Why Can't Analysts Get on "Fossil Standard Time"?

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Fossil (NASDAQ: FOSL) shares popped 19% on August 6 after the watch and accessory maker released second-quarter earnings before the market open. If you're a "watch person," you might not be surprised that Fossil didn't give analysts the time of day as it once again beat revenue and earnings estimates.

A brief recap of the results before we dig further:

  • Revenue rose 11%, beating estimates of an 8.6% increase.
  • EPS rose 25%, beating estimates of a 1.1% increase.
  • Year 2013 guidance was raised: EPS in the $6.15 to $6.35 range, up from $6.00 to $6.26; revenue in the 11.0% to 12.0% range, up from 10% to 11%. 
Importantly, $.08 was added to EPS due to the shifting of marketing expenses into the third quarter. Absent this shifting, EPS would have risen 16.3%.

Why can't analysts get on "Fossil Standard Time"?

As I've previously written, many – and that includes analysts – have long been buying into what I view as a faulty assumption: That the watch industry's days are numbered due to the high penetration rates of cell phones. I disputed that view with these reasons: 

  1. Watches are accessories, not solely utilitarian objects to tell time
  2. It’s easier and less conspicuous to glance at your wrist to check the time than to pull out a phone
  3. Some watches are “hardier” than phones

Digging into Fossil's 2Q results

Here's how its second-quarter broke out:

<img alt="" src="http://g.foolcdn.com/editorial/images/64590/fossil-q2-13-rev-mix-mckenna-the-motley-fool_large.jpg" />
 Numbers from Fossil's earnings report 

Quarterly product line growth: 

  • Watches: 14.8%
  • Leather: -5.4%
  • Jewelry: 24.3%

Quarterly division growth:

  • North America wholesale: 4%
  • Europe wholesale: 16%
  • Asia Pacific wholesale: 14%
  • Direct to consumer: 16% (its stores + website)

Watches had a solid showing, and jewelry growth was standout. It's smart of Fossil to focus on growing jewelry sales. There's synergy between watches and jewelry; not so with leather products. 

Europe -- which has been mired in a debt crisis and lingering recession -- has largely come back for Fossil. Fossil noted strong results in Germany and the U.K., while France was weak. 

North America wasn't as weak as the numbers suggest. Sales were negatively impacted by $15 million in shipments that shifted into the first quarter. Absent this shift, sales would have risen more than 10%. (This "shifting" should be monitored; a one-time thing is not an issue, but a trend could pose a concern.) 

As for Asia, the company said sales in China, Japan, and India were particularly strong. 

Fossil's business and strengths 

One Fossil strength is it offers watches in price niches from moderate to pricey, and in a wide array of styles. Its brands include Fossil, Relic, Skagen, Michele, and Zodiac. Skagen is a Danish brand Fossil acquired in 2012.

Fossil's management has a reputation for making shrewd acquisitions. Skagen's performance has been a growth driver for Fossil over the past year, so that reputation is again proving accurate. 

Another Fossil strength is that it can benefit from what's hot since it also sells products under licensed brands. It manufacturers Michael Kors (NYSE: KORS) watches, so it's benefiting from the Kors-mania. When Kors is no longer the "it" brand – and that will likely occur, as it almost does -- Fossil will still have its strong core brands and be able to license the next "it" brand. 


Swatch (NASDAQOTH: SWGAY.PK) and Movado (NYSE: MOV) are two main competitors. 

Swatch designs, manufactures, and sells watches, jewelry, and watch movements and electronic components. Earlier this year, It announced a $1 billion deal to acquire Harry Winston Diamond's watch and jewelry brand. 

Movado designs and sells fine watches. Its better-known brands include Movado, Coach, Lacoste, and Tommy Hilfiger. 


<table> <thead> <tr><th> <p><strong>Company</strong><strong></strong></p> </th><th> <p><strong>Trailing P/E</strong><strong></strong></p> </th><th> <p><strong>Fwd P/E</strong><strong></strong></p> </th><th> <p><strong>5-Yr PEG</strong><strong></strong></p> </th><th> <p><strong>3-Yr Avg Rev Growth (%)</strong><strong></strong></p> </th><th> <p><strong>3-Yr Avg EPS Growth (%)</strong><strong></strong></p> </th><th> <p><strong>Net Margin (ttm) (%)</strong><strong></strong></p> </th><th> <p><strong>ROE (ttm) ($)</strong><strong></strong></p> </th><th> <p><strong>Debt/Equity (mrq)</strong><strong></strong></p> </th></tr> </thead> <tbody> <tr> <td> <p>Fossil</p> </td> <td> <p>20.5</p> </td> <td> <p>16.8</p> </td> <td> <p>1.4</p> </td> <td>22.7</td> <td>39.3</td> <td> <p>12.1</p> </td> <td> <p>30.9</p> </td> <td> <p>.1</p> </td> </tr> <tr> <td> <p>Swatch</p> </td> <td> <p>19.3</p> </td> <td> <p>--</p> </td> <td> <p>--</p> </td> <td> <p>14.9</p> </td> <td> <p>27.6</p> </td> <td> <p>20.5</p> </td> <td> <p>18.5</p> </td> <td> <p>0</p> </td> </tr> <tr> <td> <p>Movado</p> </td> <td> <p>16.2</p> </td> <td> <p>16.1</p> </td> <td>1.7</td> <td> <p>10.1</p> </td> <td> <p>N/A</p> </td> <td> <p>11.5</p> </td> <td> <p>14.5</p> </td> <td> <p>0</p> </td> </tr> <tr> <td> <p>Kors</p> </td> <td> <p>36.8</p> </td> <td> <p>21.5</p> </td> <td> <p>1.0</p> </td> <td> 62.5</td> <td>107.7</td> <td> <p>18.9</p> </td> <td> <p>52.9</p> </td> <td> <p>0</p> </td> </tr> </tbody> </table>

Yahoo! Finance; data to Aug. 9; Swatch growth data to year-end 2012.

Fossil and Kors are the standouts. They both have outstanding ROE, a measure of how efficiently a company uses investors' money to generate profit. Their growth rates are also the best. 

Kors reported a knock-out quarter on August 6: Revenue was up 54.5% and EPS up 79.4%. 

Swatch sports a high profit margin (because it mostly sells higher-end watches), but its growth rates and ROE indicate there's better opportunity elsewhere. Movado is expected to post strong EPS growth this year (75%) and next year (25%), but that's only because comparison numbers are poor. It had negative EPS in 2010 and 2011. It reports quarterly results on August 26; I'd wait to see if it can turn back time and get back into a growth mode before investing. 


My opinion on Fossil remains the same:

"Fossil appears a moderately attractive holding for long-term investors. The company has an exceptional ROE and management known for its acquisition prowess, plus it regularly beats analysts' estimates.

However, the success of smart watches, particularly Apple's rumored in-the-works iWatch should be monitored. Smart watches could cut into some traditional watch sales."

An additional note: Investors need to watch the "shifting" of revenue and expenses between quarters, as discussed. 

Kors appears a quite attractive investment. Its status as an "it" brand has quite a bit more room to run, in my opinion. 

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BA McKenna has no position in any stocks mentioned. The Motley Fool recommends Fossil. The Motley Fool owns shares of Fossil and Movado Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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