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We reaffirm our Neutral recommendation on Fossil Inc (FOSL - Analyst Report). While the company has been delivering solid quarterly results, increasing input costs and the weaker operating margins concern us.

Why the Reiteration?

Fossil has been posting better-than-expected results over the last two years. Strong top-line growth driven by double-digit increase in global watch sales have remained the company’s strength over the years. Product innovation and continued momentum of the Fossil brand also added to growth. The company is also keen on improving its jewelry and leather businesses in order to further boost sales.

Fossil has a solid watch portfolio and has witnessed strong sales growth owing to its strong global distribution platform and successful innovations. The company has also regularly acquired and developed new brands and inked licensing agreements to suit customer preference and lifestyle.

Fossil’s acquisition of privately-held Nevada-based Skagen Designs, Ltd. and its certain subsidiaries in Aug 2012 helped the company strengthen its European and East Asian emerging market business. The company’s watch sales received a boost following the Skagen acquisition. The company launched Skagen jewelry in the first quarter of 2013 and is expected to enhance its jewelry product portfolio in the near future.

Fossil intends to redesign its store concept in 2014. In addition, the company will expand its leather line of products in 2014 and launch Tory Burch line of watches, which will help in attracting more customers.

Fossil has a significant presence in international markets and has department stores in over 120 countries worldwide. Fossil is progressing steadily in newer markets as well as in existing markets like Japan, Australia and Korea. The company also undertook a major step in building brand awareness in China with the opening of the first Fossil flagship store in Hong Kong in the third quarter of 2013.

While Fossil has been delivering positive comparable store sales for the past 20 quarters driven by continued strengthening of the Fossil brand outside the U.S., the company is witnessing sluggish comparable store sales in the U.S. since the past few quarters due to weak traffic.

Poor footfall in the stores has been impacting the business, especially at its full price stores since the last few quarters owing to the tough retail environment. The company is therefore resorting to promotional techniques to drive traffic. However, more than planned promotional costs adversely affected profit margins in the third quarter 2013. Fossil holds a Zacks Rank #3 (Hold).

However, better-ranked stocks in the retail sector include Conn’s Inc (CONN - Snapshot Report), Finish Line, Inc. (FINL - Snapshot Report) and The Men’s Wearhouse, Inc. (MW - Snapshot Report). While Conn’s carries a Zacks Rank #1 (Strong Buy), Finish Line and Men’s Wearhouse carry a Zacks Rank #2 (Buy).

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