It’s a fine company with a once-impressive string of earnings reports; earnings that not only grew, but grew consistently. And, its watches look good, too!
Fossil Group, Inc. (FOSL, Financial) has fallen on harder times lately, most recently in February 2015 when it warned earnings for this year and next year would fail to match the level of those in 2014. To make the future even more interesting, Apple (AAPL, Financial) has finally brought out its Watch, which some say could be a category killer (although they’ve been vague on which category).
So we have to ask, is this a company that can regain its stride and get back to heady earnings growth, or have the springs in this metaphorical watch lost their bounce?
Here’s a look at that history, first using annual data for the share price (in green) and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization in blue):
Now let’s look at that same 10-year history using quarterly data (again share price in green and EBITDA in blue):
History
1984: Based on a suggestion from his brother Kosta, Tom Kartsotis of Dallas, Texas, forms a company called Overseas Products International, which imports fashion watches with a retro look.
1990: The line expands with the addition of Fossil-branded leather goods and the Relic watch line.
1993: An Initial Public Offering brings in $19 million.
2001: Acquires Zodiac, a Swiss watch brand, from Genender International.
2003: Introduces Fossil Wrist PDA, which ran on Palm OS.
2004: Buys Michele Watch, another Swiss brand.
2007: Financial Innovations Systems, LLC accuses Fossil of infringing a patent; the case is settled out of court.
2007: Buys The Watch Station International chain.
2012: Acquires Skagen Designs, another watch brand.
2013: Introduces the Fossil Swiss line, which is manufactured in Switzerland.
History based on information from Wikipedia.org and FundingUniverse.com
Comments: A company that’s grown very big in a fairly short time, through development of its own product lines and the acquisition of brands, products, and facilities.
Fossil’s business
Fossil Group is in the consumer fashion accessories business, More specifically, it designs, manufactures, markets and distributes fashion watches for women and men, as well as jewelry, handbags, small leather goods, belts, sunglasses, soft accessories and what it calls "select apparel." It might also be thought of as a brand manager, as it promotes and extends them.
It sells these products to a broad range of consumers, both in the U.S. and internationally. It notes, in its 10-K for 2014 (the fiscal year that ended January 3, 2015), “Based on our extensive range of accessory products, brands, distribution channels and price points, we are able to target style-conscious consumers across a wide age spectrum on a global basis.”
Price points start at $7 in the mass market channel and go up to $4,990 in the luxury distribution channel; the majority of its products range from $85 to $600.
American distribution involves department stores, specialty retailers, watch and jewelry stores, company-owned retail and outlet stores, mass market stores and its ecommerce website. International distribution includes retailers in some 150 countries worldwide, through 25 company-owned foreign sales subsidiaries and a network of more than 60 independent distributors.
Segments
The company divides its operations and financial reporting into four segments:
- North America wholesale segment
- European wholesale segment
- Asia Pacific wholesale segment
- Direct to consumer (includes company-owned retail stores and ecommerce activities).
Revenue sources
As the following table from the 10-K for 2014 shows, the company depends on watches for more than three-quarters of its revenue:
And this table shows the origins of revenue by segments/geographic regions:
Like many other retailers, FOSL experiences seasonality in its sales; relatively slow first and second quarters, with big third and fourth quarters because of Back to School and Christmas.
Here are revenues for the four quarters of 2014:
- March: $777 million
- June: $774 million
- September: $894 million
- December: $1,065 million
Competitors
Fossil Group lists its main competition for watches, its most important product line, as the companies that produce the Anne Klein II, Guess? (GES, Financial), Kenneth Cole and Swatch labels. For fashion accessories, the main competitors its lists are Coach (COH, Financial), Guess?, Kenneth Cole, Liz Claiborne and Nine West.
In its 10-K, it reports, “We differentiate our products from those of our competitors principally through innovations in fashion details, including variations in both the materials and treatments used for dials, crystals, cases, straps and bracelets for our watches, and innovative treatments and details in our other accessories.”
Since the debut of the Apple Watch, some observers have questioned the future viability of other watch companies; however, in our opinion, consumers buy Fossil products for the fashion statement they make, rather than the time of day.
Yahoo! Finance lists FOSL’s main competitors as Guess? Inc., LVMH Moët Hennessy Louis Vuitton SA (private) and The Swatch Group SA (private). It also shows FOSL with a much larger market cap than GES, $4.30 billion and $1.62 billion respectively. It lists their industry as Textile - Apparel Footwear & Accessories.
GuruFocus compares Fossil Group with Nike Inc (NKE, Financial), Adidas AG (ADDYY, Financial), Belle International Holdings Ltd (BELLY, Financial), Yue Yuen Industrial holdings (YUEIY, Financial) and Daphne International Holdings Ltd (DPNEY, Financial).
Other
Incorporated in Delaware, headquartered in Richardson, Texas.
Listed on the NASDAQ Global Select Market.
15,200 employees, including about 7,500 employed outside the U.S., as of January 3, 2015.
Comments: Fossil Group is a fashion company, focusing mainly on watches in the middle price range. Its competitive advantage lies in its ability to design products, including watches, that meet the fashion preferences of a broad group of consumers.
Opportunities, risks and growth
Opportunities (10-K)
The company sees further development of the Fossil line, and more specifically innovation and global awareness, “Realizing the full potential of this vintage American lifestyle brand is a key element of our long-term growth strategy.”
It also has high expectations for the recently acquired Skagen business; it plans to grow it into a multicategory lifestyle brand through the Fossil Group infrastructure.
Fossil sees its collection of watch brands as a portfolio and a tool that can help it gain market share, with synergies in design and innovation as well as leveraging the strengths of its existing supply chain and global distribution network.
Existing global distribution is also considered a strategic lever, giving it opportunities to gain market share through widening of existing brand awareness, broadening of merchandise lines and other measures.
Increasing efficiencies by leveraging its existing infrastructure, which involves such tactics as adding new brands to existing retail outlets.
Risks (10-K)
The global economic situation, and in particular, consumer confidence and spending matter to this company; any decline could materially affect the financial results.
Fashion, as we know, is a fickle thing, and this company has staked its future on staying ahead of, or at least keeping up with, consumer tastes. Failure to do so could leave the company gasping for financial oxygen.
Sales of licensed goods made up more than 53% of consolidated net sales in 2014; sales of Michael Kors products alone accounted for more than 26%. These licenses require regular renewals, and failure to get them could hurt the bottom line.
Manufacturing and sales of some products could be compromised because key components in some of its products come from limited sources of supply. One such interruption occurred with the Japanese earthquakes of 2011; in addition, limited supplies mean less power to negotiate prices.
As noted above, the Apple watch is not an immediate threat to Fossil, but the company is, nevertheless, watching this new category, “Wearable technology is an emerging category of fashion that offers customers new functionality with accessories, including jewelry and smart watches.” See Wearable Devices Market Makes Himax Technologies A Good Value for more on this subject.
Growth
Here’s how Fossil Group has grown its revenue (green line) and Earnings Per Share (blue line) over the past 20 years:
While that’s an admirable chart, the immediate future looks less rosy, according to analyst estimates and the company’s own guidance.
On February 17, 2015, the company dashed the Street’s earnings expectations –Â around $7.50 –Â with guidance of $5.45 to $6.05. In its Fourth Quarter and Fiscal 2014 Results news release, Fossil said, “For fiscal 2015, the company expects that its results will be significantly negatively impacted by foreign currency changes as well as restructuring charges.” That compares with $6.56 for fiscal 2013 and $7.10 for fiscal 2014.
Analysts followed by Yahoo! Finance now estimate fiscal 2015 earnings at $5.70 and fiscal 2016 earnings at $6.53.
As outlined in the Opportunities section above, FOSL does have many areas where it can grow, through both organic initiatives and acquisitions.
Comments: Fossil Group shocked investors and analysts alike, by pulling back hard on guidance for 2015. Based on what the analysts now forecast, it will take at least a couple of years for earnings to get back to the 2014 level, and if the stock price follows earnings, then long investors will be in for a long wait.
Management
Chairman of the Board and Chief Executive Officer: Kosta Kartsotis, age 61, CEO since 2000 and chairman of the board since 2010. Kartsotis joined the company in 1988 and has been a director since 1990.
Chief Financial Officer, Executive Vice President, Treasurer of Fossil Group, Inc.: Dennis R. Secor, age 51, has held the position since 2012. Previously, CFO Secor served at Guess?, Inc., a Fossil competitor, and at Canada's Electronic Arts, Inc.  (EA, Financial), a video game developer.
Board of Directors: three related directors, including Kartsotis, and eight independent directors with connections to retailing, banking, technology, IT management, real estate and investment management and finance.
ISS Governance QuickScore: 8, a relatively poor rating on this index: “A decile score of 1 indicates lower governance risk,while a 10 indicates higher governance risk.” FOSL receives red flags for: Board Policies, Meeting and Voting Related Issues, Use of Equity and Equity Risk Mitigation; it also receives one green star for Other Issues.
This section is based on information published at Reuters.com.
Comments: The CEO and chairman is the brother of the company founder; his retail experience produced the idea that led to Tom Kartsotis founding Fossil in 1984. Presumably, he has the experience and expertise to lead the company through its current malaise; in addition he has the support of what appears to be a well-diversified board.
Ownership
Gurus: Only three of the investors followed by GuruFocus have holdings in Fossil Group: Ruane Cunniff (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio), and Ron Baron (Trades, Portfolio); the biggest holding is Baron’s at 600,000 shares.
Institutional Investors: While the Gurus may not hold many shares, other institutional investors certainly do; as nasdaq.com reports, more than 95% of FOSL belong to them:
Short Interests: GuruFocus puts the current short interest at 17.84%, and provides this chart, which shows the shorts are increasingly interested:
Insiders: We also see a hefty holding by insiders, mainly the founder Tom Kartsotis and his brother Kosta, the current CEO and chairman. This GuruFocus chart shows they hold a bit over 19% of the 21% held by insiders:
Comments: Something of an unusual pattern, with hefty ownership by institutional investors and insiders. From a retail investors’ perspective, the continued ownership of the Kartsotis brothers will be reassuring, although it also gives them a lot of influence over board decisions. And we can’t help but wonder about the growing number of shorts.
FOSL by the numbers
Comments: The share price sits near its 52-week low; it boasts Return on Equity of 37.55% for 2014, and an average ROE of 30.37% over the past five years; it pays no dividends; and it bought back 6.63% of its shares last year (an average buyback of 5.27% per year over the past five years).
Financial strength
As we can see in the table below, the GuruFocus automated system gives FOSL a rating of 8/10 for both Financial Strength and Profitability and Growth:
Following up with some investigations of our own, let’s start with a look at the company’s debt history:
Before 2012, the company carried only a few million dollars' worth of long-term debt. By the end of 2012, that had jumped to $75 million; by the end of 2013 it reached $495 million, and at the end of 2014 stood at $614 million.
Free cash flow has also gone up but not as dramatically as long-term debt:
Still, the company remains on solid ground. Looking further down the table, we see interest coverage of 35.64 (this means the company has enough operating income, EBIT, to pay its interest expenses more than 35 times over).
The GuruFocus system also warns of Fossil’s Equity-to-Asset ratio, which, while still reasonable, has been declining (the red line shows the long-term trend):
The company has this to say of its financial situation in its 10-K for 2014:Â “At the end of the fiscal year 2014, we had working capital of $1.0 billion compared to working capital of $987.6 million at the end of the prior fiscal year. Additionally, we had approximately $16.6 million of outstanding short-term borrowings and $613.7 million in long-term debt.” It also notes, “During fiscal year 2014, we repaid $15.6 million on the Term Loan and had no additional borrowings. The average interest rate during fiscal year 2014 for borrowings under the Term Loan including the impact of the interest rate swap was 2.5%.”
Comments: While long-term debt has certainly gone up, and gone up faster than free cash flow, Fossil Group still has more than enough financial muscle to handle this low-cost debt. If the long-anticipated interest rate hikes really do arrive, investors will likely be less comfortable.
Valuation
FOSL appears on the Undervalued Predictable screener at GuruFocus because of the relatively high consistency of its earnings growth and because its current price lags intrinsic value, based on Discounted Earnings. It is also close to making the Buffett-Munger screener, with a 4-Star rating and a PEG ratio of .46 (indicating it is undervalued).
The following chart shows us how earnings have grown and how the relationship between share price and earnings per share has unraveled over the past few years:
Over the past three years we get a better sense of where prices are going by looking at EBITDA rather than EPS. The following chart shows quarterly EBITDA (blue line) and share prices (green line).
Note the disconnect that emerged early this year, when the company issued guidance indicating it expected EPS to decline from $7.05 (fiscal 2014) to something between $5.45 and $6.05 for this fiscal year.
Over the past five years, its Return on Equity (ROE) has averaged an impressive 30.37% per year.
And, also over the past five years, share buybacks have averaged more than five and a quarter percent per year.
Comments: Fossil shares may be undervalued, and fairly so, at the moment because of headwinds from foreign currency changes and restructuring costs, however we should also keep in mind the company’s history of earnings growth in the past and potential to do so again.
Conclusions
Back to the question: Is this an opportunity to catch a break on the price of Fossil Group stock, or is it a futile attempt to catch a falling knife?
If company and analyst estimates are reasonably accurate, we shouldn’t expect much price growth for Fossil Group shares this year or next year. That said, the company does have a plan to grow organically, through acquisitions, and through operating efficiencies. In addition, it has a seasoned management team with a healthy stake in the company’s fortunes, and strong cash flow that is not needed for dividends.
On balance, it seems likely Fossil will bounce back into favor with investors, but that could take some time and as noted, there is no dividend to collect while you wait.
Perhaps investors might buy after a better-than-expected earnings report (if there is one), when the rest of the investing community takes interest and the large population of shorts dwindles.
