The Poor Investor

Investigatory Value Investing

Fossil: A Diamond in the Rough

Fossil recently reported earnings that “The Street” did not expect. Forward guidance was not as optimistic as expected either. Investors reacted by a massive sell-off, resulting in the stock dropping over 19%, from $99 to $80. I believe this was an extreme overreaction.

While there are worries that a company like Fossil will go the way of Kodak (fear that traditional watch companies will be replaced by Apple), these worries are inconsequential to the company as it stands today. Even if the company takes a hit to sales (which is expected), the stock is still attractive at today’s price as a short-term holding (although it should be noted that I generally recommend long-term holdings).

While I don’t see Fossil to be in the same category as what Warren Buffet might deem the “forever category,” I’m sure someone could make the argument for Fossil as a long-term holding.  Obviously though, there is much to be said about the impact new technologies have on long-standing companies.  For instance, a forward-thinking company like Tesla could easily replace the entrenched automakers such as Ford, GM, Toyota and Honda, just as Netflix replaced Blockbuster. Not to mention, since the 50’s, the average lifespan of a Fortune 500 company has dropped from 61 years to 15 years.  But, the long-term argument is an argument for a different post.  My argument, however, is merely a valuation argument.

So back to brass tacks…

The company stated in its latest earnings report that it expects the following for fiscal 2015:

• Net sales to be in the range of a 3% decrease to a 1% increase
• Operating margin in a range of 12% to 13%

Current net sales sit at $3.51 billion. Being conservative, let’s assume a 5% drop in net sales. Conservatively, let’s say only 8% of that translates to net margin, so $266.40m. At the level of current shares outstanding, 51.3m (diluted), this translates into an EPS of $5.19 per share. At this extremely conservative level, assuming the company buys back no shares, this puts the PPS at $62 at the current P/E of 12.

But this is not the full story. The company has $1.1 billion in its coffers earmarked for share repurchases. Assuming the company will “strike while the iron is hot,” and use the full amount to buy shares aggressively after the recent drop, this allows for 12.0m shares to be repurchased, even if the company buys them for $92 per share on average ($7 per share more than the current market price). This would put the share count at 39.3m. Thus, using the previous assumptions, the EPS translates into $6.78 and a PPS of $81.36.

However, this is an extremely conservative scenario. I would go as far to say that this is the “extreme worst case.”

A much more plausible scenario would be a slight decrease in net sales, say 1%, and net margins near 9%. Also, P/E would revert more in-line to what the company traditionally trades for, for conservative investors’ sake let’s say around 15 (actual five-year average P/E is 18.8). Using these assumptions, and assuming no share repurchases, this translates into a PPS of $73.15. Now, no repurchases is extremely unlikely. Assuming repurchases at the $92 level (same as above) the PPS would translate to $119.37.

Moderately optimistic and optimistic scenarios need-not be included in this evaluation. The main thing is figuring out what the downside risk is. For those that missed the point, it is virtually nil. Assuming the reality lies somewhere in the middle of the “moderately optimistic” and “pessimistic” view, this would bring us back to the “plausible” scenario. Hence, I’m arguing the stock will easily trade within the range of $100-120 in the near-term future (less than 1 year).

If the company does not aggressively repurchase shares, and say, only repurchases half of the above assumed amount, a $100 PPS is still easily obtained at 15 times earnings. The most realistic pessimistic assumption translates to $80 in PPS. This translates into a $5 per share loss at the current market price of $85, or a decrease of approximately 6% (though, if this lower PPS level is reached then the company is more likely to repurchase shares, thus putting upward pressure on the stock price). The potential upside, conservatively speaking, is around 17-41%.  Thus, the risk-reward seems incredibly favorable at the current PPS.

Disclosure: Long FOSL


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