Description

Overview

Fossil Inc. is a specialty retail company that produces designer watches. They have historically produced watches on their own brand name Fossil. Fossil has though started to implement a new branding strategy during the past few years by introducing new lines of watches. The effect of introducing new brands to the market is a two-edge sword, it could increase revenue through the new brand, and however it also could steal revenue from the existing brand, leaving total revenue the same, minus the increased branding expenses. To Fossil’s credit, they have introduced new brands to the market and have been able to grow their revenue stream quite successfully. Fossil also is known for manufacturing other company’s lines of watch products. This year Fossil has inked deals with Walt Disney and DNKY to produce watches. These outsourcing deals all are focused on markets that Fossils does not participate in, thus not destroying the Fossil brand.

Fossil has designed and implemented their business model almost to perfection. They are a very conservative company in my opinion, looking for maintainable and steady growth. For the last two years retailers have sold out of Fossil watches during the holiday season, which Fossils did not replenish for a few months. I believe this done on purpose from a lesson learned in 1995 when they projected too much too fast and were stuck with excess inventory. They rather be the Christmas tree seller going home for the holidays early instead of being the dealer on the lot Christmas day wondering if they are going to break even.

Fossil is opening yet another new brand, but its not watches this time, its clothing. Again they are approaching this in quite a conservative manor by opening only 12 stores. The clothing will only be sold at Fossil stores. They want to get into this market, they want to learn the lesions that needed to learned, and then grow at a reasonable rate.

Why a reasonable rate of return? I really do not have the answer, but my guess in supply and demand. If Fossil wanted to take over the retail world today, they probably could. They would have a great year or two. But Fossils then would no longer become a brand, but rather the dreaded trend, here today gone tomorrow.

The Numbers

Fossil is one of the best-run companies period. They are among the top in the retail industry.

The 5-year earnings growth rate is 40% with a revenue growth rate of 20%. For the past 5 years the return on equity has increased, going from 20% to 28%. The company has no debt and about $100 million in cash. Insiders owner over 45% of the company's outstanding shares.

The Market

The market has been cruel to Fossil and the entire retail sector. The sector is beginning to bounce, look at ANF, bouncing from 8 to 23 in less than two months. Fossil is a great sector play.

The Return

I like a nice margin of safety. I believe Fossils will grow sales about 20% a year for the next 5 years. But to be on the safe side I am going to drop that figure down to 15%. Based on this sales growth, the expected earnings growth will only be approximately 8%. However Fossil is a superior company that has grown earnings at twice the rate of sales. Using the past 5-year historical data, earning growth based on a 15% sales growth would be in the 30% range. Lets knock down that figure down as well, saying that company has reached its max ROE, and sales growth is now has a one to one relationship with earning growth. Thus my earnings growth would also be 15%.

Based on the numbers, Fossil should earn $3.18 in five years. The PE range Fossils has traded in from 7 to 30 during the last five years, in which each year the ratio having a minimum PE deviation of 12 points. There seems to be a fairly volatile market for Fossil. Assuming that a growth rate of 15% would command a PE 15, Fossils would sell at $46.80, for a compound rate of return of 22.2%. Again being conservation again, lets knock down the PE its current level of 10, or for a share price $31.80. This still would provide a rate of a return of 12.7%.

Again I have faith in Fossil, the 12.7% rate of return is assuming that both revenue and earnings growth decrease dramatically. If the company continues to execute it business plan as it has done in the past, the rate of return will be much much greater.

Other

Fossils might buy something to help increase earnings. This deal will be financed with both cash and stock. Why? Because the board of directors quietly voted to double the number of shares allocated six months ago.

Catalyst

Continued Growth, Good FCF, Sector bounce, GARP