Sometimes companies have problems just sticking to what they know. It seems that this is the case with Fossil Group Inc (NASDAQ:FOSL), and their different divisions that are not necessarily contributing to the company’s image or profits. The truth of the matter is, Fossil Group Inc (NASDAQ:FOSL) is a great watch manufacturer, this division is growing faster than the rest, and the company needs to make the smart decision and reward their shareholders with better results.
Diversified Sometimes Is Diworsified
As Peter Lynch used to say, sometimes a company’s diversification became diworsification, because they would buy or get into a business they did not know enough about, and their results would suffer. When it comes to Fossil’s competition, they each offer a lineup of high-quality items, but Fossil Group Inc (NASDAQ:FOSL) needs to just stick to watches.
Fossil has to deal with competition from much larger companies like PVH Corp (NYSE:PVH), which owns brands like Tommy Hilfiger and Calvin Klein. The company also faces such heavyweights like Ralph Lauren Corp (NYSE:RL), and though they manufacture Michael Kors Holdings Ltd (NYSE:KORS) watches, this company also competes in other segments as well.
If you want proof that these brands all are premium brands, you only need to look at their gross margins. Fossil Group Inc (NASDAQ:FOSL)’s gross margin is the second lowest of the bunch, but still stands at 55.59%. Only PVH Corp (NYSE:PVH) carries a lower margin at 53.82%. Ralph Lauren Corp (NYSE:RL) and Michael Kors Holdings Ltd (NYSE:KORS) both command gross margins of better than 59%. When you can get margins of 50% plus in any business, you know you have pricing power.
The problem is, while each of these other companies is diversified into clothing, accessories, shoes, and other goods, Fossil essentially operates three divisions. Fossil Group Inc (NASDAQ:FOSL)’s fastest growing and largest division is their watches unit, which makes up more than 75% of total revenues. Their other two units are leathers and jewelry. The bad news for investors is, their leathers and jewelry business are dragging down the star of the show, which is Fossil watches.
Good Results Made Better
It’s not that Fossil Group Inc (NASDAQ:FOSL)’s results are terrible. In fact, the company’s current quarter was not bad at all. The company’s overall sales increased 15%, and adjusted Earnings Per Share (EPS) increased 23.66%. When you compare these results to the expectation of just 5.7% revenue growth from PVH Corp (NYSE:PVH), or the 6.6% expected revenue growth at Ralph Lauren Corp (NYSE:RL), Fossil looks very good.
However, if you compare Fossil to Michael Kors Holdings Ltd (NYSE:KORS), the numbers start to work against the company.
While it’s true that Michael Kors Holdings Ltd (NYSE:KORS) sells more than just watches, this is the key product that Fossil licenses from the company. With Kors’ overall sales jumping by 57%, you can imagine the popularity of the brand is helping drive Fossil’s sales as well. In fact, Fossil not only saw growth in North America and Asia, but the company’s wholesale revenue increased 14% in Europe as well. Given the well-known economic issues in the region, these results are very good.
That being said, the breakdown of where the company’s growth came from is telling. Fossil’s fastest revenue growth came from watches, with a 22.61% increase. By comparison, jewelry didn’t do badly, with a 7.91% increase in sales, but leathers reported a 1.15% decline. Given that Fossil is expected to grow earnings by 15% over the next few years, imagine how analysts’ expectations would change, if the company rid itself of these slower growing divisions.
What Would Be The Result?
Fossil currently sells for a forward Price/Earnings (P/E) ratio of 16.74, which is a premium to its expected growth rate of 15% of about 112%. Their two larger competitors, Ralph Lauren Corp (NYSE:RL) and PVH Corp (NYSE:PVH), also sell for a premium to their growth rates. However, Ralph Lauren sells for about 180% of its expected growth, and PVH Corp (NYSE:PVH) sells for 131% of its growth rate. By contrast, Michael Kors Holdings Ltd (NYSE:KORS) actually carries a forward P/E that is just 84% of its expected growth rate.
While I could easily make the argument that investors consider buying Kors’ stock instead of Fossil, it’s not that simple. Fossil is less of a pure play on luxury items, and some investors aren’t comfortable relying on high-end goods to drive sales. In addition, Fossil retired over 4% of their outstanding shares in the last year. Fossil also carries about $90 million in net cash and investments.
While Fossil’s balance sheet looks stronger than PVH Corp (NYSE:PVH), with a debt-to-equity ratio of 0.68, it doesn’t rate as highly as Ralph Lauren Corp (NYSE:RL) or Kors. Kors has over $400 million in net cash and investments, and Ralph Lauren Corp (NYSE:RL) carries well over $1 billion. Since Fossil’s management has shown a willingness to reward shareholders, it’s possible that the proceeds from a sale of the leathers and jewelry business could be used for further share repurchases. In addition, the company’s growth rate would certainly increase, as this quarter alone, their revenue would have move up from 15% growth to 22% growth.
Fossil is a great company hiding inside of a good one. If the company took the bold step to spin off or sell their leathers and jewelry business, this stock would be a bargain. Until that time, Michael Kors Holdings Ltd (NYSE:KORS) has better margins, more cash, and a much higher growth rate. The opportunity is available, and if Fossil eliminated its slower growing divisions, investors could watch as the stock takes off.
Chad Henage has no position in any stocks mentioned. The Motley Fool recommends Fossil. The Motley Fool owns shares of Fossil. Chad is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Watch Out for This Company originally appeared on Fool.com is written by Chad Henage.
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