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Don’t Overpay for the Rebound Story In Guess Stock

GES stock - Don’t Overpay for the Rebound Story In Guess Stock

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Clothing retailer Guess (NYSE:GES) just reported exceptional second-quarter numbers that affirm that this company’s multi-quarter rebound narrative remains on track. In response to those strong numbers, GES stock jumped higher by more than 10%.

While it may be tempting to jump into this red-hot retail stock, I’d caution investors not to overpay for exposure to the Guess rebound.

Yes, things are improving by a whole bunch for GES stock. Comparable sales growth is tracking in consistently positive territory, and improving sequentially. Gross and operating margins are trending way higher, too. Earnings growth has come roaring back into the picture. The multiyear outlook for this company to drive healthy earnings growth through solid top-line growth and robust margin expansion is promising.

But, GES stock is up more than 46% year-to-date. The stock also trades at more than 19X forward earnings, which is a pretty big multiple for a retail stock and is a level which has historically proven unsustainable.

As such, while I like the Guess growth narrative, I don’t think GES stock is a buy after this big post-earnings pop. The time to buy was back in June, when GES stock was reeling after first quarter earnings and dropped below $20. Now, with GES stock soaring, it is time to sell.

Here’s a deeper look.

The Guess Narrative Is Improving

Across the board, the Guess narrative is dramatically improving.

For a few years, this was a company characterized by all the negative attributes of a troubled retailer — comparable sales were falling and margins were compressing, leading to earnings erosion with no end in sight.

But, things have changed over the past few quarters, and are only getting better today.

Revenues jumped over 12% higher in the second quarter. That is a big increase, and it is better than the first quarter’s 8% revenue growth. Moreover, comparable sales growth was positive in every region (Americas, Europe and Asia), and improved sequentially everywhere except Asia, where comparable sales growth went from 15% in Q1 to 14% in Q2 (an insignificant slowdown).

Meanwhile, gross margins expanded 230 basis points in the quarter. That is huge expansion. It is also bigger than the first quarter’s 160 basis point expansion. On the expense front, the opex rate is inching higher, but that is mostly due to growth-related investments in Europe and Asia. Plus, the opex rate isn’t rising by as much as gross margins, so operating margins rose a whopping 130 basis points in Q2, after a 100 basis point expansion in Q1.

Looking forward, management hiked the full-year sales and earnings guides, calling for 8%-plus revenue growth and essentially 100 basis points of operating margin expansion this year. Long term, management sounded a bullish tone about continuing to grow sales at a moderate rate, and getting operating margins back to their 7.5% level (another 300 basis points of expansion).

Overall, the growth narrative at Guess is good and only getting better.

Guess Stock Is Priced for These Improvements

All the aforementioned improvements in the Guess narrative are now fully priced into GES stock.

At current levels, GES stock is trading at 19X forward earnings. Since the start of 2017, GES stock has traded at this big of a multiple only twice (January 2018 and May 2018). Both times, GES stock was approaching a near-term peak, and proceeded to drop in a meaningful way over the next several weeks.

I think history will repeat itself here. Or, at the very least, I think GES stock trades sideways into the end of the year as fundamentals try to catch up to the price tag.

Revenue growth is robust right now. But, after this year, Guess will be nearing peak 2012/2013 sales levels. Thus, growth going forward after this year will likely be moderate, or in the low single digit range. The company still does have a huge growth driver with margin expansion, and all signs do point to operating margins trending towards 7.5% over the next several years. But, even with that big margin expansion, earnings won’t be big enough in a long-term window to support the current price tag.

In five years, I think moderate revenue growth and margin expansion towards 7.5% will lead to $2.10 in earnings per share. A market-average 16X forward multiple on $2.10 leads to four-year forward price target of $33.60. Discounted back by 10% per year, that equates to a year-end price target of $25.

Thus, I think GES stock is currently trading right around its year-end price target.

Bottom Line on GES Stock

Great story. Bad price. Because the story is great, I don’t think GES stock drops a bunch from here. But, I do think this stock trades largely sideways into the end of the year.

As of this writing, Luke Lango was long GES. 


Article printed from InvestorPlace Media, https://investorplace.com/2018/08/dont-overpay-for-the-rebound-story-in-guess-stock/.

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