Fossil Group: Don't Catch This Falling Knife

Summary

• This once popular brand has fallen on hard times.
• Financials have been deteriorating for 6 years.
• Company management is making an effort to turn things around.
• Don't invest in the turnaround, until evidence shows a record of success.

Fossil Group Inc. (NASDAQ:FOSL) is a designer and manufacturer of watches, leather goods, and jewelry. They design Fossil brand merchandise as well as licensed goods for many top brands including Kate Spade, DKNY, Armani, and BMW. In total, the company produces goods under 17 brand names. At one time, their flagship Fossil brand was extremely popular. I have owned several Fossil watches and other merchandise over the years, as have many of the people I know. However, in recent years, the company has fallen on hard times. Their financials have been falling for six years and do not yet show signs of a turnaround. Although the stock price is very low, Fossil is not currently a good investment, even for speculative investors hoping for a turnaround. The likelihood of failure is simply too high without evidence of gradual success.

(Source: FossilGroup.com)

Financials

At one time, the Fossil Brand was very popular. Fossil stores were in many malls and, constantly, seemed busy. It seemed that almost everyone had something from the brand: a watch, a belt, or a wallet. Much of what they sold was unique and different. I once had a Fossil watch that had a beveled crystal top, that was not like anything else I had ever seen. I frequently received compliments on it. Much of their merchandise was unique in that way.

For years, the stock of Fossil Group had solid financials that grew and improved, in the way that excellent companies, with in-demand products, often do. Year after year, the revenues, profits, and book value rose. However, this began to change in 2014 when the numbers began to weaken and fall.

	Revenue Per Share	Earnings Per Share (Basic)	Book Value Per share
2004	13.5	1.22	7.37
2005	15.23	.90	7.7
2006	17.93	1.13	8.89
2007	20.56	1.82	11.07
2008	23.81	2.02	12.06
2009	23.14	2.07	14.48
2010	30.44	3.83	16.14
2011	40.56	4.66	17.79
2012	46.88	5.63	20.69
2013	56.79	6.59	19.53
2014	66.37	7.12	19.26
2015	66.16	4.42	19.15
2016	63.20	1.64	20.85
2017	57.53	-9.87	11.84
2018	51.66	-.07	11.82
2019	44.15	-1.04	9.86

Click to enlarge

(Sources 2004-2009 compiled from Valueline. 2010-2019 Seeking Alpha)

As you can see in the numbers above, Fossil Group went from numbers that were consistently improving to numbers that were steadily falling. While the revenue per share fell off in a somewhat steady decline, the book value numbers were almost halved in one year (between 2016 and 2017). The EPS fell from a high of $7.12 per share to three years of losses starting in 2017.

Revenues continue to struggle. Management has reported that global comparable sales for the first quarter of 2020 declined by 14% due to COVID-19 closures. As for earnings, they posted a first quarter operating loss of $134 million compared to $20 million in 2019. The company further announced that they expect second quarter results to show a sales decline of 60-70% due to COVID-19. This is in large part due to the fact that all of the company's US stores have been closed since March 17 as well as the majority of European stores. Sales will be further hurt by the fact that the company's wholesale retail partners have been shuttered by the COVID-19 shutdown as well.

(Source: FossilGroup.com)

So, why has Fossil Group had such a remarkable fall from grace? The chart above may provide some clues. The vast majority of the company's revenue is generated through watch sales. In the last 13 years since the smartphone revolution, many people no longer feel the need to wear analogue wrist watches. Especially, among the younger generations, analogue wrist watches are seen as no longer a necessity. It is simple and convenient to use your phone to check the time, date, weather, and anything else you may care to know.

Watchmakers have been struggling with this change for several years. In March of 2016, a meeting was held where 1,500 watchmakers met to discuss the future of the wristwatch and how to help their businesses. At that time, only the highest end watches ($100,000 plus) continued to do well. All other segments were struggling.

Since that meeting, the popularity of smartwatches has breathed life back into the watch industry. However, many of those are made by phone and technology conglomerates like Apple (AAPL) and Samsung. Many of the traditional watchmakers have continued to struggle. Some of the legacy companies even declared at that meeting that they had no intention of changing.

We create unique designs, artwork. We want to stay true to ourselves," said Alain Bernard, chief executive, Americas, at Van Cleef & Arpels.

For Fossil Group, the fact that so much of their revenue was and is based on analogue watch sales likely caused a great deal of their financial trouble. While they have begun to branch out into smartwatches, the majority of the real estate on their Fossil.com website continues to be dedicated to celebrating and advertising traditional analogue watches. If the company is to turn the corner, they will likely have to move more strongly into tech that younger people are interested in. They could then shift their traditional analogue watch sales focus to areas that are most lucrative like China.

(Source: Fossil.com)

Hope For A Better Future

While I do not think the corner has yet been turned, there are some excellent green shoots beginning to be seen breaking through the surface of the company's balance sheet. Spring could be coming.

First and foremost, the company is taking big steps to reduce costs and improve margins. According to the 2019 Annual Report, they recently completed the New Fossil World 1.0 program. This was a three-year initiative that:

delivered $200 million of run-rate improvement across gross margin and operating expenses

They are also proceeding with their new initiative dubbed New Fossil World 2.0 - Transform To Grow. This program is designed to continue where NFW 1.0 left off. As described in the Annual Report:

Our New World Fossil 2.0 - Transform to Grow program, which is designed to drive operational efficiency and improve profitability, while also providing us with the ability to invest in new growth opportunities. In 2019, we captured total benefits of $50 million, primarily through operating expense reductions, which puts us on track to achieve gross margin benefits and operating expense reductions totaling $200 million by 2021.

These are excellent steps toward a return to improving sales and eventual profitability, and they may be yielding some results. According to their First Quarter 2020 Earnings report, the first quarter was yielding higher global sales (1% over the comparable quarter in 2019) before COVID-19-related store closings.

(Source: Fossil.com) Hybrid Smartwatch and Analogue Watch

As mentioned above, the company is also expanding into smartwatches and smartwatch hybrids. These watches are compatible with Apple and Google phones and come in a variety of styles. Management states that these designs have met with a positive response from consumers. They also state that their new strategy of an:

accelerated product drop strategy, combined with a digital first marketing approach drove more consumer engagement than ever before.

The company seems to recognize that they fell behind in the digital revolution. This is true both with their products, that only now are really diving into the smartwatches that are demanded by younger consumers, but also with their failure to roll out an effective Direct To Consumer, Web/Digital marketing strategy. So many of the companies that are successfully navigating the changing world of retail are doing so because they have found synergistic ways to link their digital and retail location marketing and sales efforts. It appears that Fossil had not previously managed to make this transition to a hybrid approach. However, the CEO appears to have seen the light, and he states that a priority going forward will be:

driving commercial transformation. The consumer is increasingly gravitating to all things digital, and we're moving quickly to improve our digital capabilities across the company. The implementation of our new eCommerce platform is in process now and will bring us a robust set of tools to support a larger direct to consumer business in the coming years.

If the company is to turn their corporate ship around, this is an absolute must. While they are definitely late to the transition, a late start is better than no start at all. They are beginning to make this crucial change, and that could help a global sales a great deal in the years to come. According to their statements in the Q1 2020 Earnings press release, their new eCommerce platforms have allowed them to meet the significant demand increase for web-based sales that resulted from COVID-19 store shutdowns.

(Source: Fossil.com)

Another key development from CEO Kosta Karatsotis' letter to shareholders, in the annual report, is their strategy in relation to Asia. He states that a key priority for the business going forward will be to

expand on our opportunities in China and India, where the emerging middle class has a strong affinity for our categories and brands. We've had great success with our localized marketing and segmented assortment approach, and we see even more runway to accelerate growth in these markets going forward.

This may be the most important business decision they are making. China is far and away the largest consumers of watches in the world. In 2020 they are expected to purchase more than $68 million in watches. That number does not even include consumption in Hong Kong. The US is a distant second with a little over $8 million in expected watch sales. This is followed by India at number three, with $4.4 million in expected sales. A move to focus on China and India is crucial. India is likely a few years behind China in the development of their middle class. Like has happened in China, as India's middle class grows, their consumption will explode. Focusing on China is likely to dramatically increase sales in the near term, while India is likely to fuel longer term growth. As long as watches are fueling corporate sales, then Fossil Group needs to have a big presence in the parts of the world fueling watch demand. The chart below illustrates the point.

(Source: Statista.com) Expected Global Watch Demand For 2020

A factor that may be harder to quantify but could prove key is employee morale and loyalty. According to the statements regarding the corporate moves regarding COVID-19, the company planned to continue to pay team members through the shutdown and to provide flexible work scenarios to ensure the safety of essential workers, unable to work from home.

While they do not go into any detail about how payment and compensation computations would work, this could prove important to maintaining dedicated employees who are willing to do all they can to help the company succeed. In such difficult economic times, where as many as 40 million Americans are out of work, Fossil Groups' efforts to support their employees during a shutdown is likely to engender feelings of loyalty in their staff. As they begin to reopen stores, with the hopes of being fully open by the end of June, this dedication to their people could very well result in employees whom are excited to return to work, and willing to do all they can to help the company that helped support them in difficult times. While almost impossible to measure, this could be a crucial ingredient in helping the company to navigate the business storm they have found themselves in over the past few years. Motivated and happy employees are far more effective with customers, and that drives sales.

Conclusion

Fossil has been in a deteriorating shape for many years. This company whose flagship brand was once very well-liked has seen its fortunes fade. This has been shown in the financials in the last 6 years.

The positive news is that the company is beginning to take major steps that could result in a turnaround. They are reducing expenses, expanding product lines into smart technology, investing in eCommerce, expanding into the most profitable areas (for their primary product) in the world, and supporting their employees through a difficult time.

All of this is fantastic. However, until these steps provide evidence of improvement in sales and earnings, I do not believe it is wise to invest in the possible turnaround. Until there is evidence, it is just hope. And while the small improvement in the pre-COVID-19 sales of the first quarter is a start, it is not enough.

I would recommend waiting for two quarters of improving sales and earnings before making an investment. Assuming that the second quarter is as bad as management believes it will be, this would mean that an investment may be possible after positive quarterly results for the third and fourth quarters. It will be hard to compare numbers to the 2019 results, as COVID-19 is likely to skew 2020 results downward. As such, I would look to see third quarter results that are better than the first quarter, and then fourth quarter results that are better than that.

I believe this company is making some very good moves. The stock is incredibly low-priced ($5.25 as of this writing), but that doesn't necessarily mean cheap. If the company fails, an investment at that price was money wasted. I know it's tempting, but until there is evidence of improvement it is just not safe to invest.

I plan to keep an eye on the company going forward. It may become a great turnaround play in the future. Yes, that may mean buying at a higher price, but with a clearer financial outlook and a safer path forward. Until the evidence shows the turnaround is succeeding, any investment is likely to be too costly.

Good Luck and Good Investing

Price Target

Not enough information for me to predict currently.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.