Fossil, Inc. (FOSL) is an international retailer and wholesaler of watches (71%), leathers (17.7%) and jewelry (6.6%). The company is made up of four segments: North America wholesale (38.2%), Europe wholesale (25.9%), Asia Pacific wholesale (13%) and Direct to consumer (22.9%). The Direct to consumer segment includes company-owned retail stores, e-commerce sales and catalog activities. Data for this article is sourced from the most recent quarterly report and earnings conference call.
Strengths
A Google (GOOG) Insights search for "watch" yields Fossil #4 and #5 in the results. Fossil has built a brand for the ages, behind only Rolex, and that brand power is a tool that can be used to leverage sales of accessories, clothing and handbags.
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The Michael Kors (KORS) brand was a significant contributor to the rise in sales the past quarter and is at the top of the rising searches for Google Insights. If it weren't for the almost $25M increase in Michael Kors brand watch sales, Fossil's quarterly results would have been even worse.
Overall, Q1 2012 net sales increased 11.1%, or $59.8M, compared to Q1 2011. Watches made up $50.9M of this increase.
Watches | $ change to prior year Q |
Michael Kors | 24.6M |
Marc Jacobs | 6.6M |
Fossil | 5.2M |
Weaknesses
Europe.
As Kosta mentioned, we saw strong a double-digit growth in markets like the U.K. and France. And obviously, Scandinavia still increasing nicely for us, but on a much smaller base of business. Italy and Spain have turned seriously negative (see map below). We're talking double-digit declines there. And Italy itself has been rather bumpy over the last 3 quarters. If you recall, we saw a pretty sharp decline in Q3. We were able to recover some of that in Q4 last year and now we're back down in those sharp decline. What's going on in terms of the macro environments in Italy and in Spain are probably as much do with the cadence in our business now as anything else. Germany, we saw soften as we mentioned. And again, this is something that kind of progressed through the end of the quarter, I would say for the first 2 months of the quarter. We were coming through nicely in terms of our expectations, and then we saw most of that deterioration occur in the third month of the quarter, which is obviously a 5-week month and more impactful anyway. But I would say it kind of progress towards the end of the quarter when we saw the change.
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The eyewear and jewelry segments, though a small portion of sales, experienced declines in Q/Q growth compared to last year. FOSL was once trading at multiples in the high 20s, which seems unsustainable when the watch segment is growing at less than a 14% clip. The eyewear and jewelry business' small but negative growth, even when compared with successful previous quarters, is not part of the makeup of a 25+ multiple stock.
Item | % change to prior year Q | $ change to prior year Q |
Watches | 13.7% | 50.9M |
Leather goods | 15.8% | 14.3M |
Eyewear | -25.6% | -4.6M |
Jewelry | -4.8% | -2M |
Opportunities
The Michael Kors brand has saved Fossil's licensed watch business, but in order to grow Fossil must continue to add brands to their portfolio. In Q1 2013 the company plans to introduce a line based on this man…
His name is Karl Lagerfeld. This is some German guy my wife and many of her fashion forward friends - except for one, have never heard of, but I guess he is really big over there. Anyway, betting on FOSL at these prices assumes the successful launch of watches associated with this guy. I'm not sure I can sleep peacefully knowing this guy represents any portion of my portfolio.
Fossil recently purchased a Danish company called Skagen. There are supposed synergies and they sell products at similar margins. This will give the company more exposure in Northern Europe and will give them a new line to promote.
Turning to guidance for the balance of 2012. For the second quarter, we expect reported net sales to increase around 16%, with constant dollar net sales increasing 19%. Net sales of Skagen included in this estimate are expected to benefit overall sales growth by 6% during the quarter.
Mike, I think we're, as Kosta mentioned, excluding Skagen, we're guiding toward low to mid- single-digit increases for the balance of the year in Europe.
Threats
The company does not expect sales to be any good in Q1 and rising inventories are a concern.
Inventory at the end of the first quarter was $512 million, representing an increase of 27.2% in comparison to last year's Q1 balance of $403 million. This increase is primarily related to the shortfall of expected sales for the first quarter and increased levels of watch component inventories.
If you look at the Google Insights search results above you will notice that Singapore and India are situated at the top of the list. The map below shows virtually no representation for Fossil in these countries. Is there too much focus on Northern Europe with the Skagen acquisition and Germany with the new Karl Lagerfeld line instead of looking to the Far East for growth?
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$80.25 Target Price End 2012
This price target takes into account the recent drop in Q/Q sales growth and assumes low single-digit growth for sales in Europe. If Europe were to deteriorate further, then a worst case scenario price target would be around $64 per share. We are assuming that China will continue to grow at 15%+ throughout the year and leather goods will continue to grow in the teens. The company's estimated EPS for 2012 is $5.30 - $5.40 per share and we assigned an earnings multiple of 15x to arrive at our price target. See the chart for FOSL's P/E over time below, courtesy of ycharts.com.
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Technical Analysis
Looking at the daily chart, the most obvious characteristic is the huge breakaway gap that was formed on May 8 after Fossil released disappointing Q1 sales and spoke of growing concerns in Europe. This gap will be significant, as we believe its endpoint of $93.60 will serve as a tough resistance level that won't be breached for some time. In the meantime, oversold momentum indicators seem primed to rebound, so some retracement of the current move should be expected as the market digests a new reality for FOSL going forward. We view the $80 mark as the first "sticking point" FOSL may encounter in its bid to find a new higher level.
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The longer term weekly chart shows price reacting off of the low of $69.57, which is the exact low made during the second week of August 2011. With previous activity in this area, we feel confident that current conditions will allow this price to serve as a stern level of support. With the moving averages overhead and the current fundamental challenges, a longer term range between $80 and $100 is likely depending on market direction.
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Conclusion
Although shares are off almost 50% from their recent high we believe Fossil shares to be fairly valued. Fundamentally we believe that $80.25 is a reasonable price given the current conditions in Europe. Technically we see likely activity between $70 - 80 in the short term, with longer term upside to around $100. A combined picture supports our $80.25 target for the end of 2012.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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