This Market Needs Some Prozac – Part 2
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Just five days, that's all it takes in this market to lose nearly 44%. Now I can understand if the company reported some horrifically bad report saying they were re-stating earnings. I could also understand a 44% drop if a company said they were going to lose money this year, when previously predicting a profit. However, in today's market, all it takes is an earnings announcement that doesn't live up to every bit of expectations. A good example of this is Fossil (NASDAQ: FOSL). The company reported earnings and the stock is down significantly.
This appears to be another case of a gross overreaction by the market, to news that just isn't nearly as bad as the drop in the stock price suggests. In February I wrote that Fossil could be worth $135 a share. At that time, my main argument for this valuation was tied to the valuation of Coach (NYSE: COH) a direct competitor. With Coach selling at a premium to its expected growth rate, I argued that Fossil should sell for a premium as well. When I wrote the article, Fossil was valued at about $99 a share. Just 5 days ago those same shares traded as high as $138. Today they are at $78 and change. Does my theory still hold up that Fossil should sell at a premium? What happened in the most recent report to cause such a steep drop? That's what we are here to find out.
Fossil now trades for about 14.5 to 14.75 times the company's predicted 2012 earnings. With analysts calling for 20% growth going forward that gives the company a PEG ratio of about 0.72. Coach, the aforementioned competitor's PEG is 1.24. Both companies are expected to grow earnings at a healthy pace going forward. Even with Fossil's revised guidance we are still talking about at least 15% EPS growth. Coach, on the other hand, is expected to grow earnings by 16% in the next few years. If a company's worse scenario still gives you a PEG of 1, and their closest competitor sells for 1.24 there could be a disconnect in the market. That being said, let's see what happened to cause this drubbing.
Fossil's headline numbers revealed constant dollar net sales up 11.1% and diluted EPS up 8.1%. The company reported $0.93 a share in earnings versus the average estimate which was $0.92. So the company beat earnings for at least the fifth consecutive quarter, this time by about 1%. Sales overall were good, global watch sales were up 13.7%, the leathers business was particularly strong with sales up 15.8%. These strong showings were offset by eyewear, which was down 25.6%, and jewelry which was down 4.8%. On a regional basis, all three major geographical regions showed increased sales. North America was up 9.3%, Europe was up 4.7%, and Asia-Pacific was up 18.8%. The direct to consumer channel was also strong with an 18.7% increase in sales. So the current quarter sounds pretty good, what went wrong? The problem was with management's forecasted growth.
The company said that they believe, “strength in watch sales, same store sales, and square footage growth will result in double-digit sales and earnings growth for fiscal 2012.” However, what investors were not expecting was the lower guidance for 2nd quarter earnings and full year earnings. The second quarter guidance was particularly surprising, with the company expecting a 19% increase in constant dollar sales, but earnings coming in between $0.77 and $0.79 versus estimates of $0.94. What has somewhat been lost in the shuffle of the huge price drop in the stock is that this miss of $0.17 expected in the second quarter might be it for the year. With the company expecting $5.30 to $5.40 in full year earnings versus estimates of $5.56, the best case scenario is this $0.17 miss in the second quarter takes care of the difference. This would indicate a strong second half, which makes sense given the strength of the latter half of the year for most retail focused companies.
The most unbelievable part about this guidance is at worst it is 4.68% below expectations. At best, guidance is 2.88% below expectations. The idea that the stock should be worth nearly 44% less than five days ago because of a full year miss of between 3 – 5%, is ridiculous to say the least. Keep in mind that analysts had raised their estimates, from $5.46 just 90 days ago, to $5.56 before this report. This means literally 3 months ago, this guidance would have been even closer to what analysts were expecting. When the company says they will earn $5.30 at worst and that potential 5% miss causes a 38% drop in the price in a day, something is wrong. While at $138 this $5.30 in earnings would have implied a forward P/E of 26, is that really significantly different than the 24.82 forward P/E that the company would have had if they met expectations? I'm sorry, but this seems like panic selling. If you are a long-term investor and you've been waiting for a chance to buy Fossil on the cheap, today is your day. For those of us that already own Fossil, this is just another example of the market overreacting. How many people think if the company had reported 5% better expectations for the year, that the stock would have jumped 44%? Anyone believe that? Yeah I didn't think so. Now ask yourself why this makes sense on the way down, clearly it doesn't.
MHenage owns shares of Fossil. The Motley Fool owns shares of Fossil. Motley Fool newsletter services recommend Coach and Fossil. 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. If you have questions about this post or the Fool’s blog network, click here for information.