Guess What? Asia Might Boost Guess’s Stock Valuation In The Future

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Guess (NYSE:GES) has been grappling with its Asia business since 2013. After witnessing significant growth in revenues in Asia for several years, Guess’s Asian operation lost steam in 2013 as its net sales increased by just 0.4%. In 2014, Guess’s revenues in Asia declined by 4% to $281 million, primarily due to the macroeconomic weakness in its core market, China. However, we have reasons to believe that Guess’s Asia business might recover in the coming years. Two important reasons for this are China’s economic recovery, which may already have been set in motion, and Guess’s newly appointed CEO who has a successful history with Inditex in Asia, and wishes to focus on Guess’s Asian business growth. In the event that Guess’s performance in Asia improves significantly over our forecast period, there could be a meaningful positive impact on our stock price estimate for the company.

Our price estimate for Guess stands at $24, implying a premium of over 10% to the market price.

See our complete analysis for Guess

China’s Recovery And Retail Sector Growth

1. Is China Rising Out Of The Slump?

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The Chinese market in 2014 performed poorly due to weak salary growth which, in turn, dampened consumer spending. The country’s GDP growth was at 24-year low in 2014. In line with this, we’d predicted that 2015 will also not be a great year for Guess’s Asia business. However, things are changing, and we believe for the better. Here’s why:

According to a research report in the Wall Street Journal, by China Beige Book (CBB) – a survey of 2,000 Chinese firms, the Chinese economy is finally recovering from its disappointing performance over the last few quarters. According to the CBB data, revenues, capital expenditure, domestic orders, hiring, wages, and the profit levels were some of the parameters that showed improvement in Q2 2015. The labor market had demonstrated improvements of both wages and employment. The input costs and sales prices have also increased, implying that China might be slowly recovering from its deflationary environment. [1]

According to the study, the second quarter improvement is based on expanding sales volumes by firms, without the sacrifice of profit margins. The reason for the growth was stronger sales instead of greater investments, and that can be construed as real improvement, as China seemed to be suffering from a chronic problem of excessive  investment without a concomitant rise in consumption. [1]

The gains were also noticed in the real estate and retail sectors. Retailers in China reported the second consecutive quarter of improvement. The retail sector grew at a faster rate than manufacturing for the first time in the last 18 months. However, the retail growth was fueled mainly by business to government. [1] Nevertheless, the improvements do bring out optimism that China might be finally on the track to recovery.

2. China’s Retail Sector Promises Of Good Times In The Future

According to another report by PricewaterhouseCoopers (PwC), China is forecast to be the global leader in retail markets by 2018, however, the growth will be at a slower pace, and the focus is shifting from physical retail towards the e-commerce channels.

China

 

(Image Source: 2015-2016 Outlook for the Retail and Consumer Products Sector in Asia, PwC)

The fast fashion firms, that are rapidly bridging the gap between luxury and standard apparel, are expected to grow rapidly, especially in China and India.

fast fashion

(Image Source: 2015-2016 Outlook for the Retail and Consumer Products Sector in Asia, PwC)

Over the next five years, the Asian clothing and apparel sector is expected to grow at the rate of 9.5%, surpassing the growth rates of all other regions of the world.  As more poor households move up towards the middle-income bracket, their fashion consciousness is also expected to rise. Also, demography-wise India and China had a combined population of 2.6 billion in 2013, comprising 37% of the world’s population. As the population grows, there will be a resultant increase in apparel demand. Consumer expenditure on clothing and footwear is forecast to reach around $920 billion in 2018 from $625 billion in 2014. Out of this, the China market will alone account for around $500 billion in 2018. In 2014, Inditex, the global leader in apparel, opened its 500th store in China. Also, companies like GAP, Fast Retailing, and H&M are rapidly expanding in China. Other than China, countries such as South Korea, Taiwan, and South-East Asia are also on the radar for further expansion by the leading fashion brands. [2]

clothing market demand

(Image Source: 2015-2016 Outlook for the Retail and Consumer Products Sector in Asia, PwC)

Guess’s Newly Appointed CEO Has A New Game Plan With A Focus On Asia

In July, Guess had appointed Victor Herrero as the Chief Executive Officer of Guess Worldwide. This is the first instance in which someone outside the Marciano family assumed the position. Mr. Herrero has a successful past with the global apparel leader, Inditex, where he built a $4 billion business in Asia after starting from scratch. Guess’s strategic appointment of Victor Herrero suggests that it is striving to make a turnaround in its current lackluster performance. Victor Herrero is famous for having caused some major disruptions in the fast fashion industry. So, we can expect him to use his past expertise to try to make Guess a successful retailer once again.

In Guess’s Q2 FY2016 earnings call, Mr. Herrero had laid down a 5-pronged strategy to revive Guess. [3] You can read more about Guess’s performance and future course of actions, here.

Along with the initiatives of improving pricing strategies and attaining a flatter organizational structure, Mr. Herrero has specifically talked about the company’s future focus on Asia. Asia contributes to around 10% of Guess’s revenues currently (amounting to ~$250 million). Mr. Herrero aims to increase the contribution to $750 million or around 25% of the company’s total revenues.

We currently forecast Guess’s revenues from the Asian operations to increase from around $250 million in 2014 to around $300 million by the end of our forecast period. We also forecast Guess’s EBITDA margin from Asia to remain flat at its 2014 level of around 16% till the end of our forecast period. However, in case the above scenarios significantly grow Guess’s business in Asia, then Guess’s  Asia revenues can increase to over $500 million, and its Asia EBITDA margin can rise to around 20% by the end of our forecast period. Consequently, this might lead to around a 10% increase in our valuation for Guess.

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Notes:
  1. China’s Economy Is Recovering, Wall Street Journal, July 15, 2015 [] [] []
  2. 2015-2016 Outlook for the Retail and Consumer Products Sector in Asia, PWC, February 2015 []
  3. Guess Q2 2016 Earnings Call Transcript, Seeking Alpha, August 26, 2015 []