Guess’s Shares Up On Better-Than-Expected Earnings, But There’s Nothing Promising

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Guess‘s (NYSE:GES) shares increased by over 5% after it reported Q1 fiscal 2016 earnings that were marginally ahead of its expectations. The company reported 8.4% decline in its net revenues to $478.8 million, but excluding the impact of currency headwinds, the year-over-year change was flat. Despite the substantial fall in revenues, Guess surprisingly reported profits of $3.3 million with operating margins of 0.9%, better than its earlier guidance of -1.5% to -1%. In comparison, it had reported losses of $2.1 million in the year ago period. The significant improvement in Guess’s bottomline performance can be attributed to a weak comparable period, tight expense management, a favorable impact from segment and business mix, fewer markdowns and higher initial markups. On the other hand, negative currency headwinds and the fixed cost structure for stores generating negative same store sales had a mitigating impact. [1]

While flat year-over-year change in revenues looks good for Guess, considering its past couple of years’ performance, comparable sales continued to fall across the board. Comparable sales growth in North America excluding the impact of exchange rate fluctuations and including e-commerce sales was negative 3.8%. In Europe, while retail segment performed marginally better, wholesale weakness weighed heavily on sales, bringing net revenues down 7.5% year over year. This figure was negative 6% in Asia. Fortunately, Guess’s licensing and North American wholesales revenues increased moderately by 1% and 1.4%, respectively.

Things look much worse for the company after factoring in the exchange rate. Comparable sales for North American retail and wholesale were down 5.9% and 5.2% respectively, and revenues from Europe and Asia fell 13.7% and 8.7%, respectively. Exchange rate fluctuations have pummeled Guess’s revenues more than other retailers, thanks to its business’s geographical diversification. This clearly indicates that strengthening dollar will continue to trouble Guess throughout the year. In fact, the retailer said in its press release that currency headwinds will have a negative impact of almost 9.5% on consolidated revenue growth for the second quarter and 7% for the full year.

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Our price estimate for Guess stands at $28.32, implying a premium of close to 50% to the market price. However, we are in the process of updating our model in light of the recent earnings release.

See our complete analysis for Guess

How Can Guess Improve In North America?

Buyers across the U.S. are gradually shifting to online channel due to its convenience and incentives. Foot traffic across the industry is coming down, which is impacting sales of store-based retailers such as Guess. Though the online shift is helping Guess’s e-commerce revenues, it is still losing more due to the loss of store customers. During the quarter, the retailer’s e-commerce revenues increased 14%, which isn’t enough the drive overall growth and is even too slow by Guess’s standards. The company has seen significantly better growth in its online revenues in the past, though it may have lost a substantial portion of its growth to strengthening dollar this time around. For improving its business in North America, the company needs to add a greater balance to its business model, which at the moment is heavily reliant on physical stores. Guess stated in its earnings call that it is making some progress on omni-channel integration, and will deploy other initiatives intended towards the same end.

Some portion of Guess’s underperformance during the quarter can be attributed to the West Coast port disruptions, that hampered its supply chain. However, this is just a temporary drag and its effect should neutralize in the upcoming quarters. Where the retailer actually needs to work its its merchandise portfolio. While Guess’s Marciano line delivered positive comparable sales growth despite West Coast port issues, its other brands aren’t delivering the same results. The retailer needs to leverage its Marciano strength to identify the shortcomings in the remainder of its portfolio. It should subsequently aim for a gradual product overhaul. However, this is much easier said than done. We believe that the retailer is trying hard to position its merchandise portfolio inline with consumer preferences, but its efforts haven’t yielded any promising results so far.

To improve its store productivity, Guess is looking to close its under-performing stores and open new ones at other lucrative locations. During the quarter, the company closed 11 such stores, that brought its store count to 470. [2] For the full year, Guess planned to close 60 stores and open 10 outlets across North America. Along with the negative impact of strengthening dollar against Canadian dollar, this will suppress the retailer’s revenues. However, its profitability can improve given that expenses will fall at a faster rate than revenue decline. Nevertheless, we still believe that Guess needs a wider store presence in North America to cater to a larger audience.

How Is Guess Faring In Europe?

Guess struggle in Europe is not new. Even before currency headwinds took charge, the retailer’s business was struggling due to weak consumption across its main markets. Economic growth in Italy and France has been painfully slow, arising from weak domestic demand, which is troubling retailers such as Guess. Even during the first quarter, revenues across these markets were down in low-mid single digits, despite relatively better economic environment. Since the company cannot expect a substantial rise in demand in the foreseeable future, it may have to consolidate its business and work towards distinguishing its brand image in the market. The latter will require significant effort and time with no certainty of success, since competition in these markets is already fierce. Guess may see some improvement in its performance towards the latter half of the year, but it will be more than offset by negative currency headwinds. Overall, things aren’t looking too good for Guess Europe.

Why Asia Remains A Concern?

After a runaway growth in Asia for several years, Guess lost its momentum is 2013 and continues to struggle to date. The slowdown in Chinese and South Korean economies has made its extremely difficult for Guess to match its historical performance, and currency headwinds have just made things worse. Last year, the Chinese economy did not do too well, as salary growth across the market remained weak, which negatively impacted consumer spending. The country’s GDP growth rate hit a 24-year low in 2014, and is expected to grow at an even smaller rate in 2015. [3] Hence, Guess may continue to see weak foot traffic and cautious consumer spending in 2015, forcing it to persist with aggressive promotions and discounts. In South Korea, economic growth softened towards the latter half of 2014 the country’s central bank expects the economy to slow down further in 2015, on account of lower inflation and weak consumer spending. [4] This can push Guess to go heavy on discounting this year, that can weigh on its revenue growth and margins.

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Notes:
  1. Guess Reports First Quarter Results, Guess, June 2 2015 []
  2. Guess’s Q1 fiscal 2016 earnings transcript, June 2 2015 []
  3. China’s 2014 economic growth misses target, hits 24-year low, Reuters, Jan  20 2015 []
  4. South Korea GDP Growth at Nearly 1-1/2 Year Low, Trading Economics, Jan 22 2015 []