As specialty apparel retailer Guess (NYSE:GES) comes out with its Q3 fiscal 2014 earnings on December 4, it might find it difficult to improve its performance. We believe that the retailer’s growth will be slow due to sluggish economic recovery in Europe, pullback in Chinese consumer spending and an edgy retail environment in the U.S.
During the second quarter of fiscal 2013, Guess’ revenues from Europe increased by 1% but declined 3% in local currency. This revenue decline was not as intense as what the company has seen in the previous quarters. Good results from Russia, Germany and other new markets along with the marginal economic rebound in the eurozone had a slight offsetting impact on the results. However, the glimpse of economic recovery in eurozone vanished in the third quarter as consumption slowed down. This is likely to keep Guess’ recovery in Europe at bay.
In China, consumer spending growth remains sluggish, which can translate into another weak quarter for the retailer’s Asian business. In North America, a highly promotional environment and a change in consumer spending patterns may well be reflected Guess’ results.
Our price estimate for Guess stands at $35, which is roughly inline with the market price. We will update our price estimate post earnings release
Weakness In Europe To Continue
Guess has been struggling in Europe for some time now due to the economic crisis. Its revenues from the region declined by 7% in fiscal 2013 and 13% in Q1 fiscal 2014. The retailer’s revenues declined by a further 3% (in local currency) despite strong results from Russia, Germany and other new and under-penetrated markets. This is attributable to the fact that some of Guess’ more mature markets are still reeling under the impact of economic crises. Even though eurozone showed some signs of economic recovery in the second quarter, with faster than expected growth in Germany and France, it was not enough to boost Guess’ results in its other markets. 
After showing signs of recovery in the second quarter, economic growth in Eurozone slowed once again. While the region’s economic growth stood at 0.3% in the second quarter, it was just 0.1% in the third. Germany’s GDP growth rate settled at 0.4%, following 0.7% growth in the second quarter. French GDP remained flat after registering a strong growth of 0.5% in the second quarter. Spain’s GDP growth also remained flat and Italy turned out to be among the weakest performers.  Since individual consumption accounts for 70% of eurozone’s GDP, it is clear that weak consumer spending is the main contributor to the sluggish economic growth.  Therefore, we expect Guess’ weak performance in Europe to continue in the third quarter.
Weak Consumer Spending Can Undermine Efforts In North America
During the second quarter, Guess’s North American comparable store sales declined by 2%. Though this is not a pleasing picture for the retailer, it was still better than its first quarter performance (-10%). Guess realized healthy growth of 25% in its direct-to-consumer revenues which had an offsetting impact on the comparable store sales decline. We expect this growth to continue in the third quarter as well. Additionally, the retailer is taking several measures to address problems such as lower store traffic, lack of competitive prices, absence of popular fashion trends etc. Guess appointed a new design head to specifically focus on its product designs and added more product categories to its opening price tier. It increased its denim offerings and iconic styles at opening prices of $75-$95, while the majority of its apparel products were previously in the $108-$148 price range. Guess stated that the customer response to these products was good. Additionally, the retailer hired Mike Relich ,who has 30 years of retail experience as chief operating officer, to lead supply chain, omni-channel and process improvements. With enhanced focus on inventory management, Guess entered the third quarter with a clean inventory position which would allow it to introduce new fashion and operate with fewer markdowns.
Despite these efforts, we believe that the retailer will report slower growth in the third quarter on account of the prevailing weakness in the U.S. apparel industry. Pressurized by slow job growth, higher healthcare and gasoline costs, and the payroll tax hike, U.S. buyers are spending less on discretionary products this year. Moreover, they have diverted some of their spending to cars and houses to take advantage of low mortgage rates. This trend has hit a number of apparel retailers in the U.S. and we expect Guess to feel its impact as well.
Fading Consumer Spending In China Will Hurt Asian Results
Guess’ Asian revenues have grown at a tremendous pace historically, but they declined by 1% in Q2 fiscal 2014 mainly due to weak results from China. The company stated that the recent pullback in the consumer spending in the region was the main reason for this dismal performance. Though the region’s apparel market is set to boom in the long term, the near term outlook does not seem as pleasing.
Salary growth of Chinese consumers is slowing down, which is directly impacting the region’s consumer spending. This is hampering the retail market growth, which in turn is weighing on China’s economic growth. The region’s GDP growth rate decelerated to 7.5% in Q2 from 7.7% in Q1, and the outlook for the year was lowered to 7.5%. This is China’s slowest economic growth since 1990.  This clearly suggests that consumption will remain weaker during the rest of the year, which will create roadblocks for retailers’ growth. Hence, we expect another weak quarter for Guess’ Asian business.Notes:
- Germany, France haul eurozone out of recession, Reuters, Aug 14 2013 [↩]
- Euro Zone Q3 GDP Preview: Recovery Lacks Momentum As Growth Slows In Germany, France, International Business Times, Nov 12 2013 [↩]
- Consumers and the recession: Trends in Eurozone consumer spending, Deloitte University Press [↩]
- China Falters In Efforts To Boost Consumption, The Wall Street Journal, July 16 2013 [↩]