Fossil (NASDAQ:FOSL) lost nearly 90% of its market value over the past five years as demand for its watches faded. Its annual revenue fell for four straight years, and analysts expect that losing streak to continue for at least two more years.

Yet Fossil now trades at less than 0.3 times this year's sales, so contrarian investors might be wondering if a rebound is overdue. Let's examine its current challenges to see if Fossil is actually a deep value play.

A Fossil ad with a smiling woman in a restaurant displaying her watch

Image source: Fossil.

What happened to Fossil?

Fossil sells its own watches, licensed watches for other brands like Capri Holdings' Michael Kors, and other fashion accessories. Fossil once turned heads with unique watch designs (like animated watch faces), but subsequent designs failed to stand out in the crowded midrange watch market.

Weak marketing campaigns failed to bring back shoppers, and a glut of off-price items in outlets and wholesale channels diluted Fossil's brand and pricing power. Younger shoppers also drifted away from traditional watches as they checked the time on smartphones, while the rise of smartwatches -- which bridged the gap between the two products -- left Fossil behind the tech curve.

Fossil tried to keep pace with its own fitness trackers (by buying Misfit) and smartwatches, but it still struggled to gain ground against market leaders like Apple (NASDAQ:AAPL). Millennial shoppers warmed up to upscale mechanical watches as status symbols over the past two years, but that recovery didn't lift demand for Fossil's midrange devices.

Can Fossil make a comeback?

Fossil's revenue has been in a constant decline since 2015, but its gross margin expanded last year:

Metric

2014

2015

2016

2017

2018

Revenue growth (YOY)*

8%

(1%)

(4%)

(7%)

(13%)

Gross margin

57%

54.3%

51.9%

48.7%

52.7%

Data source: Fossil. YOY = Year over year. *In constant currency terms.

Fossil attributed that improvement to a favorable comparison with 2017, when it struggled with an unsold glut of fitness trackers and smartwatches; fewer promotions and markdowns; a more favorable product mix of higher-margin devices; favorable currency rates; and benefits from its NWF (New World Fossil) turnaround initiative.

The NWF plan consists of two major phases. The first phase, which wraps up this year, mainly focused on cost-cutting initiatives. The second phase, which is expected to last through 2020, focuses on identifying growth markets, improving the speed at which its products reach the market, and optimizing its prices.

But can Fossil ever grow its revenue again?

Those initiatives stabilized its gross margin in the first half of 2019, but its revenue continued to decline:

Metric

Q1 2019

Q2 2019

YOY revenue growth*

(15%)

(11%)

Gross margin

53.3%

52.9%

Data source: Fossil. YOY = Year over year. *In constant currency terms.

The company expects its third-quarter sales to decline 8% to 12% annually and for its gross margin to come in between 52% and 53%. It also expects its revenue to fall 8% to 12% for the full year.

The main problem for Fossil is that it still doesn't have a clear path toward growing its revenue again. The company is pegging its future on new smartwatches, but it faces a brutal uphill battle against Xiaomi, Apple, Huawei, Fitbit, and Samsung.

Those five companies controlled 65.4% of the wrist-worn wearables market in the second quarter, according to IDC, up from 54.1% a year earlier. This indicates that the market for lower-tier smartwatch makers like Fossil is rapidly shrinking. By comparison, Apple said its wearable sales rose over 50% annually last quarter.

Fossil also sold some of its smartwatch tech (and part of its research and development unit) to Alphabet's Google earlier this year, and that downsizing could make it tougher to keep pace with the market leaders.

Fossil's newest Wear OS smartwatches

Image source: Fossil.

Fossil is also expanding its presence in higher-growth markets like China and India. Its sales in Asia are certainly improving (with 9% constant currency sales growth last quarter), but they still aren't offsetting its double-digit declines in the U.S. and Europe.

Fossil is also expanding its e-commerce and DTC (direct-to-consumer) capabilities as it reduces its brick-and-mortar store count. However, a lower store count also reduces the visibility of Fossil's fading brand, while the ongoing reduction of its marketing expenses could curb its ability to attract shoppers with aggressive marketing campaigns.

There are better value stocks on the market

Fossil's stock might look cheap relative to its annual revenue, but its forward price-to-earnings ratio of 18 isn't cheap for a company with negative revenue and earnings growth. It also doesn't pay a dividend.

By comparison, Apple trades at just 19 times forward earnings, has a forward dividend yield of 1.3%, and is a better-diversified business with more irons in the fire. Therefore, value-seeking investors should avoid Fossil and stick with better-run companies with comparable valuations instead.