Guess (GES) tanked 7.7% after hours on Wednesday after a disappointing report that included downbeat guidance. Meanwhile, competitor Express (EXPR) did much better with investors after its latest report. However, that might not mean that Express offers the better investment opportunity right now.
While the clothing retail business remains very promotional, Express still managed to turn itself around with a potential buyout by Sycamore Partners looming. Could Guess attract the attention of a prospective buyer as well?
First of all, Guess saw sales drop globally this quarter. In constant currency terms, it actually did best in its home market of the United States where retail sales dipped 4%, as sales fell 9% in Europe and 8% in Asia. Overall sales declined 6% for the quarter, also in constant currency terms. While the company did point out e-commerce growth as a bright spot in its release, many retailers have seen their customers switch from shopping at stores to shopping online and thus posted large gains in this area, so this looks more like an industry trend than an unexpected source of sales strength. Guess also collected half as much income as it did in the year-ago quarter. Meanwhile, peer Express managed to attract buyers even with falling sales.
Express did slightly better in overall terms as sales fell 2% from the year-ago quarter. However, this wasn’t why its stock price soared 12.75% on Wednesday. In a market where price competition remains intense and a takeover remains a possibility, this clothing retailer had little choice besides slashing costs. It looks like this worked as Express reported earnings per share of $0.08 and raised and narrowed its guidance. Now the company expects to earn $0.85-$0.95 per share in 2014.
Buyout interest from a private equity firm could convince Guess to cut its costs as well, but how likely is this to happen? Well, for a buyout to look likely investors would want to see both moves by activist investors and a good case for the deal itself. Both of these elements seem like they’re present with Guess. First, the decision by Sycamore Partners to take a stake in Express shows that activist investors are watching the sector. Second, analysts already made the buyout case for Guess back in 2012.
Some elements of the situation have changed since then, but it’s still worthwhile to consider why analysts saw Guess as a buyout candidate, to begin with. First of all, Guess traded at an EV/EBITDA ratio of 5.5 before its fall after-hours versus 3.5 two years ago. However, the market’s also risen since then so finding a bargain has become less likely. Express also trades at a higher EV/EBITDA ratio of 5.8 and that doesn’t seem like it’s scared off Sycamore Partners. So the retailer’s valuation doesn’t seem like an issue here. The main attractions for the buyout case, Guess’ cash stockpile and sizable free cash flow are still present as well.
Normally when a company drops after a weak report, it’s a reason to stay away. Guess’ drop makes sense from that perspective, but its buyout potential complicates matters. A possible buyout is a risky reason to buy a stock by itself, but it does look like this clothing retailer has some characteristics that could attract a buyer. Guess looks like a stock worth following in case a potential acquirer does show some interest in the retailer.