An Opportunity in a Difficult Business

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

I’m constantly on the lookout for new stocks to follow. Since I’m a big fan of Peter Lynch’s investment style, one way I find new ideas is from retailers that are popular with my family. When I asked my wife what her nieces favorite stores were, she said they all liked Francesca’s (NASDAQ: FRAN), and I immediately put it on my watch list. As Lynch said, it’s not a certain buy signal when family members like a store, but it certainly helps to have the perspective of real-world customers. Much like Lynch used to do, I took this initial tip, and then dug into some research on whether this might be a potential investment.

A Difficult Business to Say the Least
Clothing retailers have a difficult enough time keeping up with different fashion trends, and when you add in the ever-changing tastes and trends among young adults, the business becomes even more difficult. Francesca’s competes in this highly challenging market along with such well-known names as American Eagle (NYSE: AEO), Abercrombie & Fitch (NYSE: ANF), and The Buckle (NYSE: BKE).

While each of these retailers has its own niche, Francesca's has to be doing something right to attract the taste of three different personalities in my wife’s nieces. They definitely don’t agree on everything, but as Lynch once said it’s a good bet that if they like the store there are likely thousands of young adults across the country that have the same opinion. If Francesca’s can capitalize on its current popularity, this would be a point in favor of investing in the stock. However, I like to see much more concrete evidence that the company will perform well, so let’s take a look at some of the important numbers that define this story.

This One Is Not Even Close
When investigating a new investment opportunity, I start by taking a look at analyst expectations for earnings growth over the next few years, as well as revenue growth expectations, and past earnings performance. If investors are judging Francesca’s versus their peers on these three measures, the case is closed, the stock is a buy.

When it comes to expected earnings growth, the average analyst expects Francesca’s to increase earnings by 24% per year over the next several years. By comparison, none of the companies Francesca’s competes against is even in the same ballpark. Abercrombie & Fitch is expected to grow earnings by over 16%, American Eagle is expected to grow by around 11%, and The Buckle is expected to post growth of just over 6%.

This trend continues if you look at the company’s expected revenue growth this year. Francesca’s handily beats the competition with expected revenue growth of just under 25% for 2013. The company’s peer group on the other hand, is expected to post revenue growth of between 1.4% and 3.2%.

Francesca’s has also been consistently beating earnings expectations up to this point. In the last four quarters, the company beat earnings three different times by an average of 8.95%. None of the company’s competition comes even close to this performance. Relatively speaking, the next best performer was Abercrombie & Fitch, which beat earnings three times, missed once, and exceeded estimates by an average of 3.28%. American Eagle performed slightly less well, beating earnings twice, missing once, and averaging a beat of 2.3%. Of the group, The Buckle beat earnings twice, missed once, but on average only beat expectations by 0.58%.

As you can see, if investors are looking for the fastest revenue growth, earnings growth, or the most consistent performance beating analyst expectations, Francesco’s takes all three categories.

What’s the Bottom Line?
It’s one thing for a company to report impressive earnings growth, it’s something else for that same company to turn earnings growth into free cash flow that can reward investors. One way to compare companies in an apples to apples manner is to look at how much free cash flow they generate for each dollar of sales.

Using this measure of free cash flow per dollar of sales, Francesca’s is performing quite well. The only peer to generate more free cash flow from each dollar of sales is The Buckle, which brings in about $0.12. By comparison, Francesca’s generated about $0.10 in free cash flow for every dollar of sales. The far more established American Eagle and Abercrombie & Fitch generated $0.07 and $0.04 in free cash flow respectively.

While I wouldn’t call this an exhaustive investigation into Francesca’s, we’ve seen that the company’s revenue, earnings growth, and historical earnings performance beats three of their well-respected peers. The company generates significant free cash flow from each dollar of sales, and it seems a safe assumption as the company grows it will be able to leverage its expenses to improve free cash flow even further. For growth investors, I would definitely suggest adding FRAN to your personalized Watchlist on Francesca’s operates in a difficult industry, but the company seems to have its finger on the pulse of fashion for young adults. If management can keep this up, the stock’s performance could cause investors' hearts to race as well.

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Chad Henage has no position in any stocks mentioned. The Motley Fool recommends The Buckle. The Motley Fool owns shares of The Buckle. 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!

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