The Ratings Game: Fossil shares skyrocket after surprise beat, but wearables still lag

Fossil’s wearable business has picked up but it still missed initial guidance for the year

Fossil Group Inc. shares skyrocketed 64% on Wednesday after earnings beat expectations, but analysts were not entirely convinced by the move.

Some market participants said the rise may be driven by short-covering. Short interest, or bets that the stock will fall, have more than doubled in the past year to a record high of 18.9 million shares at the end of January, which represents about 39% of the shares outstanding, according to FactSet. In comparison, short interest in Fossil rival Movado Group Inc. MOV, +5.03%  represents just 3.8% of the shares outstanding.

A high number of short interest can be viewed as bullish for a stock, since those who bet on price declines have to buy the stock to close out the bearish bets.

Wells Fargo analysts said they are still concerned about the prospects for the company, including its wearables business.

Fossil FOSL, +57.74%  reported adjusted earnings per share of 64 cents and sales of $920.8 million. The FactSet consensus was for EPS of 40 cents and sales of $890.0 million.

“While we acknowledge that the stock hasn’t had any type of good news in well over a year, valuation had compressed meaningfully (to 4.5x EBITDA) and shares have massively underperformed over the past 12 months (Fossil shares –70% vs. SPX +20% in 2017), we would still contend that the fundamental story here remains extremely challenged,” wrote Wells Fargo analysts led by Ike Boruchow.

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One of the key points analysts make in their latest note is the miss in wearables.

Fossil Chief Executive Kosta Kartsotis said the company’s connected business “nearly doubled last year, but we fell short of the aggressive goals that we set for ourselves in this new business,” according to a FactSet transcript of the late Tuesday earnings call. Wearable sales totaled $300 million in fiscal 2017.

“Given our success in 2017, we remain confident that wearables can be one of the key catalysts that offsets the declines that we’ve seen in our traditional watch business,” Kartsotis said.

Wells Fargo analysts point out that the initial guidance was for sales of $450 million.

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“As the wearable category continues to miss, Fossil has been stuck with excess inventories that will be liquidated in 2018 – which necessitated a second consecutive quarter of reserve charges after saying three months ago that there would not be any more charges after Q3,” analysts said.

Analysts are not impressed with the sharp stock increase either. “[W]e feel this is more a function of positioning/sentiment… with a fundamental backdrop that remains one of the most challenged in our universe,” the note said. Wells Fargo rates Fossil shares underperform but raised its price target to $8 from $4.

KeyBanc was far more bullish on the earnings report. “We think the fashion watch market is being disrupted by wearables and Fossil is well positioned to be the second-largest player in the fashion wearable space,” wrote analysts led by Ed Yruma.

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“We think Fossil is finally making demonstrable progress in its transformation.”

KeyBanc rates Fossil shares overweight and lifted its price target 67% to $25 from $15.

Instinet raised its price target to $13 from $8.

Fossil shares are up more than 106% for the last three months, but are down 34.8% for the past year. The S&P 500 index SPX, +0.45%   is up 14.5% for the last 12 months and the Dow Jones Industrial Average DJIA, +0.14%  has gained 20%.

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