Why Fossil Can Keep On Ticking

Fossil (NASDAQ: FOSL  ) has been on a good run this year as shares have appreciated almost 40%. Making watches for luxury fashion brands such as Armani, Tory Burch, and Michael Kors (NYSE: KORS  ) has helped Fossil record good sales growth. Moreover, Fossil's products are priced at different price points, so the company is not just restricted to affluent customers.

A mixed quarter
Fossil's growth continued in its third quarter as revenue grew 18% year-over-year to $810.4 million, which exceeded consensus estimates. Revenue growth was fueled by double-digit growth in the watch and jewelry categories, along with strong sales of the Fossil and Skagen brands. Performance across all geographic regions was encouraging.

On the back of positive pricing, a booming retail business, and strategic acquisitions, Fossil's operating income increased 25% from the prior-year quarter. The company's diluted earnings per share increased 25% to $1.58. Despite beating expectations, Fossil shares fell 6% after the earnings release as its outlook was not up to the mark .

Fossil expects fourth-quarter earnings between $2.26 per share and $2.46 per share, and revenue growth of 6% to 8%. These numbers were lower than analysts' expectations of $2.60 per share and a revenue increase of 10%. However, Fossil could improve in the future, as the company has a lot of opportunity in emerging markets.

A look at the opportunity
The Asia-Pacific region is estimated to account for around 31.2% of the global market for luxury jewelry and watches. This is expected to be the fastest growing region in the world over the five years from 2012-2017, with spending growing by $31.9 billion.

This strength also reflects in Fossil's third-quarter results, where the Asia-Pacific region had the highest jump in sales of 12.9% with China, India and Japan being the major drivers. As a supplier to heavyweights like Armani, Kors, etc, the company stands to gain from their expansion plans as well.

Fossil has licenses to sell watches under labels including Burberry, Marc Jacobs, and Michael Kors. Michael Kors purses and ready-to-wear clothing can cost hundreds or thousands of dollars, and thus these products are beyond reach for most. Fossil-produced watches can cost as little as $120, which makes its offerings more reasonable for an emerging market middle class and could lead to better sales.

Headwinds
The luxury timepiece business may be in for lot of surprises going forward. The possible introduction of smart-watches from major players like Apple, Sony, and Samsung could lead to fierce competition in the segment.

Competition is also heating up as arch rival Movado (NYSE: MOV  ) , licensed to sell Coach branded watches, has plans to come up with a more expansive portfolio of watches. Movado's licensed brands include Coach, Tommy Hilfiger, Hugo Boss, and Lacoste. These have grown sales by 50% in fiscal 2012 and fiscal 2013, making up 45% of revenue in fiscal 2013 .

At the moment, Coach's watches are positioned for direct competition with Michael Kors. Going forward, one can expect Coach to expand its price points in order to offer more competition to Kors, which could be a boon for Movado .

Michael Kors watches may already be losing their charm. Earlier this year, Fossil's sales in the U.S. wholesale channel rose a solid 11%. However, comps at Fossil stores were flat from a year earlier, the first time in 20 quarters that comps didn't rise. It could be a matter of concern if sales of Kors watches are really losing steam. Macy's, a major seller of Michael Kors watches, didn't single out watches as a category of strength for the July quarter, and this happened for the first time in several quarters.

However, Michael Kors' expansion in Asia could help Fossil gain more traction in that region. Kors also has plans to expand its footprint in other regions, such as Europe. The company will be opening 40 stores in these areas in fiscal 2014, while 100-125 stores are planned for China going forward .

Takeaway
Fossil has done well so far in 2013, but its outlook for the current quarter put a damper on things. Looking at the long run, the company still looks positioned for growth in markets such as Asia. Its diversified product portfolio, which spans different price points, is impressive. This is why the company has done well despite shaky consumer sentiment, and could also perform well in the future.

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