Movado After Q4: Company In Good Shape, Stock Fairly Priced
- Movado reported a solid Q4 with an excellent top-line growth and a solid margin expansion.
- The solid performance was mainly driven by licensed brands, while the Movado brand posted a decline compared to Q4 2017.
- The company is solid and the performance was good, but I remain moderately cautious on the prospects of future growth and margin expansion.
The watch industry has lived a few difficult years for sure. A combination of industry headwinds, competitive pressures, and macroeconomic deceleration triggered weakness on many fronts and Movado (NYSE:MOV) was not immune to those forces, although its business resisted well in comparison to peers such as Fossil (FOSL).
Movado's revenue growth declined significantly in 2015 but went into negative territory only in fiscal 2017 (ending January 2017) when sales declined 7.1%. The company recovered in fiscal 2018 and posted a 2.8% increase in revenue with a recovery in EBIT margins, at least if measured in adjusted terms. Before analyzing Movado's recent results, let's do a recap of what happened in the past few years, with a particular focus on the issues that the company and its peers had to face.
Declining tourist spending. Between 2015 and 2016, watchmakers and many other industries exposed to fluctuations in tourist spending were negatively affected by a negative macroeconomic environment triggered by a combination of a strong dollar, recessions in emerging countries such as Russia and Brazil, and the economic slowdown in China, in addition to the concerns related to terrorism in Europe. The combination of these factors determined a decrease in tourism and spending by tourists, which is extremely important for basically all the companies in the space.
Smartwatches. The launch and the increasing popularity of smartwatches produced by well-known tech brands such as Apple (AAPL) and Samsung generated further competitive pressures for Movado and the likes, as a significant number of customers started to shift to those devices at the expense of traditional watches. The competitive pressures from smartwatches were particularly evident in the mid-price segment, where Movado and Fossil operate, while it was definitely negligible in the high-end and low-end segments.
The environment started to improve in more recent times, as the United States, which were the most troubled retail market among the main economic regions, started to give signs of a better consumer spending environment and increasing levels of foot traffic. Many retailers reported record sales during last holiday season thanks to a combination of factors such as low unemployment levels, a favorable wealth effect triggered by the bull market, and signs of maturity in the smartphone market, whose fast expansion limited the spending power available for different items in the previous years. In this context of improving conditions for the retail industry in general and the fashion industry in particular, let's give a look at Movado's recent results in order to understand its prospects better.
Fourth Quarter - Key highlights
Fiscal 2018 was a good year for Movado Group, as the company reported the highest revenue growth rate since 2015, gaining market share and posting a good expansion in margins. In the fourth quarter, sales grew by 14.1% to $149.2 million, with a positive 6.4% comps growth, mainly driven by a 20% growth in the international business while sales in the North American business increased only slightly (+1% YoY).
Profitability trends were positive as well. In particular, gross profit was $78.6 million, which translates into a 52.7% gross margin compared with just 49.5% in the fourth quarter of fiscal 2017. Nonetheless, it's important to mention that the 320bps expansion in gross margin was primarily a result of favorable currency effects. Considering that the Movado brand (which has a higher gross margin) didn't perform particularly well, it's reasonable to assume that the impact of channel and product mix on gross margin was not particularly favorable.
Operating expenses expanded 12.1% to $64.2 million, mainly driven by a $5.8 million increase in performance-based compensation and payroll related expenses, a $1.7 million increase in other expenses, and a $1 million increase resulting from the unfavorable impact of foreign currency exchange rate, partially offset by a $1.5 million decrease in marketing expense. Even if we ignore the effects of gross margin expansion, which was driven by currency advantage, we should notice that the increase in operating costs was lower than the increase in sales, which suggests some good operating leverage in the business.
Therefore, as a result of good sales growth, gross margin expansion, and operating leverage, operating income was $14.4 million, which translates into a 9.6% operating margin, compared to 5.7% in the fourth quarter of fiscal 2017.
Thoughts On Brands And Channels
Something relatively disappointing is that sales in the Movado division were down mid-single digits for the quarter, despite the improvements in the retail environment in the United States and a good performance in the retail and digital divisions, as the company stated that the wholesale channel in the United States is still challenging.
The launch of Movado Connect, the company's first Google-powered smartwatch, didn't help generate sales growth for the division, which is not great news in a world of increasing smartwatch sales. On the other hand, it's good to see a solid performance in the digital channel, as the company reported that movado.com sales grew by 53%. This is good news because the e-commerce channel usually reports slightly better margins, especially when it reaches a decent size. Nonetheless, the channel seems to be still small and its growth is expected to decelerate significantly. During the earnings call, an analyst asked a question about the future growth of the e-commerce channel, and the management pointed to a clear deceleration expected for 2019 and beyond:
Source: Q4 earnings call
It's normal to expect a deceleration as the recent growth rates are obviously not sustainable in the long term. Nonetheless, it's important to take into account the management's emphasis on third-party e-commerce platforms for future growth, as those channels don't have the positive effect on margins that the company's own direct-to-consumer segment has. Actually, the expansion in those channels may even have a margin-dilutive effect due to the higher concentration of the market.
On the other hand, the company does expect the conditions in the mall-based chain store channel in the U.S. to remain challenging, as "the leading retailers in this arena continue to adapt to a more digitally focused environment". Nonetheless, it expects the overall performance in the region to turn positive in 2019, which is confirmed by a positive momentum for the business seen so far in the first quarter.
The underlying trends in the business are overall good if we exclude the soft performance in North America. E-commerce is growing fast, but the success of its DTC channel and private brands, which now include Olivia Burton, can translate into a positive effect on margins. I am also a bit disappointed by the apparent poor performance in the smartwatch segment, but that is a crowded space where the company faces strong competitive pressures from high-tech giants with larger financial resources and brand power.
Expectations for Fiscal 2019
Let's give a look at what the management is expecting for 2019:
- Sales in a range of approximately $605 million to $615 million, which translates into a 7.4% YoY increase using the midpoint of the guidance. This would be the best YoY growth rate since 2014.
- Gross margin to be flat to slightly improved from fiscal 2018 at around 53%. While it's true that we can't expect a gross margin expansion in line with 2018, given the positive effect of favorable currency variations, it's a bit disappointing to see that the addition of Olivia Burton and the emphasis on private brands growth will not generate a positive effect on gross margin.
- Operating income in a range of approximately $68 million to $71 million, which translates into an 11.4% operating margin, indicating a further expansion from the current levels.
- Net income in a range of approximately $50.5 million to $52.8 million, which translates into a range of approximately $2.15 to $2.25 in EPS.
We can say that Movado posted a solid quarter despite the soft results in North America. The entire retail space in the region has recently experienced a significant recovery and the 1% growth posted by Movado doesn't seem to reflect any particular strength. Nonetheless, international growth is proceeding fast and the outlook for 2019 is promising too, both in terms of sales and margin expectations.
I maintain a neutral position on the stock because I think the company should offer more clarity on the sources of long-term growth and should also offer more granular data on the performance of each channel and brand. The recent strength looks likely a result of specific strength in some licensed brands such as Tommy Hilfiger, while the performance of the private brands continues to lag and was actually negative in Q4. The excessive reliance on licensed brands and the scarce momentum of the Movado brand suggests the expectations of structural gross margin expansion may be limited and the positive effect of e-commerce growth on profitability may be marginal or totally absent, considering the emphasis on third-party platforms. Movado is a solid company for sure, but my nature of highly-selective fundamental investor forces me to remain on the sidelines for the moment. At 17.5x EPS expectations that may or may not materialize, MOV looks fairly priced at this level, which makes it a decent hold in a diversified portfolio but not a bargain for sure.
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