Fossil Group (FOSL) – A great value stock with only temporary problems ? (part 1)
Fossil is a relatively well-known, US-based company which sells mostly watches and other accessories across the world, under its own brand but also under licenses from other famous labels (Michael Kors, Armani etc).
The stock has been hit hard in the last months and has lost more than 50% since its peak in 2012/2013. The Stock chart is a typical “falling knife”:
Fundamentally the stock looks very cheap, especially compared to historic profitability and growth:
Market cap: 2.660 mn USD (55 USD per share)
P/B 3,2
EV/EBIT 7,8
P/E Trailing 7,8
P/E est (2015) 10,7
10 year averages:
– P/E 17,7
– Profit margin 9,9%
– ROE 23%
– EPS growth 19,1%
So only looking at those historic numbers, Fossil looks like a high growth, capital light and highly profitable company at a bargain price. But as I have written before: Especially in an environment like now, cheap stocks are cheap for a reason.
Why is the stock cheap ?
There is a pretty decent Value Investor’s Club short thesis from late 2014 which lists a lot of the issues issues nicely. I would summarize it as follows:
1. The watch market in general is cooling down rom a high growth period
2. One of the main drivers, the Michael Kors brand (~1/4 of Fossil’s total sales) is having problems and the license agreement was expiring
3. The potential impact of Smart Watches.
I would personally add another fundamental issue which is:
4. Changes in the distribution structure & Social media branding
Let’s look Smart Watches first
Smart watches (and other wearables) are clearly a threat for established watch makers. It is hard to say if they will replace a significant share of traditional watches. With regard to Fossil one can make however the following observations:
a) Fossil is clearly NOT a first mover. They unveiled some first models in August and want to be on the market before Christmas but Sony ,Samsung, Motorola and of course Apple were much faster. Samsung now has 2 years experience and the new Gear S2 looks pretty good.
b) However the BIG question for Fossil is: If Smart Watches are succesful, will “Branding” work for Smart Watches the same way as for normal watches ? Fossil makes most of its money with branding, i.e. buying the stuff cheap in China, getting a license and putting a fancy name like Michael Kors on it and sell it expensively.
If you look at smartphones, branding for smartphones doesn’t really work. There was the Prada phone from LG but this seems to be not worked very well as I haven’t seen any new Prada phones since 2012. Most phones are sold under the name of the producer more like “regular” electronics. Why doesn’t branding work for smart phones ? I am not sure but I think it has to do with several factors such as rapid technological change. A brand like Samsung or Sony stands for technical excellence and people won’t pay more for a fancy name. If you want something fancy then you buy yourself maybe a Hermes Iphone case for 340 USD but not a Hermes branded phone.
I could imagine that Sports branding could work, as Smart Watches seem to focus on health and activity. For some reason however, adidas seems to have launched their first version of a smart watch already 2 years without the help of Fossil. So it seems that the Adidas license does not cover automatically all kind of watches.
Finally an interesting quote from the Michael Kors CEO with regard to slowing watch sales under the Michael Kors brand (from Bloomberg):
“A slowdown in our watch business, that has been significant and it happened very, very quickly. While I think many people think it is a result of the Apple Watch, it’s actually not. I think it is a result of the iPhone 6 where we did see some softening in our business when iPhone 6 was introduced. There’s clearly a younger customer, in particular, in America who is wearing watches less because they view the iPhone as something that they tell time with and watch becomes slightly less relevant.”
John D. Idol – Chairman, CEO, Michael Kors, Deutsche Bank db Access Global Consumer Conference, June 11, 2015
It could easily be that the Michael Cors CEO tries to blame the Iphone for the decline of his own brands but interesting nevertheless.
Changes in distribution & Social media branding
Historically,the distribution system of Fossil was clearly one of the competitive advantages. They did have own stores but most of their watches were sold in department stores like Macy’s or JC Penney plus Walmart. However as the department store format works less well, they have to adapt. They seem to do this by opening more and more own stores. They also clearly try to sell more online. However, as I experienced with Piquadro more than 3 years ago, moving from a more wholesale oriented model to a direct one is not easy.
Renting and running own stores is very different from delivering watches to a department store. It is riskier, you need more inventory and you need expertise in real estate.
Another threat is that the internet and social media seem to have lowered the barriers to entry. I had linked a few days ago to a story about Brandtech, the way some companies like Tesla use social media to create powerful brands.
If you go on Amazon and search for watches, the first page is dominated by “Daniel Wellington” watches. On the German site Amazon.de, the 20 most sold Watches are dominated either by super cheap no names below 10 EUR or Daniel Wellington. 6 of the 20 most sold watches are Daniel Wellington with an average price of 100 EUR, only 2 are Fossil watches. Amazon’s US top selling watches are interestingly allmost all very cheap models with Casio dominating the rankings.
Daniel Wellington is an only 4-year-old Swedish company which managed to go from zero to more than 200 mn USD sales in 4 years. The trick seems to be aggressive promotion via social media as outlined in the Brandtech article:
Tysander refuses to pay for traditional advertising, instead working with thousands of bloggers, celebrities, and other “influencers” worldwide. One of them, Blake Scott, 27, has been collaborating with Daniel Wellington for a little more than a year, sharing the watches with his 318,000 Instagram followers. “I first found out about Daniel Wellington via Instagram: Everyone outside the States was wearing one, and it seemed so cool,” he says. Soon after, someone from the brand reached out and said he wanted to give Scott a couple of watches to post on his feed. Eventually he negotiated a deal with the company, which paid a few hundred dollars for a multiweek campaign.
Other than that, they do exactly the same thing as Fossil:
Although DW bills itself as a Swedish company, the watches are manufactured in China, which is how the company keeps prices so low. The internal quartz movements—a battery and vibrating crystal to keep the time, essentially—come from Miyota, a Japanese supplier popular with lower-price brands, because their products are reliable and they always have a massive inventory. The rest of the components are made and assembled in Shenzhen, a manufacturing hub.
So clearly Fossil does not have anything like a moat, even the wholesale distribution network seems to be quite open for newcomers like Daniel Wellington. If you can build fresh brands as quickly as that, one also needs to think about how this changes the value of licenses of “famous” brands at least in the fashion category. One needs yet to see if Daniel Wellington is only a short-lived outlier or if more is to come.
What I like about the company
In general I found their annual reports pretty good and informative. If a company is in a situation like Fossil, with growth going away and cash flows still coming in, the danger is always that they do something stupid and/or incentives of management and shareholders are not aligned.
At Fossil however I found two statements which are quite impressive and indicate an above average management quality of the company.
This is a statemnt from the annual proxy statement about Kosta Kartsotis, Co-founder, CEO and 13% shareholder:
The Board believes that this structure is effective and best for the Company at this point in time for several reasons. Mr. Kartsotis joined the Company in 1988 and has been a director since 1990. He holds a significant number of shares of our Common Stock, and since 2005 he has refused all forms of compensation for his service as an executive officer, expressing his belief that his primary compensation is met by continuing to drive stock price growth.
Compared to this, Warren Buffett looks quite greedy in earning 100 K a year for being CEo. Mr. Kastsotis is basically working here for free. He has reduced his stake over time but in the last few years very little. Clearly without a salary he needs to sell some shares in order to get cash, but it would be quite easy for him to command a normal salary which could be at lest a mid single million USD number and no one could complain.
There was another great statement in the annual report on capital allocation and dividends:
Cash Dividend Policy.
We did not pay any cash dividends in fiscal years 2014, 2013 or 2012. We expect that for the foreseeable future, we will retain all available earnings generated by our operations for the development and growth of our business and for the repurchase of shares of our common stock
Fossil has bought back massive amounts of its own stocks in the last few years, around 1/3 of the outstanding shares have been bought back and they continue to buy more. Although part of thse stocks have been bought at 100 USD or more, I prefer this kind of capital allocation to doing stupid M&A transactions.
Summary part 1:
Fossil clearly has some fundamental issues to cope with. A general slow down in the industry combined with expiring license agreements has had direct and short-term negative effects on margins. The thread of smart watches adds further uncertainty. On top of that new competitors like Daniel Wellington seem to have no problems to enter the market and quickly gain market share.
Such a uncertain situation would normally be a clear reason NOT TO INVEST and stop researching as any margin of safety could quickly disappear.
On the other hand, Management seems to be properly incentivised and the capital allocation looks top notch. So I will digg a little deeper and try to come up with a valuation in a second post.
value and opportunity 
Thanks for the great article. Fossil Group Inc. – as cheap as it can get. Market cap USD 485 mn, EV USD 780 mn. FCF Q1/2017 USD 45 mn. I think, it’s time to revalue.
Well…”fallen angels” are not my specialty. Maybe its yours ? The massive sale of Stock by the founder is also not really encouraging. But who knows, maybe its the opportunity of a lifetime, maybe not.
Vorbörslich -18% auf 18,65 USD. Damit seit deinem 1. Beitrag rund 2/3 günstiger geworden und inzw. unter dem EK gehandelt. KGV10 von 4,x und KGV5 von 3,x …
Hello, regarding your good point/question “If Smart Watches are succesful, will “Branding” work for Smart Watches the same way as for normal watches ?”, please have a look to the following link : http://urbanwearables.technology/kate-spade-brings-fun-and-cuteness-with-smartwatch-tracker-trio/
The answer could be yes. On these 3 WEARABLE products, as far as i am concerned, there is a KATE SPADE identity
well it is clear that they try but the question is: Will it be succesfull. Perosnally, I discarded my Samsung Gear 2 already months ago. Nice gadget but nothing more.
So you reply to your own question and your n°3 risk identified for a Fossil investment “The potential impact of Smart Watches”…
If you consider smart watch to be “a nice gadget but nothing more” so the risk for Fossil traditional watch for the long term is low (and maybe very low)
I don’t think that this will make Fossil an attractive investment for me. The “License” model in my opinion is not a very good one in the long run.
http://gannonandhoangoninvesting.com/blog/2016/1/16/a-simple-way-to-think-about-moat
Hoang seems to be more bullish. If this drops further, I will get interested.
Hoang and Geoff invested into Swatch and Movado at much higher prices. I do think they have done their homework but I don’t fully share their view.
Licensing brands in my opinion is not a moat business as the owner of the brand will charge you more if things go really well. So I don’t buy their argument of constant margins. If you look at Fossils numbers, their argument is not sutainable.
Is the youth really wearing less traditional watches? I doubt that. If I look around, I see the opposite: more millennials are wearing watches than ever. They only don’t wear Fossil, Armani, MK or other traditional brands, but new brands that dominate social media such as Daniel Wellington, MVMT and CLUSE. Fossil just does not know how to market to millennials, I think that is the fundamental issue here, and has nothing to do with smartwatches. The Fossil brands are just not cool enough, they don’t connect with the millennial generation. I find it awkward that Fossil is not mentioning anything about this in their Q3 results report, they should know that they have lost huge ground to these new “traditional” watch brands. I can only imagine that they have not mentioned anything to prevent a total collapse of their stock price.
interesting observation. I was also astonished how Daniel Wellington went from 0 to 400 mn sales in only 4 years….
I see it a little differently.
Fossil, Relic, etc. are fashion brands. Once everyone has it, it is no longer considered cool. So it is said.
See Abercrombie & Fitch, American Appare, Bijou Brigitte, Coach, the aforementioned GAP, etc.
They may be cyclic but probably without long term growth.
The licensing part makes no difference in these days as long as it involves no new hot things.
I do not want to repeat previous comments. However it seems very obvious that watches are becoming less relevant in future. If you look at other declining industries such as newspapers there are niches maybe on a more local level where they have a moat. Why do you think Fossil has an advantage over other watch makers/time telling devices apart from brand diversification and how do you think the long term value of such business could be determined with? Looking forward to part two 😉
#Seb,
as a contrarian investor you often invest against consensus. In the case of watche,the consensus seems to be that watches are dead. Am not there yet, but this is exatly one of the situations where there COULD be value.
For instance I feel also very comfortable to bet against the irrelevance of car insurance because of elf driving cars.
mmi
Hi mmi, I agree that watches are not dead. However they become less relevant. There are a number of professions such as doctors or the students you mentioned that will keep using them. Others have multiple access to time now. My point relates to the time frame and risk margin required for an investment in an industry in the middle of a major change. I think this is quite different to companies such as Admiral with no immediate threat and an asset light business that can be “copied” to other countries. The “less relevant” part makes it just more difficult to value long term. In the short and medium term this could look differently indeed.
Hi Seb, what is your FACT to say that watches become less relevant? Do you have some data related to the number of watches sold per year during the last 10/20 yars? Or the evolution of the number of watches owned? Or the penetration of watches regarding to the world population?
Hi Rom, no, don’t have data. From an objective perspective, time is available to almost everybody through smartphone and other devices. Therefore, I conclude that in particular younger and poorer people do not want to wear classic watches anymore to get that information. It’s a typical market disruption. However, some groups are likely continue to wear watches as they use it as a gadget to show status or watches may be better suited to their professional needs. All in all relevance is lower due to the availability of time telling devices and watches are more luxurious goods today. Record players are not dead either. But they are much less relevant today than they were back in the 70ies!
Swatch is also interesting, they have 30 % of the watch market in China. Similar sell-off reasons with the addition of “China-fear”. Thanks for an interesting read, looking forward to the next part! Would be interesting to see if Fossil/the CEO did any major changes to their business model before – if they did, it seems more likely that they will be successful again.
thanks for the comment. Yes, they changed their Business model in the past. They started only with the Fossil Brand and changed to licensing later.
“There’s clearly a younger customer, in particular, in America who is wearing watches less because they view the iPhone as something that they tell time with and watch becomes slightly less relevant”
A similar comment came spontaneously to my mind when I read you are talking about a watchmaker.
Looking around (in Germany, not the states) I see more and more people not wearing any watch, due to having a clock at the smartphone alway at the body.
Watchmaker may adapt to smart watches, it is be very hard to adopt to “no watches”, to watches getting out of vogue.
Hi Roger,
valid point, that’s why I put that quote into the post.
Some counter arguments to that:
– in many schools,kids are wearing watches AGAIN because mobile phones are not allowed in class 😉
– the driver for future sales is the emerging middle class in China and India and they still like watches big time
– mabye Apple can make Watches cool again ? Maybe we see the emergence of the “wrist computerwatch” which you wear when you don’t want to use your 10 inch smart phone ?
The stock charts of Swatch and Movado clearly show that the danger you mentioned is real and tha’t why the stock is cheap.
mmi
I dont know what the kids are doing today but i can confirm that the iPhone6 is definitely not the first Phone with a clock.
I think in 10 years we will wear the same (dumb-)watches as today, will use a bracelet for sportmonitoring, and will look back at all those strange 2015 smartphones. Anyone remember the casio calculator watch?
I am looking at the margins: 70m Income for 740m of top line = 9.5% – do you have any comps on operating leverage?
Not sure why one would pay 2.4x shareholder equity for a declining industry….regardless of how incentivised management is.
BUT debt is well covered for a change.
tony,
P/B is not that usefull for a capital light business,especially when they alreadybought back 1/3 of their shares.
A very similar situation exists with Gap. Top notch capital allocation, family owned but facing problems … In both these cases the moat is really difficult to ascertain. I am steering clear.
I think the business model of Fossil is different from GAP epecially with regard to the licensing part which is 50% of sales for Fossil. GAP is much more a “Traditional fashion retailer” where real turn arounds are very rare.
I would be surprised if licensing is a source of moat. Fossil has done quite well by the numbers, but the negotiating power lies with the brands, surely.
The recent negotiations with Michael Kors for example.