2023-07-18 07:10:46 ET
Summary
- According to the results of the 1st quarter of 2024 (fiscal), the company's revenue decreased by 4% YoY, while the operating loss amounted to 0.2% of revenue.
- The decrease in the share of revenue in the US segment continues to have a negative impact on both the growth rate of revenue and the consolidated level of operating.
- My recommendation is HOLD as I expect pressure on growth and margins to continue in the coming quarters.
Introduction
Guess (GES) shares have fallen 7% YTD. In my first article , I followed a buy recommendation on a company's stock based on an attractive business valuation. Shares rose 23.8%, outperforming the S&P 500, which posted a 20% gain. However, then I changed my view on HOLD in view of the growth of quotes and pressure from macro headwinds on financial indicators. At the moment, I would like to update my view on the company's shares.
Investment thesis
In my personal opinion, right now is still not the best time to go long. First, macro headwinds continue to put negative pressure on consumer spending in the discretionary segment of the US market, thus the traffic in the chain's stores continues to be under pressure. Secondly, management's comments about traffic in the US market in the coming quarters are not encouraging. I believe that consumer spending will recover with a lag to slow inflation in the second half of 2023 (if inflation slows down), as consumers will still face relatively high levels of daily and interest spending. In addition, the US segment is the leader in terms of operating margin, so the decline in business volumes in the US is particularly negative for consolidated business results.
Company overview
Guess designs, distributes and sells contemporary clothing, bags and accessories for men and women. According to the results of the 1st quarter of 2023, the company has 1,631 stores, of which the company manages 1,064 stores directly, and 567 stores are managed by the company's partners. The company operates in the markets of North America, Europe and Asia.
1Q 2024 (fiscal) earnings review
The company's revenue decreased by 4% YoY . In terms of revenue geography, we see the largest decline in Americas Retail and Americas Wholesale, where revenues decreased by 14% YoY and 25% YoY, respectively, due to pressure on consumers from macro headwinds. While in Europe and Asia, revenue increased by 2% YoY and 26% YoY, respectively. You can see the details in the chart below.
Gross profit margin decreased from 41.6% in Q1 2023 (fiscal) to 40.7% in Q1 2023 (fiscal) due to investment in prices and losses due to changes in exchange rates. SGA spending (% of revenue) increased from 35.4% in Q1 2023 (fiscal) to 40.5% in Q1 2023 (fiscal) due to pressure from inflation and the suspension of government subsidies related to COVID.
I also believe that it is necessary to pay attention to operating profitability by geography. So, if we look at Q1 2023 (fiscal), we see that the North American segment of the business is the leader in terms of operating margin of sales. Thus, a decrease in the share of revenue from the Americas Wholesale segment and a decrease in operating margin in the Americas Retail segment makes an increased negative contribution to the operating margin of the entire company.
Operating margin by geography (1Q24 fiscal vs 1Q 23 fiscal) (Company's information)
Thus, operating margin decreased from 6.1% in 1Q 2023 (fiscal) to -0.2% in 1Q 2023 (fiscal). You can see the details in the chart below.
Margin trends (Company's information)
In addition, I would like to point out that the company has slightly raised its revenue and operating margin expectations for 2024 (fiscal).
Outlook (2024) (Company's information)
My expectations
At the moment, I expect pressure on both business growth and operating margins to continue in the coming quarters. Despite the fact that during the Earnings Call following the release of 1Q results, management indicated that it sees room for growth in the Europe and Asia segments, I believe pressure in the US segment will continue to weigh on consolidated results as: 1) At the end of Q1, the American segment accounts for about 34% of total revenue, while the Asian segment is only about 12% 2) Operating margin in the Americas Wholesale segment is at the level of 25.5% at the end of the first quarter, which is significantly ahead of the operating margin profitability in the European and Asian markets, which is about 0.6% and 5.4% respectively.
In my personal opinion, the pressure on business growth in the US segment will continue in the coming quarters, even if we see a slowdown in inflation in the second half of 2023, because, I believe that consumer spending will recover with a delay, as consumers continue to face with relatively high food and housing costs. Below you can see the management's comments on the traffic dynamics in the chain's stores in the US market.
Our American retail business remains challenging. US traffic headwinds persist and customers appear to be very prudent in their spending. We had been expecting to recover some of the markdown pressure that impacted last year, but there is now more risk to that if the current environment persists.
Risks
FX: a strengthening dollar against the euro and Asian currencies could have a negative impact on the growth rate of the European and Asian segment of the business, as the company's revenue is denominated in US dollars.
Competition: a high level of competition in the sector can lead to a decrease in the company's market share and additional investments in prices and marketing, which can have a negative impact on the operating profitability of the business
Revenue: here I would like to point out a general risk, namely high inflation, which has a negative impact on consumer spending in the discretionary segment of the US market. Thus, a decrease in revenue in the North American segment may have an additional negative impact on the overall level of operating profitability, since wholesale sales in the US are the most profitable for the company.
Valuation
Currently, Valuation grade is A-. Under P/E ((FWD)) and EV/EBITDA ((FWD)) multiples, the company trades 53% and 25% lower than the sector median, respectively. However, I don't think it's worth making an investment decision based solely on multiples valuation. In my personal opinion, the stock is trading at a discount due to pressure on business growth and margins. Thus, the discount may be maintained until the company demonstrates an improvement in financial performance.
Conclusion
So, despite the attractive level of valuation in accordance with the multiples, I believe that now is not the best time to go long. I expect the pressure on the company's financial performance to continue in the coming quarters due to weak trading trends in the US market, which is a significant contributor to the consolidated business results. Thus, for the moment, I'm sticking with the HOLD recommendation for the company's shares. I will gladly revise my recommendation when I see signs of improvement in the company's financials in the coming quarters.
For further details see:
Guess: Still Not The Best Time To Go Long