GES: Timing is Everything

I think we are 2-3 quarters away from the realization that GES is overearning. I struggle with whether or not Wednesday’s 2Q EPS will be the event. While I think that certain facts are increasingly ominous, I don’t think Wed will be the event where the fundamental story buckles.

As I’ve stated in the past, I think that GES is a solid brand, and unlike others in the space, it definitely has a reason to exist – but simply not at an 18% operating margin. My view is that the company has underinvested its FX and sourcing benefits over the past 4 years, and as such its top line growth trajectory, margin rate, or both, will take a hit as FX reverses course and cost of goods races higher.

Here’s one of the more frightening call-outs for me…
1) Growth in almost every Guess? business has decelerated over the past 2 quarters, with the one accelerating business being US retail.
2) Take a gander at this quote from the 1Q conf call. “Our U.S. retail business continued to benefit from tourists coming to the country with strong currencies 80% of our U.S. stores are located along the coast and in key tourist cities.” My Partner Todd Jordan (Gaming/Lodging/Leisure) has been calling this out for his companies, such as Starwood. Not an accident that the past 2 quarters have been among the most favorable yy comparisons as it relates to FX.
3) Assuming the dollar stays where it is today, we are nine weeks away from parity vis/vis year-ago levels.


So 48% of GES sales are in the US – a large portion of which is tied to travel markets. Those markets are unlikely to sustain the growth levels we’ve seen over the past few years. At the same time, international sales will be translated back to US$ at a less favorable rate. I can’t imagine that US consumers step up their int’l travel activity and buy more Guess? apparel.

I think it all comes down to timing.
On one hand, company guidance for Wednesday looks reasonable. Margin expectations call for no sequential change from the rate we’ve seen over 2 quarters. I can live with that (for another quarter), especially with inventories ending last quarter in check. Sales growth guidance of 15-20% calls for an 8-10% slow down from the company’s recent run rate. Again, this is probably doable.

But on the flip side, this is what the ‘expectations game’ looks like every quarter. This company has only missed one quarter out of the last 20, 100% of the sell-side ratings are ‘Buy,’ and though still high at 12% of the float, short interest has been ticking lower.

I don’t love the fact that margin compares start getting a bit easier starting in 3Q, but we’re still talking about lapping positive numbers from a year ago. If the macro environment plays out like I think it will, then we could see 2+ years of down margins, and that 20%+ consensus CAGR through 2011 will look like a pipe dream.
GES EBIT Margins vs FX

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