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Will the Slowdown In Fossil’s Margins Continue in 2Q16?

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Margins moving southwards

Fossil’s (FOSL) margins have been in a declining trend during recent quarters. The consensus estimates expect the company to continue this trend. Fossil’s gross margins dipped 250 basis points year-over-year to 52.8% in 1Q16. The strength of the dollar brought down the gross profit to $348 million in 1Q16, which was a decline of 13%. The margin was hampered by the markdowns and marketing costs at the European outlet stores. Higher discounts compared to the previous year and lower product margins further hit the 1Q16 gross margin.

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Dismal operating and net margins

Fossil’s operating margin was 2.2% in 1Q16 compared to 7.7% in 1Q15. The consensus estimate for 1Q16 was 2.4%. The decline was due to the adverse currency fluctuation of $13 million. Operating expenses in dollar terms fell by 3.1% to $334 million in 1Q16. However, operating expenses as a percentage of sales rose by 310 basis points due to the deleveraging of fixed costs on lower sales. The acquisition of Misfit last December added another $7 million to the operating costs, which negated the effect of the decline in the total operating expenses compared to the previous year.

The consensus estimates for gross margin and operating margin for 2Q16 are 52.2% and 2.2%, respectively. Fossil’s net income margin declined to 0.9% in 1Q16 from 5.3% in 1Q15. The decline was due to an increase of 43% in interest expense.

Peer comparison

In the comparable quarters, the operating margins of peer luxury goods retailers (RFV) Michael Kors Holdings (KORS) and Ralph Lauren (RL) fell by 330 basis points and 370 basis points, respectively, to 20.4% and 6.4%. In the quarter ended March 26, 2016, Coach’s (COH) operating margin dipped by 30 basis points to 13%.

We will discuss Fossil’s valuation in the next part of this series.

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