Bullish on GES

Guess?, Inc. is a California-based company that designs, markets, distributes, and licenses casual apparel and other consumer products. Among its branded names are GUESS, GUESS?, GUESS U.S.A., GUESS Jeans, and G by GUESS. The Company’s apparel is targeted for both men and women primarily in the ages between 18 and 32. GES operates in five segments: North American Retail, European Operations, Asia Operations, North American Wholesale, and Licensing Operations. The Company is part of the ICB’s Consumer Services industry and, within that, of the Apparel Retailers subsector.

GES, as of 1/27/12, is trading at 29.26. Its 52 week high was 48, reached on 2/22/2011, while its 52 week low was 25.99, made on 10/4/2011. With 92.777 million shares outstanding as of 12/1/2011, GES has a market cap of $2.71466 billion. The Company paid a .2 dividend on 12/12/2011, representing an annualized 2.73% yield at the current price.

Shares have underperformed the market and peers in the industry year-to-date. GES has fallen 1.88% YTD, while the S&P Index (SPX) has returned 4.95%, and its group of Bloomberg Peers has seen returns of 7.55%. GES shares fell 37.14% in 2011.

At the current price and with ttm EPS of 2.94, GES is trading at a P/E ratio of 9.97. The average P/E ratio for the Apparel Retailers subsector is 22.05, while the average P/E ratio for the group of Bloomberg Peers is 26.00. This suggests that GES is trading at a very significant discount to similar companies.

The past 5-year earnings growth rate for GES was 15.24%.  Currently, the long-term growth rate for earnings is projected by Bloomberg to be at 14.67%. Using this value and the P/E ratio of 9.97, the resulting PEG is .68, and signals a severe undervaluation.  However, Standard & Poor’s projects an 8% compound annual growth rate in the earnings for the following 3 years. The S&P projected 8% CAGR would result in a PEG of 1.25. The average PEG ratio for the Apparel Retailers subsector according to Bloomberg is .79, while for the group of peers according to Bloomberg the average PEG ratio is 1.51. GES is undervalued as it is trading at a PEG below one when using its long-term growth rate. Furthermore, it is also trading at a discount compared to its peers as these have greater PEG ratios. This demonstrates that the undervaluation which was claimed when analyzing the P/E ratios was not due simply to different earnings growth rates. Taking into consideration the growth of earnings, GES continues to be undervalued by investors.

GES is trading at a P/S ratio of 1.00, compared to 1.36 for the Apparel Retailers subsector and 1.38 for the Bloomberg Peers group. The P/B ratio for the Company is 2.22, compared to 6.02 for the Apparel Retailers subsector and 3.75 for the Bloomberg peers. The P/FCF is at 11.64, compared to 34.70 for the Apparel Retailers subsector and 34.42 for the Bloomberg Peers. These three ratios serve to further confirm GES’s relative undervaluation.

GES is a financially strong and safe company. It operates using very low levels of debt. Its total debt to total capital ratio is 1.07%, while the average of the Apparel Retailers subsector is 16.40% and that of the Bloomberg Peers is 21.73%. The fact that GES has such a small percentage of debt, both in absolute and relative terms, signals that it would be better able to endure through an economic recession or depression when compared with other companies with more elevated debt levels.

GES’s quick ratio using data from the most recent quarter is 1.89. Compared to the quick ratio of 1.14 for the Apparel Retailers subsector and 1.42 for the Bloomberg Peers, GES has greater short term liquidity and, therefore, is better able to meet any short-term obligations.

The following table demonstrates that GES is more effective than other similar companies, as it is able to obtain greater returns on its assets, on equity, and on its invested capital. All data is calculated using the most recent filing.

	ROA	ROE	ROIC
GES	15.05%	22.96%	25.16%
Apparel Retailers	12.90%	22.63%	20.27%
Bloomberg Peers	8.70%	16.94%	18.70%

The following table demonstrates that GES is relatively more profitable than related companies. Though its gross margins are smaller than those of the Apparel Retailers subsector and the Bloomberg Peers, the Company has greater operating and net profit margins. The margin values are calculated using data from the most recent year.

	Gross Margin	Operating Margin	Net Profit Margin
GES	43.83%	16.71%	11.64%
Apparel Retailers	45.06%	12.16%	8.52%
Bloomberg Peers	46.41%	10.45%	5.79%

The short interest on GES, as of 1/15/2012, was at 7.53% of float. This is equivalent to a short interest ratio of 3.39. The average SI ratio for the Apparel Retailers sector is 6.06, while the average for the Bloomberg Peers is 5.72. The fact that GES has relatively fewer short sellers demonstrates that investors are recognizing the fact that this company is trading at a significant discount, and that any move to the downside in share price is very limited and not as likely to occur.

A simple DCF valuation of GES’s earnings yields a higher value for GES shares than the current price of 29.26. A growth value was determined for GES earnings using the current ttm EPS of 2.94, the conservative S&P projected CAGR of 8% for the following 3 years, and a discount rate of 12%. These values result in a growth value of 8.2. A terminal growth rate of 3% was used in order to calculate the resulting terminal value of 30.17. Using the 8.2 from the growth value and the 30.17 from the terminal value, the fair value of GES shares according to the data used should be $38.37.  This represents a 31.13% increase from the current price of $29.26. I consider this to be a conservative estimate. Using the Bloomberg long-term growth rate estimate of 14.67 for the following 5 years and a terminal growth rate of 4, while holding all other values the same, the fair value is calculated to be $58.78. This represents a 100.89% increase from the price of $29.26, and is slightly above GES’s all-time high of $57.20.

The projected growth rate and the current EPS can also be used to calculate the per share value of GES. The long-term growth rate of 14.67 can be used as a multiple to the current earnings of 2.94. This would result in a PEG ratio of 1 and would signify a fair valuation of GES. The resulting fair value is $43.13, representing a 47.40% increase from the current price of $29.26.

Though GES is a compelling investment, there a couple of risks that must be considered. Firstly, the sovereign debt situation in Europe and economic turmoil are currently having an impact on consumer confidence and sales. Looking ahead, the Company could see its revenues drop severely were some sort of black swan event to occur in Europe, as revenue from European Operations accounted for 37% of total revenue in 2011. Not only is the Company affected by declining sales in Europe, but the drop in the euro and the appreciation of the dollar in the past few three months has cut into margins. However, the recent announcement by the Federal Reserve whereby it promised to keep low interest rates up to 2014 should signal a weaker dollar for the future, all other factors constant. This suggests that there shouldn’t be any further drastic margin decreases due to currency fluctuations. Furthermore, it is also important to point out that EPS growth over the past twelve months (0.49%) has not kept up with ttm revenue growth (12.51%). This is signaling that the company may be becoming less efficient at managing its resources.

One of the major catalysts for the future growth of the company is the expansion in high-potential markets, primarily in Asia. Management has focused on expanding the global image of Guess and on opening new stores worldwide. In 2011 alone, the Company opened 112 stores. GES plans on opening 125 to 130 stores in Europe and the Middle East and another 70 to 75 stores in Asia. Asia has proven to be one of its fastest growing regions, with revenue growth from the Asia Operations segment in the past two years averaging 36.49%, far outperforming all other segments of the company.

Current shares prices are a great entry opportunity for the long-term investor. Not only is GES undervalued given its long-term growth rate, but it is also trading at a discount when compared with similar companies. This is evident in the various multiples at which the Company is trading, significantly lower than its peers. Furthermore, the current earnings of GES and the projected earnings growth warrant higher share prices. Management’s strategy of leveraging the brand name and of expanding into new markets presents a catalyst for future earnings growth. However, the macroeconomic conditions and, most importantly, the credit situation in Europe, must be closely monitored, as GES’s earnings are dependent on consumer confidence and discretionary spending. GES undoubtedly presents an excellent investment opportunity given its low valuation, but caution must be taken considering current global credit and confidence conditions.