Fossil Group Inc (FOSL), Abercrombie & Fitch Co. (ANF): Should You Invest in This Consumer Fashion Accessories Business?

Recently, Fossil Group Inc (NASDAQ:FOSL) shares dropped over 5% to around $108.40 per share after Barclay’s downgraded it from Equal Weight to Underweight with a target price of $100 per share. Analyst Matthew McClintock downgraded Fossil Group Inc (NASDAQ:FOSL) because of lower sales. Should investors avoid Fossil for now? Or does the recent drop represent a good buying opportunity for investors?

A cash cow with a strong balance sheet and growth potential

Fossil Group Inc (NASDAQ:FOSL) is considered the global designer and distributor of consumer fashion accessories via its diversified distribution network in 130 countries including department stores, specialty retail locations, specialty watch and jewelry stores, mass market stores and through the company’s catalogs and website. Most of its revenue, more than $1 billion in sales, or 35% of its total revenue, were generated from the North America wholesale segment while the direct-to-consumer segment contributed more than $715.5 million in sales. Fossil derived most of its revenue from watches, accounting for nearly 75% of the total 2012 revenue, while leather product ranked second, representing 15.4% of the total sales.

What I like about Fossil Group Inc (NASDAQ:FOSL) is its growing top line and bottom line in the past ten years. Its revenue increased from $781 million in 2003 to nearly $2.86 billion in 2012, while its net income rose from $68 million to $343 million during the same period. Fossil Group Inc (NASDAQ:FOSL) has good cash flow generating ability with consistently positive operating cash flow. In 2012, its operating cash flow was $452 million, whereas the free cash flow came in at $329 million.

Investors might be extremely excited with its consistent double-digit return on invested capital in the past ten years. The 2012 ROIC was more than 27.9%. Furthermore, Fossil generates a high return without much help of leverage. Its capital structure is quite conservative. As of March, it had nearly $1.24 billion in equity, $241 million in cash and only $153 million in both long and short-term debt.

For the full year, Fossil expects to grow its net sales by 10%-11%, with its EPS guidance staying in the range of $6.00 to $6.26. Fossil is trading at $108 per share, with the total market cap of $6.34 billion. The market does not value Fossil Group Inc (NASDAQ:FOSL) cheaply, at 11.4 times its trailing EBITDA (earnings before interest, taxes, depreciation and amortization). Compared to its peers, including Guess?, Inc. (NYSE:GES) and Abercrombie & Fitch Co. (NYSE:ANF), Fossil has a much higher valuation.

The most expensive but the most profitable business

Guess?, Inc. (NYSE:GES) is trading at $34 per share, with the total market cap of $2.90 billion. The market values Guess? at only 7.40 times its trailing EBITDA. Over the years, Guess? has managed to diversify its business model, operating around 1,690 stores in 88 countries.

For the full year 2013, Guess?, Inc. (NYSE:GES) derived most of its revenue, around 43% of the total revenue, from the North America retail segment. The Europe segment ranked second, accounting for 35% of the total revenue, while the revenue percentage share of Asia was 11%.