Guess Stock: Potential Undervaluation With Attractive rag & bone Acquisition

Founded in 1981, Guess?, Inc. (NYSE:GES) sells women’s and men’s apparel, underwear, footwear, eyewear, and watches among other items through the Guess brand. The company has a global footprint with a bit over half of Guess’ 1015 directly operated stores operating in the EU and Middle East.

Guess hasn’t grown its operations very much in the past decade, and the stock price reflects the mature operations– in the past ten years, the stock has stayed nearly stable. Guess does pay out a good dividend due to a low need for growth investments with a current dividend yield of 4.80% at the time of writing.

Mature Operations, Lifted Profitability

Guess’ revenues have been quite stable overall in the company’s history from FY2008. The company achieved some growth from FY2008 to FY2020, but has had years of revenue decreases from FY2012 to FY2016, making the total revenue CAGR from FY2008 to FY2020 3.6%. As the Covid pandemic has subsided from financials, Guess has had a very mature and stable revenue performance, only showing quite minimal nominal growth.

The mature revenues have been combined with poor and worsening profitability prior to the Covid pandemic – for example in FY2020, Guess only had an EBIT margin of 5.6% after EBIT margins in the high teens at the start of the 2010’s.

Since the start of the pandemic, Guess has realized impressive progress on profitability – the company has closed down a significant number of unprofitable stores, stubbing revenue growth but allowing for significantly improved earnings. Guess has closed down 280 directly operated stores globally from FY2021 to FY2023, representing quite a significant amount with 1015 stores left standing at the end of Q3/FY2024. Currently, Guess’ trailing EBIT margin stands stronger at 8.5% despite a challenging consumer sentiment as a result of the improvements. In the Q3 earnings call, Guess’ management communicated the potential for further improvements in profitability through technology & innovation.

I believe that the current 8.5% EBIT margin could see some elevation as consumer spending improves and as better technology is implemented as the management seems to suggest. Still, I don’t believe that Guess has catalysts for a very significantly improved profitability going forward – with slowing store closedowns, margins should start to stabilize.

Is There Growth Potential?

The recent years’ growth has been slower due to Guess’ focus on profitability with the store closings – Guess’ underlying growth could be higher as store closures slow down. Trailing revenues currently stand at $2703 million, around 0.9% above pre-pandemic revenues in FY2020 despite a fifth of Guess’ stores being closed down.

In Guess’ ICR Conference presentation on the 8^th of January, the company laid out potential growth avenues. To name some initiatives, Guess plans to accelerate its ecommerce sales with better platform capabilities, improve the company’s wholesale distribution, grow in existing & new markets, and internalize the company’s brand license with G-III Apparel. The company outlined growth potential in new products and markets in the presentation.

In my opinion, Guess’ organic growth potential is still quite low. While per-store revenues have grown quite well from pre-pandemic operations, high inflation likely explains a good portion of the growth. Guess’ communicated growth potential in new products and markets doesn’t seem to have been acted on in previous years; I wouldn’t expect the growth to suddenly gear up very much after quite a modest growth history. I keep my organic growth anticipation low unless better growth is demonstrated in revenues.

Acquisition of rag & bone

Although the potential for organic growth doesn’t seem too promising to me, Guess’ recent acquisition seems to create attractive growth. Together with WHP Global, Guess announced on the 16^th of February that the companies are acquiring rag & bone’s assets. Rag & bone is a New York -based company selling quite highly priced clothing items with an expertise in denim. Guess is acquiring the brand’s operating assets, and WHP Global will be assisting with the acquisition of half of rag & bone’s intellectual property, with the other half being acquired by Guess. Guess hasn’t been active in M&A before, making the acquisition the company’s first.

In 2023, rag & bone had around $250 million in sales and an EBITDA of $18 million. Guess’ consideration in the acquisition is $56.5 million with a potential further earnout of $12.8 million paid by Guess. Assuming that half of the earnout is paid, the acquisition represents an EV/EBITDA of just 3.5 with trailing figures. Although the EBITDA will be slightly lower under the acquisition terms as Guess will pay royalties to WHP Global for the intellectual property, the acquisition seems to have been done with a very attractive valuation. With Guess’ FY2024 middle point guidance, the acquisition represents around 9.1% of Guess’ revenues – while an attractive acquisition, the addition doesn’t represent too significant total potential.

Wider potential could be revealed if Guess leverages the company’s global footprint to grow rag & bone’s sales. In the acquisition’s press release, Guess’ CEO Carlos Alberini said that Guess’ global platform and distribution allow the company to leverage rag & bone’s offering, growing the company into new markets.

Valuation

At the time of writing, Guess trades at a forward P/E multiple of 9.3. I believe that the figure is quite low and reflects the market’s shared belief with me in quite minimal earnings improvements in the future. Still, the valuation could prove to be an attractive entry point as the rag & bone acquisitions could drive good earnings growth at an attractive acquisition price.

To estimate a rough fair value for the stock, I constructed a discounted cash flow model. In the DCF model I factor in the acquisition of rag & bone subtracting $62.9 million from the company’s cash, representing around half of the earnout being paid for the acquisition. For FY2024, I estimate a growth of 2.1%, being the middle point of Guess’ guidance. Due to the acquisition, I estimate Guess to have revenue growth of 11% in FY2025 and a slightly elevated 5% in FY2026 as rag & bone’s numbers are factored in. Afterwards, I estimate a very slight elevation in growth with 3% in FY2027 and 2.5% in FY2028 as rag & bone’s offering is leveraged with Guess’ distribution. After FY2028, I estimate the growth to stabilize at 2%.

For the margins, I estimate quite a stable performance. In FY2025, I estimate an EBIT margin of 9.0%, 0.1 percentage points below FY2024 – the figure represents rag & bone’s weaker profitability than Guess’, but also an improved consumer spending that slightly improves the margin. As rag & bone is implemented and Guess’ technology implementation proceeds, I estimate the EBIT margin to rise slightly to 9.4%. With the minimal organic growth, I believe that Guess’ cash flow conversion should be fairly good.

With the mentioned estimates along with a cost of capital of 11.54%, the DCF model estimates Guess’ fair value at $33.52, around 34% above the stock price at the time of writing. The rag & bone acquisition and some earnings improvement avenues for Guess seem to represent a good amount of upside for investors at the current price, making the stock a potentially good investment after a decade of poor appreciation.

The used weighed average cost of capital is derived from a capital asset pricing model:

In Q3, Guess had around $5.9 million in interest expenses. With the company’s current amount of interest-bearing debt, Guess’s annualized interest rate comes up to 4.41%. Guess uses quite a good amount of debt as leverage in financing, and I estimate the long-term debt-to-equity ratio to be 25%. For the risk-free rate on the cost of equity side, I use the United States’ 10-year bond yield of 4.28%. The equity risk premium of 4.60% is Professor Aswath Damodaran’s latest estimate for the United States, made on the 5^th of January. Yahoo Finance estimates Guess’ beta at a figure of 1.97. Finally, I add a small liquidity premium of 0.25%, crafting a cost of equity of 13.59% and a WACC of 11.54%.

Takeaway

Guess has performed quite stagnantly in the company’s long-term history, as revenues seem to have matured. In the past couple of years, though, Guess has started to elevate the earnings level quite well with store closings, other profitability measures, and most recently the planned acquisition of rag & bone. While I still believe that Guess’ further organic earnings improvements through growth and profitability are quite limited, the current stock price reflects a potentially attractive entry point. The rag & bone acquisition, made with an attractive valuation, in my opinion boosts Guess’ prospects as a company. Although the mediocre long-term history weighs on Guess, the current potential undervaluation constitutes a buy rating for the time being.