Guess Who Is Going International?

Shas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Iconic denim manufacturer Guess? (NYSE: GES) announced its 4Q12 results on March 21 with EPS of $0.95, down 10% y-o-y but in-line with expectations. 4Q12 revenues increased 5.1% and on a constant currency basis increased 4.2%. It was able to report results at the higher end of its expectations despite facing a challenging North American market and a weak European market. On the margin front, gross margin declined 240bps and operating margin declined 280bps, reflecting the negative same store sales, expansion costs and markdowns in Europe and North America.

International expansion

Guess mentioned that it would continue to focus on its international expansion, bringing me to the question: is international expansion going to drive retail sales? In an attempt to combat saturation in domestic markets, many retailers, including Gap (NYSE: GPS), Abercrombie and Fitch (NYSE: ANF) and Guess, shifted their focus to international markets. Let us get the lowdown on how these companies have fared in the international market given the current economic conditions.

Guess faced tough economic conditions in Europe with its sales increasing marginally by 3% and with high single digit declines in comp same store sales. Further, its low sales in Italy, France and Spain (due to low traffic during its discount period) was partially offset by high revenue growth in Germany and Russia (revenues increasing 40% and 105%, respectively). Retailer haven China posted a 30% increase in its sales.

For FY13 it plans to increase its store base by 70 and will also close down 23 stores (the majority in Italy). It continues to see opportunity in China and South Korea and will open 50 stores and 45 stores, respectively. The company plans to launch in Brazil with two stores and will also open its first store in Japan by 2015.

In comparison with Gap and Abercrombie and Fitch, Guess has a larger exposure to international markets. It has 622 stores in Europe (36%) and 470 in Asia (28%) vs. 512 store in the US (30%). Further, Europe accounts for 35% of its FY12 $2.5 billion sales and 37% of FY12 operating income. China has grown by almost 75%, and South Korea has grown 25% annually in the last five years, but it accounts for only 10% of its sales and operating income.

Competitor Scenario

In the last three years, Gap began to consolidate its under-performing domestic stores and instead focused on international store growth. As it closed down ~70 under-performing GAP stores between 2009-2012, its revenue per square foot increased from $370 to $390. Also, Old Navy revenue per square foot increased from $270 to $300 with the closure of 28 stores. In FY12, it entered nine countries with 85 franchise stores and plans to add 75 mores stores in FY13.

Tapping into the booming retail industry in China, Gap opened 33 stores in FY12 and plans to open 35 more in FY13. Gap faces tough competition from Abercrombie & Fitch, which claims that it has the highest performing stores in China. Further, it opened its first store in Japan in FY12 and plans to open 20 more in FY13. Gap is the first American retailer to set up shop in Brazil (plans to enter by 2H13). However, the company may face tough competition from the European retailer Zara, which has been in Brazil since 1999 and has 39 stores and increasing.

As of Feb 2, it has 3,407 company-operated or franchise stores in 47 countries. However, its stores are still concentrated in North America (80% of its stores), while Europe accounts for 7% of its fleet (243 stores) and Asia accounts for 12% (421 stores). Europe, Asia and other regions account for only 15% of its FY12 sales.

Coming to Abercrombie and Fitch, it entered the international market in 2007 and met with initial success. But in the last two years, it began facing problems with expansion in international markets as well as domestic. In the domestic market, it made the wrong decision in expanding in regions having lower income demographics, and as a result it failed to drive traffic in its stores. However, it is now closing its under-performing stores and consolidating its stores.

In Europe, given the weak environment and cannibalization from smaller stores, it faced slower sales and a 19% decline in its comparable same store sales in FY12. As a result, the company has slowed down its expansion plans and intends to enter under-penetrated markets. But, despite this pullback, it still sees growth in the international arena. In FY13, it will open 20 Hollisters in Dubai and one in Japan. Given the strong response in China and Hong Kong, the majority of its 2013 openings will be focused in these regions.

Out of its total fleet of 1,051 stores, Europe and Asia together account for 11% (108 stores in Europe and 12 stores in Asia). However, international sales accounted for 25% of sales and 35% of total operating income in FY12. Its international operating margin of 31.8% is higher than the US margin of 16.8%.

Conclusion

International expansion does help to diversify from saturation and a slowing economy in the US, but at the same time it has the risk of a slump in sales due to weak economic environment outside the US (as seen recently in Europe and China).

On the negative side, Guess is the most vulnerable, as 35% of its revenues are driven from Europe. Out of the three, I would root for Gap, given its recent strong performance and execution capabilities. It has potential to grow further internationally and also has been able to hold up in these places at a time when its rivals are struggling.


Shas Dey has no position in any stocks mentioned. The Motley Fool recommends Guess?. The Motley Fool owns shares of Guess?. 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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