Guess? Downgraded to a Hold

We are downgrading Guess, Inc. (GES - Analyst Report) to Hold from Buy. The company’s guidance is typically conservative, which allows Guess to beat expectations on a quarterly basis. However, we think its latest guidance suggests that Guess will deliver smaller upside surprises in future quarters. With smaller upside surprises in the future, the stock’s upside is limited. Unfortunately, if Guess merely meets expectations, its stock price will decline.

The investment case for Guess is based on the company’s strong brand name, continued store expansion, and international growth opportunities. The company still enjoys strong sales of its denim wears, but its recent growth is being driven by sales of higher-margin accessories. We believe Guess accessories merchandise should remain popular with its customers for the next few quarters.

Thus far, the company has managed to avoid the problems facing many other retailers. Nevertheless, we expect the difficult retail environment to eventually put pressure on Guess’ results.

Guess shares are currently trading at 15.4x our fiscal year 2009 EPS estimate and 13.1x our fiscal 2010 EPS estimate. GES trades at a premium to its peer group based on price-to-earnings, price-to-book, price-to-sales, and price-to-cash flow. We believe a larger premium valuation relative to its peers is warranted because of Guess impressive results in recent quarters and stronger prospects for growth.

However, we believe the company will not be able to deliver upside surprises in future quarters as it has in the recent past. This will result in the stock trading at a P/E multiple in the mid- to upper-teens, compared to its long-term earnings growth of 20 percent. Our target price is $42, or 16x-17x our fiscal 2009 EPS estimate.

Read the full analyst report on GES

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