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Near a 15-Year Low, Is Fossil Group a Buy?

By Leo Sun – Jun 15, 2017 at 5:34PM

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Is the struggling watchmaker a contrarian play or a falling knife?

Five years ago, Fossil (FOSL -1.79%) was worth nearly $140 per share. Today, it's worth about $10 -- which marks a 15-year low for the stock. What happened to this once-hot maker of watches, leather goods, and jewelry? Let's take a look at Fossil's meltdown, and whether or not it can be considered a contrarian play for daring investors.

What happened to Fossil?

Fossil's last year of revenue growth was 2014, when its sales rose 8% to $3.51 billion. This was followed by an 8% decline in 2015 and a 6% drop in 2016. Wall Street expects Fossil's sales to drop another 5% this year.

A Fossil ad featuring actress Kristen Bell.

Image source: Fossil.

Fossil's bottom-line numbers are even worse. After posting 7% earnings growth in 2014, its earnings plunged 36% in 2015 and 64% in 2016. Wall Street expects another 48% decline this year. This is what happened to Fossil's operating margins between 2014 and 2016:

FOSL Operating Margin (TTM) Chart

Source: YCharts

Fossil attributes those declines to the saturation of the mid-range watch market, off-price items from outlets and wholesale channels diluting its brand and pricing power, soft demand for its leather and jewelry products, and tough foreign exchange headwinds. Nonetheless, Fossil's full-year sales would still have declined in 2015 and 2016 on a constant currency basis.

In addition to its namesake brand, Fossil produces a wide range of licensed watches for other brands like Michael Kors, Kate Spade, and Armani, but many of those watches are also struggling to stand out in the crowded mid-range watch market. The ongoing decline of "affordable luxury" brands like Michael Kors and Kate Spade has further throttled demand for their licensed watches.

How does Fossil plan to turn things around?

Fossil is relying heavily on international markets for growth. However, its only meaningful growth comes from Asia, where revenues rose 4% in fiscal year 2016 and accounted for 17% of its top line. Unfortunately, that growth couldn't offset an 8% sales decline in the Americas and a 6% decline in Europe.

Fossil, like many other watchmakers, is also trying to attract tech-savvy shoppers with fitness trackers and smartwatches. These products include its Q-series smartwatches and fitness trackers, wearable devices from Misfit (which it acquired in 2015), as well as branded smartwatches for Michael Kors, DKNY, Marc Jacobs, Relic, and Tory Burch.

An ad featuring different angles of Fossil's Q Grant hybrid smartwatch.

Fossil's Q Grant hybrid smartwatch. Image source: Fossil.

For many of these brands, Fossil offers "hybrid" smartwatches, which retain the analog style of traditional watches while adding digital features like motion tracking and notifications. Fossil says that these devices generated 7% of the company's sales last quarter, with 75% of that total coming from smartwatches.

Fossil's wearable sales rose 400% from the prior year quarter, when it offered far fewer devices. Looking ahead, Fossil claims that it can "triple" its penetration of wearable revenues as it rolls out more brands.

But despite that enthusiasm, investors should note that sales of Fossil's watches still fell 6% last year and another 9% during the first quarter -- so its wearables unit needs to grow very rapidly to offset its slowing sales of traditional watches. This could be tough, considering the Apple Watch currently dominates the high-end smartwatch market.

As for jewelry and leather products, which together accounted for 21% of its sales last quarter, Fossil believes that design improvements and pricing adjustments could generate higher sales. However, it could be tough to revive interest in Fossil's leather and jewelry products with so many competitors in both markets.

The valuations and verdict

Even after falling more than 90% from its all-time high, Fossil still doesn't look cheap. It currently trades at 21 times earnings, which merely matches the industry average of 21 times for fashion accessory makers. It's P/S ratio of 0.2 is well below the industry average of 1.9, but that valuation could climb as its revenue keeps falling.

If you believe that Fossil's Q-series wearables and licensed smartwatches can sell well enough to offset its falling sales of traditional watches, then the stock might be a worthy turnaround play. But if you believe that the smartwatch market is still too much of a niche one to bank an entire company's future on, then you should avoid Fossil at all costs.

Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of and recommends AAPL. The Motley Fool owns shares of KORS. The Motley Fool recommends Fossil Group, Inc. The Motley Fool has a disclosure policy.

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