When mobile phones flooded the market, there was a lot of concern that the need and desire for watches would decline. That hasn't happened, and many investors missed out on an opportunity to buy low on apparel and accessories stocks that were squeezed by that anxiety. However, it looks like a similar opportunity is forming now.
Watches are still a huge market for retailers, estimated at $60 billion a year globally. Yet the risk that smart watches will take some market share from conventional watches is very real. However, the threat currently applies more to the U.S. than other major growth areas.
With the rise of smart watches on the horizon, some investors are again shunning the major watchmakers. But one of the big problems with smart watches is that they haven't yet become fashionable.
Fossil (Nasdaq: FOSL) has been one of the most pressured stocks due to the notion that smart watches might eat into the market share of conventional watches. The retailer is essentially flat over the past two years.
The sale of watches has remained strong throughout the financial crisis. From 2010 to 2012, industry sales grew at an annualized rate of nearly 30%. By comparison, sales of leather goods and jewelry grew at annualized rates of 14% and 11%, respectively, in that time.
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However, the U.S. only makes up about 20% of the global watch market. Asia and Europe make up close to 40%. Currently, China accounts for a small part of the global market, but this could change quickly as its middle class continues to grow at an explosive rate.
|Despite slow traffic in U.S. stores, Fossil managed to post an impressive fourth quarter, thanks to marked growth in Europe and Asia.|
Asia holds a lot of promise for Fossil, which holds less than 2% of the market in the region. Fossil is still building out its infrastructure there, so its growth in and returns from the area have been less than some investors might like. Once its full build-out of marketing and IT is completed, I'd expect the return on investment from Fossil's Asia investments to be quite compelling.
Up until now, Fossil's presence in Asia has mainly been in the slower-growth area of South Korea. However, as China accounts for a larger share of revenue, Fossil's growth should accelerate in the region. In China, the common practice is to open shops-in-shops, which allows Fossil to quickly expand, often by opening several stores in the same mall.
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Despite slow traffic in U.S. stores, Fossil managed to post an impressive fourth quarter, thanks to marked growth in Europe and Asia. The company should continue to be resilient when it comes to beating earnings consensus. Fossil beat earnings every quarter last year by an average of 18%. Fossil should also see some improvement in its direct-to-consumer segment and North American retail market as the U.S. economy continues to rebound.
Fossil has also done a great job of expanding its brand. Beyond watches, Fossil is making the move into other accessories. Watches still make up three-quarters of its revenues, but it's quickly increasing its exposure to leather goods and jewelry. It not only sells the Fossil brand watches, but has also added Skagen and Michele to its brand portfolio. It also has licensing agreements with Armani and Michael Kors (Nasdaq: KORS).
Despite being a growth story, Fossil has done a good job of in rewarding shareholders. During the fourth quarter, the watch company spent over $120 million to buy back more than 1 million shares. For the full year 2013, Fossil bought back over $575 million in shares, twice as much as it spent in 2012.
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Risks to Consider: Fossil's plans to enter the Asia market are not without risks. A big part of its growth story relies on a successful expansion in China, as well as an expanding middle class in the country. Any hiccups here could delay growth. As well, if global smart watch adoption is faster and more widespread than expected, it could hurt Fossil's watch sales.
Action to take --> Buy Fossil for upside to $150. Using a price-to-earnings (P/E) multiple of 21 -- below the industry average, but in line with its average before the financial crisis -- on expected 2014 earnings per share of $7.21 suggests that FOSL will be trading at over $150 in less than a year. That's better than 25% upside from its current price just shy of $120.