Fossil Group: Beware Of The Red Flags (NASDAQ:FOSL)

The inventory of Fossil Group (NASDAQ:FOSL) has dramatically underperformed the broad market in virtually any time horizon one can think about. To make sure, the inventory has plunged 53% during the last 12 months whereas the S&P 500 has rallied 19% throughout this interval. Even worse, Fossil has slumped 98% during the last decade and thus it’s now buying and selling close to a historic low. The collapse of Fossil is prone to lead some discount hunters to view the inventory as engaging from a long-term perspective. Nevertheless, buyers ought to pay attention to the pink flags of the inventory earlier than buying it.

Enterprise overview

Fossil designs, develops, markets and distributes conventional watches, smartwatches, jewellery, purses and sun shades. Because of the recognition of its conventional watches, the corporate used to generate extreme income prior to now, till 2015, when its enterprise mannequin got here underneath assault. At that time, shoppers started to shift in direction of the smartwatches of Apple (AAPL) and thus Fossil incurred a significant enterprise disruption. Since then, the corporate has been making an attempt to cut back its dependence on watches however nonetheless this class generates 77% of the gross sales of the corporate. Subsequently, buyers shouldn’t buy Fossil except they see promising indicators of a sustained restoration of the gross sales of the watches of the corporate. The acute dependence of the corporate on watches, that are characterised by cut-throat competitors as a result of reputation of the smartwatches of Apple, raises a giant pink flag for Fossil.

The disruption of the enterprise mannequin of Fossil is clear within the enterprise efficiency of the corporate. Its whole revenues have declined virtually yearly during the last decade, for a complete lower of fifty%. As well as, the corporate has did not make a significant revenue for six consecutive years whereas it has incurred hefty losses in three of the final six years. To supply a perspective, Fossil has incurred a loss per share of -$1.24 during the last 12 months. This loss corresponds to 46% of the market capitalization of the inventory and therefore it’s extreme.

Sadly, there are completely no indicators of a possible restoration on the horizon. Within the first quarter, Fossil posted an 11% lower in its gross sales over the prior yr’s quarter resulting from poor demand for its merchandise. Administration boasted of decreasing inventories by 13% however an 11% lower in gross sales amid a drastic discount of inventories is definitely disappointing.

The economies of China and India are recovering strongly from the pandemic and therefore they need to have offered a powerful tailwind to the enterprise of Fossil, as these nations are main shoppers of watches and jewellery. Nevertheless, the optimistic financial tendencies of those two nations weren’t adequate to reignite development within the enterprise of Fossil. The corporate can be dealing with poor client tendencies in Europe, partly resulting from excessive inflation, which has taken its toll on client spending. Administration expects the demand on this area to stay tender for the foreseeable future.

General, regardless of the robust financial restoration of China and India from the pandemic, Fossil noticed its EBITDA worsen from -$1.7 million to -$16.4 million and its loss per share widen from -$0.37 to -$0.61. Even worse, administration stored its outlook for the total yr intact, anticipating an approximate 2% lower in its gross sales and an adjusted working margin of 0%-3%. Such a low working margin raises a pink flag, because it basically alerts that the corporate will most likely incur materials losses (after the deduction of curiosity expense) this yr. It’s also exceptional that Fossil offered steerage for restructuring prices of $25-$30 million this yr. As this quantity is about 20% of the market capitalization of the inventory, it’s undoubtedly extreme and therefore it shouldn’t be undermined by buyers.

One other pink flag comes from the tone of administration all through the most recent convention name. Regardless of the numerous lower in gross sales and the broad losses, administration appeared extremely glad with its efficiency and didn’t present any proof for an imminent restoration. This may increasingly have been a key issue behind the 11% plunge of the inventory on the day after the earnings report. As well as, the main focus of administration on adjusted working revenue as a substitute of earnings per share raises a pink flag, because it basically alerts that the corporate is way from changing into worthwhile.

Lastly, one other pink flag is the tempo of closures of shops. Fossil had 421 shops in operation globally in 2019 nevertheless it now has solely 342 shops. Administration is closing shops to be able to curtail working bills and make the corporate leaner and extra environment friendly. Nevertheless, a 19% lower within the world retailer depend in 4 years doesn’t bode properly for future prospects, because it alerts that the enterprise is shrinking at a quick tempo resulting from a gradual decline within the demand for the merchandise of the corporate.

Share repurchases

The share depend of Fossil has elevated 8% since 2016. Given the extreme losses of the corporate within the final six years and the collapse of the inventory all through this era, some shareholders most likely disagree with the compensation of administration through inventory choices.

Extra importantly, Fossil repurchased its shares aggressively throughout 2012-2015, when its inventory worth was about 30-40 occasions costlier than it’s now. Throughout these years, Fossil spent $1.5 billion on share repurchases and thus it diminished its share depend by 24%. As this quantity is greater than 10 occasions the present market capitalization of the inventory, it’s evident that the corporate utterly destroyed shareholder worth with these share repurchases. If Fossil had retained that money, its inventory worth can be a lot larger now and the shareholders wouldn’t have misplaced 98% of their capital during the last decade. The destruction of shareholder worth through aggressive share repurchases raises a pink flag for the administration of the corporate.

Valuation

Fossil has incurred losses in 5 of the final 6 years. Over the past 12 months, the corporate has posted a loss per share of -$1.24. Consequently, the inventory can’t be evaluated primarily based on its price-to-earnings ratio.

Fossil is at present buying and selling at a price-to-sales ratio of solely 0.09, which is way decrease than the median price-to-sales ratio of 0.88 of the buyer discretionary sector. Nevertheless, you will need to notice that Fossil is buying and selling at a a lot decrease gross sales a number of most likely resulting from its losses. In different phrases, its gross sales don’t generate the income that different firms within the sector get pleasure from. Subsequently, the low price-to-sales ratio of Fossil is considerably deceptive.

The opposite valuation metric that can be utilized for a loss-making firm is the Enterprise Worth / EBITDA ratio. Fossil is at present buying and selling at an EV/EBITDA ratio of 41.2, which is way larger than the median EV/EBITDA ratio of 10.9 of the sector. Subsequently, regardless of its almost all-time low inventory worth, Fossil seems richly valued when in comparison with its EBITDA. On account of its wealthy valuation and all of the aforementioned pink flags, buyers ought to most likely keep away from the inventory, which is very speculative.

Closing ideas

Fossil has slumped 98% during the last decade and thus it’s now buying and selling close to a historic low. On account of its depressed worth, the inventory may supply outsized returns at any time when its enterprise prospects enhance. Nevertheless, the corporate has unreliable enterprise efficiency, as it’s affected by a persistent decline within the demand for its watches. The huge underperformance of Fossil vs. the S&P 500 during the last decade (-98% vs. +166%) is a testomony to the extreme danger of the inventory. Subsequently, buyers ought to most likely keep away from Fossil, as its potential returns in a state of affairs of a turnaround don’t compensate buyers for the elevated danger of the inventory.