Fossil Group, Inc.

(FOSL)
Raul Romero March 27, 2014 Ticker: FOSL (Nasdaq) Price: $115.11 Sector: Industry: Consumer Discretionary Apparel, Footwear, Accs.

Highlights
Brand Strength: Since its founding in 1984, Fossil has built a reputation for delivering quality watches that embody the sophistication and style that consumers demand. Strong Operating Cash Flows: For FY 2013, Fossil produced operating cash flow from operations of 411.7 million. For the past three years, aggregate cash flows from operations totaled 1.1 billion and 1.6 billion for a five year period. International Presence: Fossil operates in 150 countries. Over half of revenues come from international markets, a sign of effective marketing of the Fossil brand. Multiline of Watches: Watches are sold under the following brands through licensing agreements and or ownership: FOSSIL, ADIDAS, ARMANI EXCHANGE, BURBERRY, DIESEL, DKNY, EMPORIO ARMANI, KARL LAGERFELD, z MARC BY MARC JACOBS, MICHAEL KORS, MICHELE, RELIC, SKAGEN, TORY BURCH and ZODIAC.

Investment Thesis
We believe Fossil to be an attractive investment in the short and long term due to its strong revenue growth and continued earnings surprises. The competitive climate in which Fossil operates makes it vital to possess an experienced management team. The accessories sub-industry is expected to grow faster than the consolidated industry of the Apparel, Footwear and accessories segment.

Stock Performance:

Financial Metrics: Price to Sales (ttm) Price to Book (mrq) Price to CF (ttm) Price to Earnings (ttm) 5 Year Projected Growth Rate PEG Ratio Dividend Yield Return on Equity 1.94 5.98 13.68 17.63 14.17% 1.17 N/A 33.51% 6.25B

Company Description: Fossil is a well-known watch manufacturer engaging in the design and marketing of accessories such as purses, glasses, belts, clothing and small articles in addition to their main product. Founded in 1984 in Richardson, Texas, Fossil has successfully captured markets in the North America, East Asia and the European regions. Through their various brands including licenses, they have remained one of the most innovative and creative manufacturers in their industry.

Market Capitalization (M)

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INVESTMENT SUMMARY
Brand Strength Fossils has built reputation for delivering innovative products that capture the interest of consumers at all socio-economic levels. Through effective marketing, Fossil has built an image of quality and sophistication. Global distribution Fossil has established a global distribution network that is the envy of watch manufacturers around the world. Through their partnerships and acquisitions they have built a robust network of retail partners and company owned stores. Their international sales outweigh the sales from the North American continent. In 2013 55.9% of sales come from overseas, in 2012 and 2011 sales from the same area were 56.4% and 54.5% respectively. This is vital to any American company as the future of growth is in the emerging markets. Management Effectiveness Various measures of management effectiveness point to a management team that leverages experience to unlock the true potential of the company, making it a well-managed company deserving praise even from its competitors. On a trailing twelve months basis, the company has returned 33.51% on equity, 17.40% on Assets and 24.56% on investments. This beats its closest competitor, Movado Group Inc, with figures of 11.71% for ROE, 7.16% for ROA and 13% for ROI.

INDUSTRY OVERVIEW
Under the Apparel, Accessories & Luxury goods industry companies compete for consumer demand of cyclical non-essentials. This industry is broad and encompasses many clothing retailers, high-end designers of shoes and hand bags as well as shoe manufacturers and retailers among others. Due to the slow recovery of the world economy, sales in this industry are in the low single digits with growth coming in the accessories segment of this industry. Going forward, companies that can leverage newness and innovation will capture consumer demand of luxury goods.

BUSINESS DESCRIPTION
Fossils integrated business model is involved in the designing, manufacturing and marketing phases of its many lines of fashionable accessories for consumers of all socio-economic levels. Founded in 1984 and incorporated in 1991, Fossil continues to expand its presence world-wide by remaining a very competitive and agile company. Fossil was founded by Tom Kartsotis as Overseas Products initially importing vintage-style watches of the 30s and 40s and selling them to retailers and through their own stores. The style of watches were well received by the affluent masses during this time because it brought nostalgic feelings of earlier eras. Overseas Products grew quickly and soon started designing their own products and marketing them under the Fossil brand. Today Fossil is recognized worldwide as an American force in watch manufacturing and design. Fossil has a portfolio of brands that it licenses and owns, they cover the low-end all the way to the luxury level. Fossil currently sells watches under the following brands: Fossil, Relic, Adidas, Armani Exchange, Burberry, Diesel, DKNY, Emporio Armani, Karl Lagerfeld, Marc by Mark Jacobs, Michael Kors, Michele, Skagen, Tory Burch and Zodiac. Their customer base includes retail stores such as Dillard's, JCPenney, Kohl's, Macy's, Neiman Marcus, Nordstrom, Saks Fifth Avenue, Target and Wal-Mart among others. Domestically they operate 123 retail stores and 119 retail outlet stores. Fossils presence spans 150 countries through direct distribution and partnerships with retail partners who carry Fossils brands where they do not have a physical presence. At the international level they operate 214 retail and 87 outlet stores. Globally, they also manage the direct-to-consumer channel trough their websites.

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Fossil reports under four operating segments separated by regions, the North America, Europe, Asia Pacific and direct to consumer segments. Over the last few years international sales have accounted for more than 50 percent of sales. Their closest competitor is Movado Group with base operations in Paramus, New Jersey. Founded in 1961, Movados current market capitalization of 1.6 billion dollars makes it more than five times smaller than Fossil. Movado owns and in some instances licenses the following brands: Coach, Concord, Ebel, ESQ, Scuderia Ferrari, Hugo Boss, Juicy Couture, Lacoste, Movado and Tommy Hilfiger. Movado operates 35 retail stores worldwide. The following table compares both companies on key metrics of performance and effectiveness. Valuation Ratios Fossil Price/Earnings (ttm) Price/Sales (ttm) Price/Book (mrq) Price/Cashflow (ttm) 17.94 Movado 23.33 Gross Margin Profitability (%) Fossil 57.11 Movado 53.53 Return on Equity Management Effectiveness (%) Fossil 32.85 Movado 11.47

1.97

2.05

Operating Margin Net Profit Margin

17.23

11.88

Return on Assets

19.06

9.33

6.09

2.52

11.90

9.04

Return on Investment
Source:

24.56

10.93

13.68

18.30

Reuters

Except for the P/B ratio, Fossil demonstrates its superiority in efficiency and performance. Trading at a P/E of 23.33, Movado is the more expensive stock. Basing our judgment on the table, Movados premium price is not justifiable.

FINANCIAL ANALYSIS

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Balance Sheet

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Income Statement

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Cash Flows Statement

Sales from the year 2010 to 2011 increased by 30%, from 2011 to 2012 to 11.54% and 2012 to 2013 to 13.79%. Net income has increased 15.48%, 16.53% and 10.13% for the same time periods. At the balance sheet level, total assets have increased 6.67%, 12.50% and 22.22% over the last three years.

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GROWTH DRIVERS
Growth will come from different areas for Fossil. Growing the amount of sales through the direct-to-consumer channel via retail stores and e-commerce is key to increased profitability. As of last year, sales from the direct-to-consumer segment represented 25% of sales, a substantial number. Through increased marketing of this channel, Fossil can expand the amount of shopping that is generated through this segment. The trend of consumers shopping online will be on Fossils side in the long term and short term. Though Fossil has operations in a great span of countries, some regions remain underpenetrated, namely the Asia-Pacific region. Last year, sales from this region amounted to 12.2%. China will remain a key battleground/opportunity for all retailers industry-wide. The increased number of people gaining middle-class status in this country will drive demand for quality products. Generally, American-made products hold a level of prestige to domestic offerings. This perception will help American firms overall and in the watch industry there, Fossil can leverage its resources to increase brand awareness and can expect to gain customers. As we transition to an ever-connected society, mobile computing will continue to gain perennial status in daily life of first-world consumers. One recently created product is the smart-watch. A watch capable of receiving calls, displaying the weather, measuring steps, taking pulse and running various apps among top capabilities. More specifically, these are the features of the Samsung Gear smart watch. Though this market still in its infancy, innovation and newness is generally well received by consumers who seek the latest and greatest technological product. Currently, Fossil is not marketing a smart watch, however, th on March 18 Google announced that it had partnered with Fossil to create the first smart watch running the Android OS. This partnership should be considered a great accomplishment for the company given the size and expertise of Google. With Fossils acumen in watch design and manufacture and Googles software, we can expect a product that has the looks and brains in this new watch. Earnings and Earnings Quality For the last four reported quarters, Fossil has beat analysts EPS and revenue estimates. For the quarter ended March 2013 analysts expected .97 in EPS and 650.91 in revenue, Fossil came in at 1.10 in EPS and 680.90 in revenue percentage differences of 13.57 and 4.61 for EPS and revenue. In the quarter ended June 2013 Fossil delivered EPS surprise of 23.55% and 2.17% surprise for revenue. For quarters ended September and December surprises for EPS were 2% and 4.98%, respectively. In revenue, Fossil delivered surprises of 4.98% and 4.15% for revenue. In the short term, Fossil is expected to follow the trend of delivering surprises. Cash Flow Cash flows from operations have remained positive for that last five FY. For FY 2013 cash flow from operations was $411,682,000, cash flow from investing was (123,168,000) while cash flow from financing activities was (149,249,000). Cash flows from operations for the previous four years were 451,600,000, 251,267,000, 209,177,000, and 265,988,000. Fossil has history of producing strong operating cash flows and this trend is expected to continue into the future.

VALUATION
The market capitalization of Fossil puts in in the mid-cap range due to a value of 6.32 billion. Movados market capitalization stands at 1.20 billion. Fossils stock returned 24.63% over a one year period.

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Constructing a Pro-forma income statement for the next five years yields the following figures using growth rates of 10,8,6,5,5 percent.

Pro-forma Revenue COGS Dep & Amr Gross inc General Exp Total Oper & E Operating Income Interest Expense Pre-tax Inc Income Tax Minority Int Net Income

10% 2014 3,630 1430 90.09 2090 1430 2970 624.14 10.45 617.65 -190.74 -10.89 416.02

8% 2015 3920.4 1544.4 97.2972 2257.2 1544.4 3207.6 674.07 11.29 667.06 -206.00 -11.76 449.30

6% 2016 4155.624 1637.06 103.14 2392.63 1637.06 3400.06 714.52 11.96 707.09 -218.36 -12.47 476.26

5% 2017 4363.41 1718.92 108.29 2512.26 1718.92 3570.06 750.24 12.56 742.44 -229.28 -13.09 500.07

5% 2018 4581.575 1804.863 113.7064 2637.877 1804.863 3748.562 787.75 13.19 779.56 -240.74 -13.74 525.08

Under this scenario, the following are the calculations for EPS while maintaining managements decision to continue share buybacks at the rates of the previous years.

Decrease in S/O Forward PE

-0.03 17 Stock Price

2014 55.97 7.43 126.36

Shares to calculate EPS 2015 2016 54.29 52.66 EPS 8.28 9.04 140.69 153.75

2017 51.08 9.79 166.43

2018 49.55 10.60 180.15

Under these models, Fossils stock is expected to rise $126.36 per share, an 8% increase in price. This is a conservative estimate as analysts expect the price to reach $135 per share at the end of the year or an appreciation of 15.44%. These numbers are attractive when taking in consideration the strength of Fossil in many regards.

In summary, our valuation reveals that Fossil is an attractive investment due to its low P/E multiple given the growth that it has experience and will continue to experience going forward. For this reason we rate Fossil a BUY.

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INVESTMENT RISKS
The following risks can negatively influence the performance of the stock: Negative reception of watch styles Currency fluctuations Lackluster demand for product in the emerging markets Deceleration of growth Lower margins Higher costs than expected in new store openings Low demand for its other accessories

CONCLUSION
Fossils strengths can be seen in its financial statements as well as in retail stores alike. We believe this company will continue its trend of delivering stellar performance as it continues to grow internationally and to a lesser extent domestically. By having a diversified portfolio of brands for its watches and accessories, Fossils has broadened its appeal to the affluent as well as the masses. Management has done a well job at increasing the companys performance in terms of equity, asset, investment, and margin returns. Overall, we expect Fossil to appreciate in price as a result of its competencies for the long term.

Robert L. Kieshnick Endowed Student Investment Corporation

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