Apparel and accessory designer and retailer Guess? (NYSE:GES) has been on a wild ride for the past couple of years as weakness in North American merchandising and operating performance, not to mention macroeonomic weakness in Europe, squared off with lucrative licensing income and the growth potential of an ongoing expansion into Asia. While Guess shares look set to jump on very encouraging fiscal second quarter earnings, the level of competition in apparel retailing in North America, Europe, and Asia makes it difficult to have a lot of confidence in the long-term outlook.
Unexpected Improvements Boost Q2
The fiscal second quarter wasn't one of dramatic net positives for Guess, but rather results that were “less bad” than feared. Given the ongoing challenges in youth retailing in the U.S., as seen at American Eagle (NYSE:AEO) and Abercrombie & Fitch (NYSE:ANF), and the ongoing difficulties in Europe, the improvements at Guess were certainly welcome.
Revenue rose less than 1% as reported and actually declined more than 1% on a constant currency basis, but that was good for a small beat relative to the Street. North American retail stores were up a on a reported basis, though comps were down about 2%. Relative to the reports seen to date from youth-oriented retailers, though, that's a strong performance and it's certainly an improvement from the negative 10% comp in the first quarter. Europe and Asia were both soft, though, with constant currency revenue declines between 3% and 4%.
Margin performance is looking better. Although gross margin did decline more than a half-point, that was not bad relative to the company's decision to compete more aggressively on price in North America. Operating income rose almost 17% on an adjusted basis, with operating margin up 150bp, with a 10% boost in lucrative licensing earnings.
Is It Assortment, Or Is It Price?
Guess management was a little vague on the conference call about the drivers underlying the better than expected comp performance in North America. It sounds like a better merchandise assortment played a meaningful role, particularly in denim, but it also sounded to me as though the company has gotten more aggressive on pricing and promotion. Assuming that retail traffic is down so much because of thinner teen/youth wallets, it makes sense to shift the assortment to lower-priced merchandise. Even with all of that said, though, I find the company's 5% inventory growth to be a little concerning, as many other teen retailers have kept tight control of their inventory growth relative to sales growth.
Will Expansion Into Asia Deliver What Bulls Hope?
One of the consistent bull arguments for Guess, apart from reversing the negative comp trends in North America and the negative trends in gross and operating margins, is that expansion into Asia will improve growth prospects. It's not a difficult argument to make, as the swelling ranks of China's and India's middle class suggest huge potential demand for apparel.
If only it were that simple, though. Retailing in India is complicated by excessive regulation and extreme logistical challenges. China is less problematic from those perspectives, but with everyone from Gap (NYSE:GPS) to Fast Retailing to Hennes & Mauritz aiming for a piece of the Chinese apparel retailing pie, it's a crowded trade. Although I don't argue with the idea that baseline demand will be stronger in China than in North America or Western Europe, I have my doubts as to Guess's ability to stand out from the ground and earn effective margins here.
The Bottom Line
I'm ambivalent about Guess at today's post-earnings price. While it's definitely encouraging to see margins and North American comps improving, it's important to note that that was already part of most analysts' expectations for the company. Although Guess does offer some upside from its own self-improvement initiatives and offers a less North American-dependent business model, there are too many bargains in retailing today for me to be all that fond of Guess after this big earnings-related jump.
Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.