In 2012, Guess (NYSE:GES) witnessed a sharp decline in its revenues from Europe due to its over reliance on the region’s southern countries, which have been significantly impacted by the debt crisis. Since European business is the most valuable segment for the retailer, it needs to address this issue soon. Guess now plans to target under-penetrated markets in northern and eastern Europe. The results from Russia and Germany have been encouraging. For the southern region, the retailer is undertaking heavy promotional activities to attract customers. While these strategies might help Guess, fierce competition and varying customer preferences are causes for concern.
Problems In Europe?
Guess is facing problems in Europe mainly due to the unfavorable economic environment and its high concentration in the worst hit southern Europe. The retailer operates more than 600 stores in the region.  As a result, it earns more than 60% of its revenues from this region and has high exposure to countries such as Spain, Italy and Greece, where economy remains weak. In addition to this, the retailer runs the risk of self-cannibalization due to its high concentration in these markets.
Since the European business accounts for about 40% of Guess’ revenues, the weakness has impacted its overall performance. In 2012, Guess’ revenues from Europe decreased by 7%, dragging its overall revenues down by 1%.  Other players such as Nike (NYSE:NKE), Abercrombie & Fitch (NYSE:ANF) and Gap (NYSE:GPS) have also struggled in sustaining their growth in Europe.
What’s The Solution?
The northern and eastern regions of Europe remain relatively untapped. Over the longer run, Guess plans to expand aggressively in Russia and Germany, which have generated promising results so far.  Although the revenue contribution of these markets is presently low, the company expects business to increase by two to three times over the course of next five years.
Russia is becoming an important market in Europe as it remains relatively untapped.  According to McKinsey, apparel space per 100,000 Russians is only 37,600 square feet, which is just 10% of what it is in the U.S.  Despite having lower per capita income as compared to Russia, Brazil has larger apparel space. Moreover, Russians tend to spend about 3.1% of their income on apparel, which is noticeably more than China, Germany and the U.S.  This clearly indicates the growth potential of Russia’s apparel market.
Through 2015, McKinsey expects the region’s apparel market growth (8%) to remain faster than the income growth (7%). Germany is the largest apparel market in Europe, generating $75+ billion in total apparel sales, but its growth has been slow (CAGR of 0.8% from 2005-2009).   However, Guess’ revenues from the region have increased substantially over the past few years.  We believe that the retailer can leverage Germany’s growing e-commerce channel as well as the fact that fashion-focused retailers have been successful in the region. 
In southern Europe, Guess is offering heavy discounts in order to drive its store traffic. Due to this, Italy, which contributes 15% to the retailer’s revenues, generated relatively better results in Q3 last year as compared to other regions such as Spain and Greece.  Although discounts can negatively impact the comparable store sales growth, it still seems to be the right way to go.
Although the weak economic environment in Europe poses a near term threat, Guess appears to be moving in the right direction. We believe that the retailer’s basic growth fundamentals are strong enough to outweigh its short term troubles.
Guess has been in Europe for a long time and has built very strong relationships with specialty retailers and department stores. In Europe, the company sells its products through large department stores such as Galeries Lafayette and Printemps in Paris, and El Corte Ingles in Madrid, as well as through smaller upscale boutiques. The retailer has established a strong brand image by combining product design, in-store experience and marketing.
If Guess’ efforts revive its growth in Europe and its revenues from the region reach $1.25 billion instead of our current forecast of $1 billion within the next 5-6 years, there can be 5%-10% upside to our price estimate. However, this will not be easy due to fierce competition from retailers such as Ralph Lauren (NYSE:RL), Burberry, Gap and J Crew. Also due to difference in preferences between northern and southern Europeans, Guess is likely to face problems in getting the right product design and mix.
Our price estimate for Guess stands at $27, implying a premium of about 5% to the market price.Notes:
- (Guess’ Q4 Fiscal 2013 earnings transcript, March 20 2013 [↩]
- Guess’ SEC filings [↩]
- Guess’ Q4 Fiscal 2013 earnings transcript, March 20 2013 [↩] [↩]
- Clothing Companies Flock To Russia in Search of Untapped Revenue, Russia Beyond The Headlines, Jan 14 2013 [↩]
- Dress For Success: Cracking Russia’s Apparel Market, McKinsey, Nov 2011 [↩] [↩]
- Apparel In Germany, Euro Monitor, April 2012 [↩] [↩]
- Germany: clothing industry guide, Research and Markets, March 2011 [↩]
- Guess’ Q3 fiscal 2013 earnings transcript, Nov 28 2012 [↩]