Summary
- Watchmaker and marketer Fossil has seen an uptick in the past week, but going by its weak past history, can it sustain?
- It's been impacted by the current macroeconomic situation, as evident in its low growth, especially from Asia and operating losses.
- Yet, its P/E ratio exceeds that for the consumer discretionary sector, indicating that more correction could be due.
Watchmaker and marketer Fossil Group (FOSL) has gained some 9% in the past week, far exceeding the 5.3% gains for the S&P 500 ( SP500 ). In fact, it hasn’t lost value in the past month, marking a break from its poor performance at the stock markets in the past year and even over the longer term. Could this imply a genuine turnaround for the long-beleaguered stock? As a consumer discretionary company, it’s subject to macroeconomic vagaries, which are dominating companies' performance right now. This analysis explores FOSL from the perspective of these very challenges to determine what’s next for it.
Macro assessment
So far, the macro assessment framework I’ve applied has focused on three big challenges - low growth, high inflation and rising interest rates. Here, I introduce the fourth challenge of exchange rates. The US dollar has been strong, touching parity levels against the EUR earlier this year. As a result, overseas revenues for US-based companies have been impacted negatively. In some cases, even changing the story in terms of whether revenues from foreign markets are growing or not.
Drag from exchange rate translation and weak demand
Consider the present case. In the second quarter of 2022 (Q2 2022), its revenue fell by 5% year-on-year (YoY) at constant exchange rates ((CER)) indicating a real weakening in demand. It showed some growth in the first half of the year (H1 2022) but it was still low compared to a substantial 14% for 2021. Clearly, it’s impacted by the slowdown. But here’s the rub. Because of the exchange rate effect, in Q2 2022 its revenue at market exchange rate ((MER)) fell by a bigger 9.7%. Further, it showed a 3.5% decline in H1 2022 at MER. This means, that the fall has been exaggerated because of a stronger dollar. In contrast, the exchange rate had actually strengthened results in 2021 , when revenue grew by almost 16% at MER. The point though, remains, that FOSL’s growth has been impacted.
Mixed inflation impact
Inflation’s impact on the company is mixed. Its gross profit margin remains strong at 51.5% in Q2 2022, which is back up after falling in Q1 2022. However, FOSL fell into operating losses this year because of higher compensation costs and increases in its investments in digitalisation. The latter isn’t bad, in that its e-commerce sales can benefit (if that’s what it means), and even potentially raise future growth. But the story, for now, is disappointing.
Debt ratios strong
This brings me to its interest coverage ratio. The interest expense has actually declined YoY but where there is no EBIT, there’s no cover, which is a challenging situation for a company. Its debt-to-equity ratio has also risen to 1.2x in Q2 2022 from 0.8x in 2021, which isn’t ideal but it’s far from being the worst. I’d watch it though. However, the company’s current and debt-to-assets ratios look good at 2.3x and 0.4x respectively. Overall, if FOSL could go back to generating operating profits, its debt picture would immediately look better.
Reduced guidance
It remains to be seen whether that can be achieved for now, however. In its latest results, the company has reduced its guidance for adjusted operating margin to 2-4% for this year, down from 5.5-6% earlier. It also expects revenue to decline between 4-8% compared to an increase of 3% expected earlier. FOSL attributes the downward revision to slower consumer spending, lockdowns in China and foreign currency translation. Still, if it’s able to achieve the target results and assuming that the ratio of reported EBIT to adjusted EBIT stays constant at 0.75x, it could still wind up with a year-end operating income of around USD 40 million. It would be a pretty dramatic fall of over 57% but even that’s better than the loss it has clocked up to H1 2022.
Despite this bleak performance expected for this year, 2023 could still be better if its Asia demand were growing. That’s not the case either. The market, which accounts for 24% of its total sales, has seen a decline so far this year of course, but even in 2021, it showed just 4.8% growth which probably isn’t enough to pull revenues up considering a slowdown is expected next year in its big markets of the Americas and Europe. And if the drag from the exchange rate persists, things could get even worse. It's also worth noting that Fossil's revenues were falling for years anyway, save the last year.
More correction possible
Yet, its stock is trading at a price-to-earnings (P/E) ratio of 19.4x compared to a 12.4x figure for the consumer discretionary sector as a whole. Its other market multiples l ook more attractive but keeping the company’s challenges in mind, they are probably low for a reason. It doesn’t help that its long-term share price trend also points downward, with a -95% return on capital over the past 10 years.
What next?
In sum, looking at the positives, it hopes to end the year with an operating profit and its debt picture largely looks fine. However, the company’s facing weak demand and its revenues have been shrinking over the past years too. Its gross margins continue to remain strong. It has also reduced its guidance for the current year. And with a slowdown in its biggest markets expected next year, it’s hard to be positive on FOSL. Its high P/E also suggests that there could be a further correction in its share price. If I had bought the stock, I’d take advantage of the current rally and sell.
For further details see:
Fossil Group Stock: Cut Your Losses