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After Fossil (Nasdaq: FOSL ) lowered earnings guidance for the year by 2% in May, the stock promptly fell by nearly 40% and it is now trading at just over half its prior level. I think it's time to dig into Fossil again now that the meltdown has cooled off somewhat. Here are three reasons why.
1. Europe is the old world
Some investors could be spooked by Fossil's exposure to Europe. And to some extent, the spookiness is warranted. The company received more than 27% of sales from its European segment in 2011.
But if we look at Fossil's rate of sales growth over the past three years, Europe is the slowest-growing segment. Asia Pacific is growing sales nearly twice as fast as Europe, while North America is growing at a 50% faster rate.
Fossil's prospects in Asia Pacific are encouraging. Scott Krasik of BB&T Capital Markets says that while China in particular has seen surging high-end luxury item sales, there are excellent opportunities for companies like Fossil. Krasik says that "middle class growth could help fashion brands that are more accessible." Other analysts, including Credit Lyonnais Securities Asia (CLSA), share Krasik's view about Fossil's potential to benefit from sales to China's expanding middle class.
The management team at Fossil intends to take advantage of these opportunities, planning to increase the number of concession locations in Asia by 30% by the end of 2012.
Will Europe cause more trouble for Fossil this year? Probably. Management's prediction of a small impact on earnings could be too rosy. Over the longer run, though, look to Asian markets to fuel Fossil's growth.
2. Connections count
While some might look at Fossil primarily as a retailer, nearly 45% of its sales stem from licensing products to other companies. Fossil has business relationships with several fashion retailers, including Michael Kors (NYSE: KORS ) .
Fossil's connection with Michael Kors dates back to 2004, when the two companies partnered to launch a watch line. They teamed up on a line of jewelry in 2011.
What's good for Michael Kors is good for Fossil and vice versa. When Fossil's stock tanked after its May earnings announcement, Michael Kors also fell, although not nearly as sharply. After Michael Kors announced strong quarterly results in June, Citi analyst Oliver Chen was quick to note that Fossil should benefit because Michael Kors accounts for about 12% of its revenue.
Another promising recent connection for Fossil is the acquisition of Skagen Design, which makes watches, jewelry, sunglasses, and clocks. Management plans to expand the Skagen jewelry business and leverage Fossil's global distribution network to build the Skagen brand's international presence.
3. Mr. Market overreacted
It's not surprising that shares sank after Fossil announced its lowered earnings guidance. But a nearly 50% drop? I think Mr. Market overreacted -- a lot.
Fossil now trades at a forward price-to-earnings ratio of 11. In comparison, Michael Kors has a forward P/E of 31.
Guess? (NYSE: GES ) , with a forward P/E around 10, is one competitor with a lower P/E multiple than Fossil's. However, its revenue and earnings decreased last quarter year-on-year while Fossil grew both numbers. My take is that both Guess? and Fossil are underpriced.
Yes, European segment results will likely continue to disappoint. But weakness in a region that makes up less than a third of Fossil's revenue doesn't warrant nearly halving the company's valuation, in my opinion.
I'm sure there are investors who disagree. Some would probably argue that any stock with significant European exposure should be avoided like the plague. Maybe they're right -- for now.
Over the long run, though, I think Fossil's prospects look great. I recommend keeping a close watch for its next earnings results and those of its brother in arms, Michael Kors. If next quarter looks pretty good, consider buying Fossil. It could be an unbelievably good deal.
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