp. (NYSE:VFC), Abercrombie & Fitch Co. (NYSE:ANF), and licensing partners Burberry Group and Michael Kors HOldings are all vulnerable. In the final analysis, the factors pushing FOSL up outweigh - and do so by a wide margin.

Fossil's next earnings report is scheduled for release on August 7, 2012. At last earnings release on May 8, the company reporter EPS of $0.93. Recently, analysts with Citi have upgraded outlook on FOSL, citing a "beaten-up" valuation. Given all of these developments, rational investors would be unwise to let FOSL remain unloved. In the next few months, the potential for significant growth exists. Insiders at the company certainly recognize this, as they bought shares by the truckload very recently, taking advantage of the precipitous price decline. As one analyst stated shortly after May's bad news, "Fossil's business model is far from broken, with a powerful fleet of licensed brands, and remains a double-digit growth story over the longer term."

My conservative target price for FOSL shares is $110. I'm trying to get in on FOSL this week at $71, and will buy anywhere before $80. Since it's likely the last time this opportunity will exist, so should you.

Disclosure: I am long FOSL.

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