2023-07-18 03:01:35 ET
Summary
- Fossil Group stock has significantly underperformed the broad market, slumping 98% over the last decade and trading near a historic low due to a shift in consumer preference towards smartwatches.
- Despite the strong economic recovery in China and India, FOSL's revenues have consistently declined, with the company failing to make a meaningful profit for six consecutive years and incurring heavy losses.
- Fossil's management has not provided evidence of an imminent recovery, and aggressive share repurchases during 2012-2015 have destroyed shareholder value, raising red flags for potential investors.
The stock of Fossil Group ( FOSL ) has dramatically underperformed the broad market in almost any time horizon one can consider. To be sure, the stock has plunged 53% over the last 12 months whereas the S&P 500 has rallied 19% during this period. Even worse, Fossil has slumped 98% over the last decade and thus it is now trading near a historic low. The collapse of Fossil is likely to lead some bargain hunters to view the stock as attractive from a long-term perspective. However, investors should be aware of the red flags of the stock before purchasing it.
Business overview
Fossil designs, develops, markets and distributes traditional watches, smartwatches, jewelry, handbags and sunglasses. Thanks to the popularity of its traditional watches, the company used to generate excessive profits in the past, until 2015, when its business model came under attack. At that point, consumers began to shift towards the smartwatches of Apple ( AAPL ) and thus Fossil incurred a major business disruption. Since then, the company has been trying to reduce its dependence on watches but still this category generates 77% of the sales of the company. Therefore, investors should not purchase Fossil unless they see promising signs of a sustained recovery of the sales of the watches of the company. The extreme dependence of the company on watches, which are characterized by cut-throat competition due to the popularity of the smartwatches of Apple, raises a big red flag for Fossil.
The disruption of the business model of Fossil is evident in the business performance of the company. Its total revenues have declined almost every year over the last decade, for a total decrease of 50% . In addition, the company has failed to make a meaningful profit for six consecutive years while it has incurred hefty losses in three of the last six years. To provide a perspective, Fossil has incurred a loss per share of -$1.24 over the last 12 months. This loss corresponds to 46% of the market capitalization of the stock and hence it is excessive.
Unfortunately, there are absolutely no signs of a potential recovery on the horizon. In the first quarter, Fossil posted an 11% decrease in its sales over the prior year's quarter due to poor demand for its products. Management boasted of reducing inventories by 13% but an 11% decrease in sales amid a drastic reduction of inventories is certainly disappointing.
The economies of China and India are recovering strongly from the pandemic and hence they should have provided a strong tailwind to the business of Fossil, as these countries are major consumers of watches and jewelry. However, the positive economic trends of these two countries were not sufficient to reignite growth in the business of Fossil. The company is also facing poor consumer trends in Europe, partly due to high inflation, which has taken its toll on consumer spending. Management expects the demand in this region to remain soft for the foreseeable future.
Overall, despite the strong economic recovery of China and India from the pandemic, Fossil saw 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, management kept its outlook for the full year intact, expecting an approximate 2% decrease in its sales and an adjusted operating margin of 0%-3%. Such a low operating margin raises a red flag, as it essentially signals that the company will probably incur material losses (after the deduction of interest expense) this year. It is also remarkable that Fossil provided guidance for restructuring costs of $25-$30 million this year. As this amount is about 20% of the market capitalization of the stock, it is undoubtedly excessive and hence it should not be undermined by investors.
Another red flag comes from the tone of management throughout the latest conference call . Despite the significant decrease in sales and the wide losses, management seemed highly satisfied with its performance and did not provide any evidence for an imminent recovery. This may have been a key factor behind the 11% plunge of the stock on the day after the earnings report. In addition, the focus of management on adjusted operating income instead of earnings per share raises a red flag, as it essentially signals that the company is far from becoming profitable.
Finally, another red flag is the pace of closures of stores. Fossil had 421 stores in operation globally in 2019 but it now has only 342 stores. Management is closing stores in order to curtail operating expenses and make the company leaner and more efficient. However, a 19% decrease in the global store count in four years does not bode well for future prospects, as it signals that the business is shrinking at a fast pace due to a steady decline in the demand for the products of the company.
Share repurchases
The share count of Fossil has increased 8% since 2016. Given the excessive losses of the company in the last six years and the collapse of the stock throughout this period, some shareholders probably disagree with the compensation of management via stock options.
More importantly, Fossil repurchased its shares aggressively during 2012-2015, when its stock price was about 30-40 times more expensive than it is now. During those years, Fossil spent $1.5 billion on share repurchases and thus it reduced its share count by 24%. As this amount is more than 10 times the current market capitalization of the stock, it is evident that the company completely destroyed shareholder value with those share repurchases. If Fossil had retained that cash, its stock price would be much higher now and the shareholders would not have lost 98% of their capital over the last decade. The destruction of shareholder value via aggressive share repurchases raises a red flag for the management of the company.
Valuation
Fossil has incurred losses in 5 of the last 6 years. During the last 12 months, the company has posted a loss per share of -$1.24. As a result, the stock cannot be evaluated based on its price-to-earnings ratio.
Fossil is currently trading at a price-to-sales ratio of only 0.09 , which is much lower than the median price-to-sales ratio of 0.88 of the consumer discretionary sector. However, it is important to realize that Fossil is trading at a much lower sales multiple probably due to its losses. In other words, its sales do not generate the profits that other companies in the sector enjoy. Therefore, the low price-to-sales ratio of Fossil is somewhat misleading.
The other valuation metric that can be used for a loss-making company is the Enterprise Value / EBITDA ratio. Fossil is currently trading at an EV/EBITDA ratio of 41.2 , which is much higher than the median EV/EBITDA ratio of 10.9 of the sector. Therefore, despite its nearly all-time low stock price, Fossil appears richly valued when compared to its EBITDA. Due to its rich valuation and all the aforementioned red flags, investors should probably avoid the stock, which is highly speculative.
Final thoughts
Fossil has slumped 98% over the last decade and thus it is now trading near a historic low. Due to its depressed price, the stock could offer outsized returns whenever its business prospects improve. However, the company has unreliable business performance, as it is suffering from a persistent decline in the demand for its watches. The vast underperformance of Fossil vs. the S&P 500 over the last decade (-98% vs. +166%) is a testament to the excessive risk of the stock. Therefore, investors should probably avoid Fossil, as its potential returns in a scenario of a turnaround do not compensate investors for the elevated risk of the stock.
For further details see:
Fossil Group: Beware Of The Red Flags