Fossil Stays at Neutral (FOSL)

We maintained a Neutral rating on Fossil, Inc. (FOSL) following appraisal of the first quarter 2012 results.

Fossil posted earnings of 93 cents per share in the first quarter exceeding the prior-year earnings of 86 cents per share, driven by double-digit sales growth, foreign currency gains and lower share count. The results also exceeded the Zacks Consensus Estimate of 92 cents per share, and were above management’s guidance of 90-92 cents per share.

Worldwide net sales of Fossil during the quarter grew 9.8% to $589.5 million, reflecting double-digit sales growth across all of the company's operating segments. On a constant currency basis, sales increased 11.1%, reflecting strong sales growth in all major watch brands and a growth in the leather business. However, sales lagged the Zacks Consensus Estimate of $618 million. The company also missed management’s expectations of a 15% growth in sales in the quarter.

We are optimistic about the company’s portfolio which has many recognized brand names such as Adidas, Armani Exchange, Burberry, Diesel, DKNY, Emporio Armani, Marc by Marc Jacobs, Michele, Michael Kors, Relic and Zodiac. The company has extended its product categories of existing brands with the introduction of jewelry collections under some of its brands and has introduced soft accessories under its Fossil brand name.

Fossil has a significant exposure to the international markets which has been driving its long-term growth. The company has penetrated the international markets by forming and acquiring subsidiaries operating outside U.S. The acquisition of privately held Nevada-based Skagen Designs, Ltd. (early April 2012) is expected to help Fossil to expand its brands in the markets of Europe and other emerging markets of East Asia, where Skagen has a significant presence. We believe that expansion in international markets will boost the company’s growth over the long term.

However, the company is generating weak margins due to a rise in production costs. Inflation in costs of watch components and labor costs throughout the year, along with increases in sales to off-price retailers impacts the margins of the company. Fossil continues to expect the prices to continue to rise through 2012.

Further, a difficult macro-economic environment is likely to continue in 2012, reflected in interest rate hikes, credit availability, unemployment levels, and high household debt levels. The continued softening macro-economic environment in Europe also poses a threat. The company remains exposed to unfavorable foreign currency translations and faces the risk of import restrictions such as antidumping or countervailing duties, tariffs or other restrictions, due to international transactions. The weak economy and the rising costs keep us on the sidelines.

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