Three Short Story Stocks
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Imagine three sisters hanging out at the mall: baby sister Fran is small and quirky, bigger sister Ann is more grown up and elegant, and middle sister Vera is artistic but troubled. I speak of none other than Francesca Holdings (NASDAQ: FRAN), ANN INC (NYSE: ANN), and Vera Bradley (NASDAQ: VRA), all small-cap retailers of women's apparel and accessories.
I visited all three stores at a local upscale mall and to my surprise the only busy one was Francesca's Collections. Two times larger Ann Taylor was virtually empty as was Vera Bradley. Since all three aim at mostly the same demographic, the 18-35 year old woman, what could explain this?
The best performer of the three has been ANN up 20.25% over the last year and with the lowest short interest at 9.70%. Up front I have to mention the enormously high short interest at Vera Bradley at 71.80% and growing. But Vera Bradley is still up 15.58%. Meanwhile, Francesca's is down 13.11% this year and has a 38.90% short interest.
What is the shorts' story?
Both Francesca's and Vera Bradley have seen CEO exits this year, and Francesca's swooned over 5% on a Wedbush Securities downgrade on July 29 from Outperform to Neutral with a $32 price target.
Francesca's debuted at the end of 2011. Francesca’s stock hasn't really recovered after a disastrous social media gaffe last summer by the former CFO who tweeted before earnings that the numbers were good and the board was happy. The stock plunged from the low 30’s to low 20’s even though they canned the CFO.
Then long-time CEO John Merritt retired in September, succeeded by President Neill Davis. The stock fell 17% followed by a secondary offering in the spring of 7.4 million shares, approximately 16% of shares outstanding.
Despite all this bad news the company has some strong points. It has no debt and its small (average size under 1,500 square feet with 3,000 SKUs) unique boutique concept with inventory changes weekly allows customers to be surprised. They buy merchandise 30 days in advance, and each store manager is encouraged to personalize the store. They are expanding from 429 stores in 44 states to an eventual 900 total planned at a pace of 80 some new stores per year.
Another strong point is an 18% insider hold with officers buying after its IPO, not selling. It has a 28.90% operating margin and a PEG of .91 indicating it's undervalued. Sales per square foot have grown from $380 in 2008 to $625 currently.
Shorts believe comp sales will decline further after the last earnings report, which was the first in the last year that didn't surprise to the upside. Comp sales were only up 2% but gross margin was good at 52.04%. Shorts also take comfort that Francesca's valuation in terms of an EV/EBITDA of 13.22 and price/book of 14.37 is high.
Its closest competitors would be ANN and Urban Outfitters but Fran doesn't fit into a mold; like I said before it's unique, and its fashion sensibility is very different from more classic ANN and edgy hipster Urban.
Same store sales slump
Meanwhile big sister ANN with 900 stores in the US has a much lower trailing P/E of 16.67 with a forward P/E of 13.04. Like similar stores in the mall, Coldwater Creek, J.Jill, and Talbots it was empty when I visited. Granted, back to school shopping is underway and the older range of their demographic is likely buying childrens' clothes and school supplies.
ANN also has no debt, a more reasonable EV/EBITDA of 5.63, and a price/book of 3.72. Ann Taylor has devised a multi-channel sales strategy of outlets (Ann Taylor factory outlets and LOFT) and e-commerce that JP Morgan analyst Brian Tunick thinks is the highest margin and fastest growing segments for specialty retailers.
ANN's closest rival is mid-cap specialty retailer Chico's FAS, which competes with ANN mainly on its Boston Proper, WhiteHouse/Black Market, and Chico's brands. It's larger with 1,355 stores in the US, Virgin Islands, and Puerto Rico. ANN also competes with Fifth & Pacific, which owns the very trendy and successful kate spade brand.
Analysts expect very respectable 12.28% five-year EPS growth, about half what's expected for Francesca's at 23.48%, explaining ANN's higher PEG of 1.24. ANN's operating margin at 6.50% is much smaller than Francesca's. It has a smaller insider hold at 3% as well.
Shorts bet against ANN thanks to last quarter's decline in same store sales of 0.5% yoy and although beating analysts' expectations, earnings of $0.44 per share drooped by 27% yoy.
What's the matter with Vera?
Although Vera Bradley's colorful accessories are popular with younger women and its trailing P/E lower than these other two at 15.03 with a forward P/E at 12.64 the shorts would have you believe it's in imminent danger of bankruptcy. The company only owns 85 stores with much of its merchandise sold at small boutiques and gift shops.
Operating margin at 19.15% is good and although total debt is high at $5 million to $8 million cash, it has the highest insider conviction at 50%. Analysts expect virtually the same 5-year EPS growth rate as ANN at 12.83%. The PEG is at 1.12.
The company disappointed by 5.7% at its July earnings release after three quarters of surprising on the upside. It also guided lower and announced its CEO departure and a rise of 41% for inventories. Net income fell 27% to $9.19 million yoy and the net operating income cash flow rate was slashed by half from July 2012.
CEO Michael Ray's leaving came after the resignation of the CFO, Jeff Blade, five months ago. Analyst downgrades followed from Wells Fargo, Piper Jaffray, Sterne Agee, and Baird. Ouch! And the shorts' case was made.
A trio of sob sisters
Big sister ANN may be the best bet with less volatility and multi-channel potential but Francesca's is the unique name for the speculative at heart with the most growth expected and expansion planned for its low-overhead, individualized boutiques. As for Vera Bradley, with those inventory troubles and management upsets this is one troubled sister, and your best bet is to stay away. There are better women's specialty retailers with yield than Vera Bradley. Women's retail is a crowded space with no excuses for stores that aren't crowded.
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