Iconic clothing brand Guess? (GES +0.00%) released an earnings report this week that beat Wall Street expectations, yet the stock sank more than seven points the following day. So what happened? Well, compared to the year-ago quarter, GAAP earnings contracted sharply, driven down by weak margins. Guidance for the coming year suggests another period of major year-over-year contraction. With the continued tepidity in the macroeconomic environment, and the strong market disfavor, can Guess? pull itself out of its rut, or would investing in this stock today be tantamount to catching a falling knife? Let's take a closer look at earnings and guidance to see.
Beat, then beaten
Guess?' stock did a funny thing this week. In this myopic market where earnings estimates are quarterly deities, Guess?' results actually surpassed expectations, only to have the stock drape down like a poorly hung pair of jeans.
For the fourth quarter of 2012, the company hauled in $815.1 million -- a reasonably large premium to the Street's expectations of $785.4 million. On the bottom line, earnings per share ticked down to $0.95 per share -- a solid $0.08 above Capital IQ's analyst consensus estimate. The company earned $1.05 per share in the fourth quarter of 2012.
Gross margins fell 270 basis points to 40.8%, with operating margins contracting roughly in line -- down 280 basis points to 14.7%. The biggest fall was in net income margin, down a troubling 350 basis points from the year-ago quarter to 8.9%.
Even though the bottom line did contract when compared to the prior year, the Street was apparently expecting this already in its pricing. So why did the stock tumble? It seems that regardless of analyst estimates, a year-over-year earnings decline of nearly 30% was perhaps just too much for investors to stomach. This news also comes on the heels of a key executive leaving the company.
Guess? is in the midst of a turnaround effort, which investors have little patience for these days. Does this create an opportunity for the value-oriented investor?
Business climate
Regardless of the weak margins and unexciting guidance, Guess? did have some bright spots to report for the fourth quarter. Even though European conditions were weak overall due to a dismal Southern European economic climate, the company's efforts in Russia grew triple digits year over year, along with 40% growth in its German market. Guess?' Asian business grew 20% overall, with China leading the pack at 30% year over year. The company's South Korean business has grown at 25% compounded annually for the past five years. On the e-front, management expects to double its current website revenue in the next three years.
These are all extremely encouraging results.
As far as outlook goes, the first half of the year looks to remain soft, with comparable sales down in the low teens. The company is in the midst of transforming its product mix, though, and this should result in better numbers starting at mid-year. For the current quarter, management expects just $0.05 to $0.10 per share in earnings, which is drastically down from prior-year numbers. Full-year earnings guidance comes in at $1.70 to $1.90, compared to $2.15 in adjusted EPS for the just-closed year.
Well, it looks like we found our culprit for the stock dive.
Valuation
At the low end of guidance, $1.70 in earnings, Guess? currently trades at a forward P/E of 14.7 times. That compares to market darling Ralph Lauren, which is growing and wowing investors, trading at 18 times forward earnings. Recent turnaround story Gap is flirting with its year high and trading at just 12 times (F)P/E. That puts a troubled Guess? in between two winning stocks, while Guess? itself is a contracting business for the next year or so.
Looking out just 12 months, Guess? is not a great buy at this price. Yet the company's cost-saving efforts and international expansion could make a two or three year forecast quite appealing at today’s price. If the company were to return to its 2013 earnings figure of $2.15, that implies a P/E of 11.6 times. Realistically, the company should not only be able to return to these numbers, but surpass them if management's efforts yield their expected fruit. With the recent departure of North American president Nancy Shachtman, though, it appears the restructuring effort is hitting some unexpected bumps.
Guess? may further contract throughout the first half of the year, giving investors a more favorable entry point for a long-term hold. At this point, I recommend waiting for a price that ensures little downside risk.
