2023-12-07 19:12:31 ET
Summary
- Guess shares have been volatile recently due to a disappointing earnings report and weak guidance.
- The company's revenue growth in Europe is solid, but it is experiencing challenges in the Americas and Asia.
- Guess's brand issues and declining store sales in the Americas are concerning, and the company's outlook is uncertain, given how much guidance has been changing.
- At 8.5x, valuation is too low for shares to be a "sell," but investors should look elsewhere for upside.
Shares of Guess ( GES ) have been a solid performer over the past year, rising about 10%; however, they have been more volatile lately, falling sharply several weeks ago in the wake of a disappointing earnings report. Subsequently, they have recouped some of the losses. While shares are not expensive, weak guidance is cause for caution at a time that many retailers are offering a more optimistic outlook.
In the company’s third quarter , Guess earned $0.49 in adjusted EPS, missing consensus by $0.12, even as revenue rose by 3% from last year to $651 million with 1% constant currency growth. Adjusted earnings rose 11% from last year, aided in part by a reduction in the share count. Adjusted operating margin was 8.9%, down 20bp from last year. However, gross margins expanded by 220bp to 44.7%.
On top of this miss, management cut fiscal 2024 guidance to revenue growth of 1.8-2.4% with an adjusted margin of 8.9-9.1%. That will result in adjusted earnings of $2.67-$2.74. This is down from a previous midpoint of $2.98 last quarter when it had just raised guidance. This about-face added to the negative reaction. In the press release, the company said it is taking a more “cautious” approach to the holiday season. We are seeing vastly different performance from the company across regions, which is what is likely driving this caution.
Guess is a truly global brand. Europe accounts for about 53% of sales, Americas retail is about 23% while Americas wholesale about 8%, and Asia is about 10%. Licensing fees are just 5% of revenue, at $33 million, but at a 93% gross margin, they generated over half of the company’s $59 million in quarterly net earnings. Guess will license its brand for fragrances, footwear, sunglasses, etc, and earn a fee for doing so.
European revenue grew 6% from last year, a solid result, which is what drove the company’s revenue gains, given it is Guess’s biggest market. On the other hand, Americas retail fell by 7% while wholesale rose by 4%. There was “ slow ” customer traffic in America retail, according to the company. Finally, Asia was up 2%, but flat on a constant currency basis with wholesale outperforming retail.
Frankly, these ex-Europe results are rather disappointing. Many retailers are seeing growth in Asia, led by China, where even if activity is muted, it is better than a year ago when the country was only recently out of its zero-COVID malaise. To generate no growth in Asia speaks to lost market share in all likelihood. In the Americas, we just had a record Black Friday, which makes management’s caution about Q4 surprising. Additionally, I have written about how companies like Macy’s ( M ), Gap ( GPS ), and PVH ( PVH ) have been able to report strong results. Interestingly, PVH, which is also quite global, has pointed to more macroeconomic challenges in Europe than America.
That is more consistent with the data, actually. As you can see below, Europe’s economy fell harder during COVID, leaving it more room to recover, which is what happened in 2022 when growth was faster. However, the US is now once again outperforming Europe. If anything, I would expect global companies to talk about continued slowing in Europe, rather than the US.
It seems more likely that brand issues are driving Guess’s headwinds in the Americas more so than macro issues. These can prove harder to turn around, and this requires further monitoring. It is also important to note that licensing margins rose 3.5% to 93.1% while retail margins were down about 1% across Europe and the Americas. Given weak sales in the Americas, this decline in margin is not surprising; the decline in Europe is more so, and it may have to do with warmer weather shifting consumption patterns. It does bear further monitoring.
I would note that the company does not see a “significant increase” in margins next year, but that they will be “preserved and protected.” This is a fairly defensive posture and runs counter to companies like PVH expecting further margin accretion as input costs decline. At the company-wide level, these challenges have been offset by the fact high-margin licensing revenue rose 19%, aided by a one-time adjustment. It is seeing strength in fragrances, handbags, and watches. While the company has clearly done a good job maximizing the value of its brand, if sluggish store sales speak to lost interest in the brand by American and Asian customers, this revenue growth could slow.
Guess is also not quite where I would like to see it on the cost side, though progress is definitely being made. Adjusted SG&A expense rose by 10% to $233 million. Excluding a performance-bonus adjustment, it would have been up 6%. This is still twice as fast as revenue growth, and why operating margins declined even as gross margins rose. Its store footprint comes with fixed costs, and lower US traffic may be weighing on results here. Over the past year, it has closed 22 stores in the US, about 5% while cutting 32 in Europe, about 4%. At least in the US, further store closures may be justified to right-size costs.
On the positive side, inventories were down 2% to $562 million. Guess expects to finish the year down 10% from last year. Across the industry, retailers are trying to reduce inventories, having carried too much in 2022, so this decline is welcome. In the November 2019 quarter, GES had $593 million of product sales and $520 million of inventory, for a 0.87x ratio. Today, its ratio is 0.91x. So, the company is still carrying about 4% more inventory relative to its pre-COVID level, which is why it aims to get inventory down further after the holiday season. Lower inventories should enable the company to be less promotional and assist in retaining wider gross margins.
A reason that retailers were carrying too much inventory is that apparel sales surged dramatically after COVID in 2021. Many retailers assumed there would be further growth in 2022, which did not materialize as inflation surged, leaving them with excess inventory and forces sales. In hindsight, apparel consumption was running well above trend. With over a year of flat sales, we are converging toward the trend (up 4% annualized since 2019 vs the ~3% trend). This should create a more favorable dynamic for US retailers next year, which we may even be seeing this holiday season.
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Unfortunately, given guidance, I do not have high conviction that GES will fully benefit from this. Fashion can be fickle. While a more favorable macro environment helps, if a brand has lost some cachet with consumers, it can take time to win them back. We are not seeing any evidence that is happening in the US. Its European results have been stronger, but given the more sluggish economic growth, I question the sustainability of those gains. Rather, just as US consumption took a pause this past year, maybe that will occur next year in Europe, as any remaining “catch-up” of COVID losses has occurred.
Now, shares are only trading about 8.5x earnings, and it has a 5.3% dividend yield, which is supported by its $160 million in free cash flow. While it has $410 million of debt, including convertible notes, the company also carries cash of $244 million, leaving its balance sheet in a reasonable position. With margins likely to be flat, US sales weak, and the sustainability of European growth in question, I would expect similar results in 2024, or about $2.60-$2.80 in EPS, but there is wide uncertainty here.
As seen in recent quarters, its shares can react violently to earnings, which speaks to some inconsistency in results. I struggle with the fact the company raised guidance in late August after reporting Q2 results, only to cut guidance after Q3 results. Sometimes, a sharp macro event can happen that requires an about-face, but there was none over the past three months. This should leave investors cautious as to how much visibility management has over results.
When management has to revise guidance in different directions each quarter, investors should assign a high uncertainty to the outlook, as we are do not see as much data as quickly as senior management does. This is likely to continue to make shares volatile, especially when it reports earnings after the holiday quarter, as I expect markets will be bracing for either an upside or downside surprise with little confidence in guidance, given the large change. It is difficult to form a long-term view and adhere to it when the outlook changes each quarter.
Shares are cheap, but to earn a higher multiple, management will need to show not only growth, but more consistency in results. At 8.5x earnings, there is likely limited downside, absent a harsh rolling over of European sales. However, I have little confidence that there is upside. With so many stocks in the sector cheap, there are stocks with simpler stories to make money in. PVH also has single-digit multiple, but it has clearer brand and margin momentum; I believe investors will be better off investing in that company. Given its multiple, I would not make GES a short. Instead, I expect GES shares to remain around current levels, making them a “hold,” and I believe investors should rotate into better performing companies at similar valuations.
For further details see:
Guess: Too Much Uncertainty To Make Shares A Suitable Investment