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As summer wrapped up, consumers' moods grew sour. Fears of a looming government shutdown led many to simply stop spending on discretionary items, leading to a cycle of lower profit forecasts for a number of retailers.
Few appear to have been as hard hit as women's apparel and accessory retailer Francesca's Holdings (NASDAQ: FRAN). In early September, Francesca's announced that same-store sales, which had been growing at a fast pace ever since its July 2011 IPO, had suddenly turned negative.
Investors were in an unforgiving mood, and shares fell sharply to a 52-week low.
News of the sudden sales slowdown led many to question if this once-hot retailer was still capable of robust growth. Sales had risen 45% in fiscal 2013 to nearly $300 million, leading to a 100% spike in 2013 earnings per share (EPS). Though analysts had been expecting another banner year in fiscal 2014, they now expect FRAN to boost sales only 17% (based entirely on new store openings) and grow EPS less than 10%.
Yet investors shouldn't conclude that FRAN's business model is broken. Instead, the recent slowdown can be chalked up to growing pains. And with sales growth expected to re-accelerate in fiscal 2015 to around 20%, investors will again start focusing on this retailer's very impressive operating metrics.
To be sure, FRAN's management concedes the in-store merchandise wasn't especially compelling in recent months -- quite a turnabout for a company known for a deft merchandising touch. On the quarterly conference call, management explained, "There has not been a dominant fashion trend to drive and chase in apparel category this season." Management also noted that FRAN's long lead times led the retailer to miss out on any fashion themes that did emerge this summer.
Also, the company said that gift items, which account for roughly 10% of sales, were poorly selected by the company's merchandisers. "We recognize the assortment needs to be refined," said CEO Neill Davis on the conference call.
To be sure, investors don't expect stellar results for the current quarter, ended in October, nor should they expect solid upside from the holiday season.
But as the next fiscal year gets under way in February, FRAN looks set to exceed a low set of expectations. For example, the company is on track to open roughly 80 stores in the current fiscal year, expanding the store base by around 20% to over 450 stores. That's roughly in line with the projected sales growth rate for next year, implying that same-store sales will be flat.
Yet that view is likely too pessimistic. After all, the company posted a slight 1% drop in sales in the most recent quarter, as a 4% drop in traffic was mostly offset by a 3% increase in average transaction prices. Assuming traffic stabilizes in the coming fiscal year and those 3% price increases stick, you already have a recipe for modest same-store sales growth.
Management expects same-store sales growth to be better than modest. "As we step into the spring of 2014, I feel very good about what the merch[andise] is going to be able to bring to the table and the responsiveness of our customers," noted Davis.
Investor sentiment toward FRAN and other retailers is understandably negative. After all, The Conference Board's Consumer Confidence Index slid to just 71.2 in October, possibly due in large part to the shenanigans in Washington, D.C. As the budget issues finally start to recede, consumer confidence and retail spending should rebound, just as it did after the budget scares of July 2011. An investment in FRAN is based on the notion that current sales trends and the weak share price are a reflection of the current somber mood and not indicative of this company's health.
Indeed, in its short tenure as a public company, FRAN has already proven itself to be a savvy financial operator. In fiscal 2013, the retailer had 54% gross margins, 26% operating margins and 16% net margins. For some context, L Brands (NYSE: LTD), a well-regarded retail operator that owns brands such as Victoria's Secret and Bath & Body Works, had 42% gross margins, 15% operating margins and 7% net margins last year.
Equally important, a larger store count should enable FRAN to glean operating leverage, enabling margins to hold at their currently high levels or rise even higher. Simeon Siegel, an analyst at Nomura Securities, said in a report, "We see a several-hundred-basis-point opportunity to bring SG&A in line with that of peers as the business scales."
In a bid to support the stock, FRAN is now in the midst of a $100 million share buyback that at current prices would eliminate more than 10% of the share count.
As noted earlier, FRAN's store base is likely to approach 450 units by the end of this fiscal year. Yet on the conference call, management said it believes that the business model can ultimately support 900 stores. "We are well positioned and focused on creating the appropriate infrastructure to undergird our long-term growth, even in a period of lower sales expectations," noted CFO Mark Vendetti.
As the tough finish to fiscal 2014 comes into focus, investors will start to focus on better trends in the next fiscal year, beginning in February. And investors are likely to refocus on what is now a very cheap stock.
Shares recently traded just under $17.50, or around 12.8 times projected fiscal 2015 EPS of $1.37. As investors focus on FRAN's capacity for 20% annual EPS growth, look for that multiple to expand to 20, yielding 50%-plus upside for this beaten-down high-quality retailer.
Recommended Trade Setup:
-- Buy FRAN up to $22-- Set stop-loss at $16-- Set initial price target at $27 for a potential 23% gain in six months
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