Buy This Specialty Retailer for a High Growth Portfolio

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Francesca’s Holdings Corp (NASDAQ: FRAN) just received the upgrade from Jefferies from Hold to Buy with a price target of $38 per share, due to its lower valuation, new management, and attractive operating characteristics. It is currently trading at only $23.83 per share. This means that Jefferies put a high price target of nearly 60% above its current price. It sounds attractive, so should we follow?

Business overview

Francesca is considered to be one of the fastest growing specialty retailers in the US, with upscale boutiques for female customers from 18-35 years old. Apparel has brought the majority of revenue to the company, with 51% of its net sales; this segment includes dresses, Tops, Denim, Pants, Skirts, etc. The second largest revenue source was Jewelry, with 20% of net sales. Accessories and Gifts accounted for 16% and 13% of the total revenue, respectively.

Francesca doesn’t own a manufacturing facility, but rather source its merchandise from more than 200 vendors. While no single vendor took more than 15% of its merchandise, the top 10 vendors accounted for 42% of its total merchandise in 2011. Interestingly, the largest and second largest vendors of Francesca, KJK Trading Corporation and Stony Leather, were owned by the retailer’s founders’ relatives. KJK Trading is owned by a brother-in-law of one of Francesca’s founders, and Stoney was owned by two of Francesca’s other founders. 

Growth Story and Growing Balance Sheet Strength

In the last 5 years, Francesca has grown its Boutiques rapidly. In 2007, it had only 78 boutiques including Mall and Lifestyle centers. In 2011, the number of Boutiques has increased to 283. The total sales per average square foot also increased from $401 in 2007 to $554 in 2011. During the last 3 years, it consistently experienced positive comparable sales growth; 9.8% in 2009, 15.2% in 2010, and 10.4% in 2011.

Furthermore, its revenue, net income, EPS, and cash flow have increased significantly during the last 3 years as well. 

<table> <tbody> <tr> <td> <p><em>USD million</em></p> </td> <td> <p><strong>2009</strong></p> </td> <td> <p><strong>2010</strong></p> </td> <td> <p><strong>2011</strong></p> </td> </tr> <tr> <td> <p><strong>Revenue</strong></p> </td> <td> <p>79</p> </td> <td> <p>135</p> </td> <td> <p>204</p> </td> </tr> <tr> <td> <p><strong>Net Income</strong></p> </td> <td> <p>-52</p> </td> <td> <p>17</p> </td> <td> <p>23</p> </td> </tr> <tr> <td> <p><strong>EPS (USD)</strong></p> </td> <td> <p>-1.99</p> </td> <td> <p>0.41</p> </td> <td> <p>0.52</p> </td> </tr> <tr> <td> <p><strong>FCF</strong></p> </td> <td> <p>8</p> </td> <td> <p>5</p> </td> <td> <p>30</p> </td> </tr> </tbody> </table>

The negative net income in 2009 was due to a $62 million payment for a preferred dividend; otherwise the net income in 2009 would be $11 million. 

In addition to the recent superior growth history, the balance sheet looks strong currently. As of July 2012, it booked $43 million in stockholders’ equity, $7 million in cash, only $5 million in long-term debt. Notably, the firm incurred $88 million in long-term debt in 2010, which it has reduced significantly quarter by quarter.

Unique boutique strategy

Looking deeper, Francesca has a unique strategy for its boutiques. It’s called board and shallow merchandising strategy, enabling the company to customize to ever changing shoppers’ preferences. The retailer would have a big merchandise selection but with small inventory, when a particular item is sold out, it would never be sold again. That triggers the sense of exclusivity and freshness to shoppers. So they just keep coming back to the boutiques to check out new items, and they urge to buy, as they know they can’t buy that item again when it is sold out.

Comparable valuation

Compared to its peers Ann Inc (NYSE: ANN) and Urban Outfitters (NASDAQ: URBN), Francesca is the fastest growing retailer. The quarterly revenue year-over-year growth of Francesca was 44%, whereas it was only 9% for Ann and 14% for Urban Outfitters. In terms of earnings valuation, Ann seems to be cheapest among the three, with 15.55x trailing P/E; whereas Urban Outfitters is the most expensive, with 27.9x P/E, and Francesca is valued at 26.27x P/E. However, if we factor in the potential growth, Francesca is the cheapest, with only 0.77x PEG, whereas Ann and Urban Outfitters are valued at 1.23x PEG and 1.38x PEG, respectively.

Foolish Bottom Line

Francesca seems to be the good aggressive growth choice for investors. With the unique merchandise strategy and small boutique stores, Francesca has significantly higher margins compared to its peers due to less rental, staff, and inventory expenses. However, with nearly 14x EV/EBITDA, it seems a little pricey. Personally, I think investors could put a small portion of their portfolio to ride the growth of this boutique retailer. 

hoangquocanh has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus