Can Fossil's Wearables Drive Away Traditional Watch Gloom?

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Fossil Group Inc. 's FOSL transition to connected wearables and smartwatches has been a catalyst in raising investor's optimism on the stock. Evidently, shares of this renowned watch and accessories brand have soared 69.2% over the past six months, outperforming the industry 's rally of 28.6%. Additionally, the company has been progressing well with its online business and strategies to gain operating efficiency.

However, with underlying weakness in traditional watches and other business categories, not all seem to be going well for the company. Moreover, the company's gross margin performance has been dismal for a while.

Let's look into some of these factors that have been affecting the company's performance and see if its growth initiatives can offset hurdles.

Wearables: The New Success Mantra for Fossil

Driven by increasing consumers' demand for digitally advanced gadgets, Fossil has been making investments to broaden connected wearables portfolio. The wearables market provides the opportunity to combine fashion and technology and launch exciting products to suit consumers' evolving needs of tech-enabled advanced connected gears. Moreover, the company is getting the advantage of Android's popularity and Google's technology in its watches.

The growing demand for tech-savvy products is reflected from the fact that Fossil's connected products have almost doubled in the past two years, reaching close to $300 million in size. Notably, wearables represented almost 20% of the company's total watch sales in the fourth quarter of 2017. Further, expansion in the wearables category enabled the company's overall watch category to grow more than 10 percentage points.

During the second half of 2017, Fossil launched close to 14 new hybrid and smartwatches across several brands. As the wearable business is expected to grow $32 billion by 2020, Fossil gears up to enrich wearables portfolio by adding new brands to its smartwatch line-up in 2018.

Strong Online Business

Fossil continues to focus on expanding its digital platform and meet consumers' growing demand for online purchasing. To this end, the company has been making several investments to improve digital marketing and drive online sales, for its website as well as other online wholesale partners. In fact, such dedicated endeavors in the e-commerce space bore favorable results during the fourth quarter of 2017.

E-commerce sales soared as much as 31%. The e-commerce platform has also served as an important sales channel for the company's wearables. Further, management is optimistic about expansion plans in the smartwatch as well as other digital offerings category and expects such moves to bolster online sales.

Other Hidden Catalysts

To further expand the company's size and offerings, Fossil has signed various licensing agreements with several brands. With the renewal of the global licensing agreement with Michael Kors and Emporio Armani through 2024, the companies were able to expand the extensive line of watches and jewelry and explore other opportunities in the accessories category. The company also signed the global licensing agreement with Kate Spade & Company through 2025 and extended global watch licensing agreement with Diesel through 2025.

Speaking of growth initiatives, Fossil's restructuring program called the New World Fossil (initiated in 2016) deserves special mention. The program aims to transform the company, fuel efficiencies, improve margins and enhance the overall operating structure of the business to drive profitability. The company is well on track with this program, which helped it cut costs by $95 million in 2017, keeping it well-placed to achieve profit improvement target of $200 million by the end of 2019.

Hurdles to Cross

Although Fossil's connected products have been faring well, its other business segments, particularly traditional watches, have been an aspect of worry. Consumers' changing preferences and a tough retail landscape has been denting Fossil's traditional watch category performance for a while. In fact, the company's watch sales dropped 6% (on constant-currency basis) during the fourth quarter of 2017, mainly due to sluggishness in the traditional category. Disappointingly, Fossil continues to witness a challenging retail environment for its traditional watch category in 2018.

Further, sales of leather products and jewelry have persistently been weak since past few quarters on account of soft demand. Well, these trends were clearly witnessed in the company's fourth-quarter 2017 results, wherein jewelry and leather business sales fell 9% and 14% (on constant-currency basis), respectively, with declines across all the broad geographical market regions. Fossil has also been witnessing lower gross margin for a year, primarily due to soft retail margins stemming from increased promotions as well as lower margins from connected products.

Final Thoughts

Despite the aforementioned hurdles, we are encouraged with this Zacks Rank #3 (Hold) company's efforts to strengthen performance. In fact, Fossil's advancement in the wearables space is praiseworthy. Also, the company's surging online business and savings initiatives have been yielding positive impacts. We expect such initiatives to aid the company in offsetting ongoing challenges and thereby uplift performance in the upcoming periods.

Do Retail Stocks Interest You? Check These

Investors may consider other stocks from the same sector such as The Gap Inc. GPS , The Children's Place Inc. PLCE and Burlington Stores Inc. BURL . All these stocks carry a Zacks Rank #2 (Buy). You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here .

Gap came up with an average positive earnings surprise of 11.1% in the trailing four quarters. It has a long-term earnings growth rate of 8%.

The Children's Place pulled off an average positive earnings surprise of 14% in the trailing four quarters. It has a long-term earnings growth rate of 9%.

Burlington Stores delivered an average positive earnings surprise of 15.2% in the trailing four quarters. It has a long-term earnings growth rate of 18.6%.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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