After hitting a 52-week low of $14.27 on September 30, 2022, the share price of Guess’ Inc. (NYSE:GES) has soared by approximately 50 percent, to trade at about $23.50 as I write.
While the price of $14.27 wasn’t reflective of its value at the time, I don’t consider $22.50 to be either, as I see that stock having got ahead of itself and due for a correction.
Considering its last earnings report was mixed and the stock was trading slightly under $20.00 per share at the time, it has continued to climb without much in the way of tailwinds to support the ongoing upward move.
Taking into account the economic headwinds, stubbornly high inflation, and the possibility consumers are going to adjust their spending habits from events and experiences that produce demand for more upscale clothing, to more casual clothes that fit more of a stay-at-home lifestyle, could mean a potential disruption in that important category for the company over the next year.
In this article we’ll look at some of its latest numbers, implications of its supply chain and inventory strategy, and its ability to continue to customize prices in key products that allow it to sell items at prices that don’t require discounts in order to move them.
Some of the numbers
Total revenue in the third quarter of 2022 was $633.4 million, compared to $643 million in revenue in the third quarter of 2021. Revenue for the first nine months of 2022 was $1.87 billion, compared to $1.79 billion in the first nine months of 2021.
One important strength of its performance in the reporting period was that most of its revenue growth was organic in nature, meaning it reflects the branding power of its products and the additional benefit of levered growth.
Markets showing strength in the quarter were Europe, Canada and South Korea, while China, Turkey and the U.S. were weaker.
Net earnings attributable to Guess, Inc. in the quarter were $21.8 million or $0.34 per diluted share, compared to $29.9 million or $0.45 per diluted share in the third quarter of 2021. For the first nine months of 2022 net earnings were $53.77 million, or $0.80 per diluted share, compared to net earnings of $102.9 million, or $1.55 per diluted share in the first nine months of 2021.
Gross margin in the quarter was 42.5 percent, down 320 basis points on more markdowns than last year and FX headwinds.
Cash and cash equivalents at the end of the third quarter of 2022 was $174 million, compared to $415.6 million in cash and cash equivalents as of January 29, 2022. It had long-term debt and finance lease obligations of $153.7 million, compared to $61 million in long-term debt and finance lease obligations as of January 29, 2022.
At the end of the quarter the company had $270 million available from several of its facilities.
Supply chain and inventory strategy
Based upon the supply chain issues the company faced starting in 2021, management decided to mitigate it by ordering products earlier than normal in 2022. This is more than just a general protective move to shore up inventory without taking into consideration customer demand.
According to management, the inventory orders are based upon “anticipated customer demand” for specific products. In other words, this is an attempt to get ahead of demand without simply stacking warehouses full of inventory.
So far, the strategy has apparently worked, as it allowed the company to meet the demands of its wholesale customers in a way that reinforced the idea that they could be counted on to meet demand. Consequently, GES was able to deliver more products to wholesalers because of it accurately acquiring enough product to ship to its wholesale customers.
As of the end of the third quarter of 2022 the company’s inventory levels were about 19 percent above the levels it was in the third quarter of 2021 and expects that to further decline.
While this is a good strategy, it can also backfire if the market suddenly changes. For example, if there are changes in inventory demand that was not foreseen by the company, and it results in either elevated inventory levels or not enough inventory.
With the company’s thoughtful strategy and analysis of the supply chain and inventory levels, it’s a higher percentage chance that it won’t miss widely on its projections, but in this economic environment a lot of things can happen quickly that aren’t able to be planned for.
Customized pricing
One of the ways GES has helped offset pricing pressures and at least partially mitigate the need to offer heavy discounts in order to move product and/or lower inventory levels has been to methodically go through its products on an individual basis and determining pricing based upon the perceived value its customers base their buying decisions on.
Over the last couple of years, this strategy has resulted in the company being able to raise prices in an efficient manner while driving average unit retail (AUR) increases.
While this generally isn’t anything new in the retail industry, management believes the company has reached a level where it is a differentiator and protects it against being forced to deeply cut prices in order to drive volume.
That is another way of saying it has improved the practice to the point it is as close as you can get to intelligent, customized pricing on a product-by-product basis. Management felt so strong about it that it declared it “the greatest transformation that we have embarked on at Guess in many years.”
FX headwinds
Any company with exposure to the U.S. dollar has FX headwinds, and it’s no different with GES, as management stated numerous times in its latest earnings report.
Based upon the impact of FX on the company’s performance full-year 2022 performance, it has modeled, based upon certain assumptions, that currency headwinds will take away close to nine points of revenue growth, ending the year at approximately $230 million. And with its adjusted operating margin, it expects it to cut it by 130 basis points or $60 million for the year. Taking away the impact of FX on revenue, and all things being equal, the company said sales growth would have been 10.5 percent for full-year 2022, or $2.8 billion. Minus FX effects adjusted operating margin would have been about 11 percent, above the $310 million in adjusted operating margin for 2021. While there is of course truth in the effects the U.S. dollar has on performance, it isn’t like it’s something new that has just emerged; it’s been around for a long time. There are always positive or negative impacts on the performance of a company in any given quarter if they compete internationally.
Sometimes an overemphasis on FX impacts can distract from weaknesses in other part of the company. In the case of GES, it was in its Americas Retail and Wholesale businesses, which were weak in the quarter without any FX impact on the numbers of those segments. In Americas Retail operating profit plunged by 53 percent and operating margin plummeted 730 basis points. The reasons given for the weak numbers was an increase in expenses, unfavorable product mix, and an increase in labor costs, among other things.
What’s interesting here is the company wasn’t able to benefit from its customized pricing efficiency, as it had to offer more products at a discount, which is what was meant by the unfavorable product mix.
In Americas Wholesale, sales fell 10 percent from some of its wholesale partners cutting back on orders in order to manage their inventory levels.
Finally, operating profit was down 41 percent and operating margin dropped 10.1 percent, also from the need to cut costs in order to increase sales volume. The point here is, not all the lower numbers came from the impact of FX, and even in some of the other segments it was only a part of reason for lower numbers.
Conclusion
I do think GES had a decent performance in its last reporting period, but I don’t think it was near as great as it was perceived to be by the market, and now that the company’s share price has reached elevated levels at a rapid pace, I don’t see anything that would keep it from correcting in the near future.
It appears a growing number of investors agree with me, as short interest now stands at 18.03 percent, and as time goes on, I think that’s probably going to increase. I believe it has move too far, too quickly, and based upon the numbers and economic uncertainty it faces in 2023, it’s probably close to taking a hit, which is why I think it’s time to take some profits off the table and wait for a better entry point to add shares or take a new position once the price corrects.
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