Chico’s FAS is a retailer of women’s apparel catering to women 35 years and older with income greater than $100,000. Unlike other apparel retailers that have to deal with fickle consumers, Chico’s customers are in a demographic that is more stable in its proclivities.

 

The company has four concepts: Chico’s, White House | Black Market (WHBM), Soma Intimates and Boston Proper. Chico’s (flag ship brand, started in 1983) and WHBM (acquired in 1985) are traditional stores that sell branded clothing.  Soma, which started operations in 2004, is a store-based concept that sells branded lingerie and beauty products. Boston Proper, acquired in 2011, is a direct-to-consumer brand.

 

The company primarily focuses on a smaller-size store format as compared to other retailers. A smaller store size allows the company to create a “boutique” experience for its clientele as well as offer more personalized service. Women in the company’s target demographic tend to prefer a personal touch when shopping. Store sizes are typically 3300-3500 sq feet for Chico’s, 3000 sq feet for WHBM and Soma. They are just rolling out their Boston Proper stores and expect them to be 2200-2500 sq feet in size. The company has a strategy of refusing to lower product quality in a promotional environment. This along with strong brand management has allowed it to garner very high productivity when compared to their peers in the specialty retail space.

 

 

 

·      AEO,CHS, TLB numbers on a selling sq feet basis. All others on a sq feet basis

·      CWTR is now bankrupt, TLB was acquired recently by private equity

·      CWTR, TLB and ANN are direct comps as they are all women’s retailers (so called “missy” segment)

·      ARO not included because it is in trouble. At its peak, ARO did $626 per sq foot

 

A key competitive advantage for Chico’s is the use of analytics to drive their real estate strategy. For example, Boston Proper has a 25 year historical consumer database which gives them great visibility into consumer interest in various geographies. The company has also learned a lot from the Soma rollout. Launched about 5-6 years ago, it was launched coast to coast and the company realized that it could not get the synergies from marketing with such a wide footprint. They have since revamped their store expansion strategy to group stores in specific areas. This is actually classic Bruce Greenwald – “all competition is local”.  For a retailer, advertising is local and by increasing the density of its stores, it is not only able to decrease its cost per customer but also target its advertising more effectively than competitors.

 

Seasonality: - Chico’s does not have the usual sales cycle of most apparel retailers (which peak in the holiday quarter). Q4 is a gifting season during which a woman will buy for others rather than herself. Their Q4 is therefore 20% less than average and they peak in the spring/summer months.

 

Their per-unit productivity is pretty good, with Chico’s/WHBM paying back their initial investments in 12-18 months (implying an IRR close to 90%) whereas Soma’s payback is 3-4 years. This is because women are quite loyal to the brand of lingerie they use and it takes time for them to switch – therefore these stores take longer to ramp up.

 

As of 02/01/2014, the company owned 721 Chico’s, 498 WHBM, 249 Soma and 4 Boston Proper stores for a total count of 1472. The company estimates that it can open 120 stores annually for several years.  They think they can get to 2000 stores in their core Chico’s, WHBM and Soma brands in the US. They have recently opened WHBM stores in Canada and estimate their Canadian potential to about 10% of their US footprint (or about 200 stores).

 

Does that look like a conservative number? Well ANF, AEO are near saturation at around 1000 stores. However, those are mall-based retailers and CHS is not. They do have some mall locations, but they also focus on smaller markets (where occupancy expenses are lower). So looks like the potential for Chico’s and WHBM is about a 1000 each. Also, Victoria’s secret has about 1060 stores in the US. Soma, which is a comp has only 249 stores today. So definitely there seems to be a potential of atleast 1500 more stores, or their 2000 store count estimate seems conservative. This does not include the rollout of their Boston Proper format  which they just acquired in 2011. Note that although Boston Proper is a direct-to-consumer brand, they do plan to open stores in this format (having already opened 4 in fiscal 2013).

 

 

CHS was a growth stock from 1999-2005, comping double digit almost every year. After a couple of years of negative comps, a new CEO was brought in (2008) who has turned around comps and restored the brand to profitability.

 

 

Since FY2009, Chicos has grown Sales, adjusted EBIT, and #Stores at a CAGR of 10.84%, 18.68%, and 8.05% respectively. I have adjusted EBIT to exclude all one-time items.

 

 

David Dyer, the new (aforementioned) CEO was the CEO of Lands’ End (the direct marketer) from October 1998 to 2002, during which he increased net income from $31.19 million to $66.92 million.  He sold the company to Sears for $1.9 billion in cash in March 2002. That amounts to 1.19x ttm Revenues, 14.8x ttm EBIT, 12.15x ttm EBITDA – a pretty good deal for shareholders. He was tapped to run Tommy Hilfiger from August 4, 2003 to May 2006, a turnaround situation. Although, he was not very successful, he was able to sell it to Apax Partners for $1.54 billion.

 

Since becoming CEO, comps have turned positive (sans the last fiscal year) and the company has been “reported” FCF positive (defined as reported OCF – capex) in the last five years. An interesting point is that Chico’s 4^th quarter was traditionally loss making (see earlier point in seasonality discussion). Since joining, the quarter is now profitable. Dyer has done this by introducing more “gifting” assortments during the holiday season. He has been patient with the rollout of Soma – refusing to close it down in 2008 when it would have been an easy sell to the BoD. In 2012, Soma reported its first year of profitability as a brand and is on target to becoming a growth vehicle.

 

The company has been a consistent buyer of its own stock returning approximately $690 million to shareholders by repurchasing 12% of its outstanding shares since 2010. It pays a dividend, currently yielding 1.89%.

 

After 4 years and 16 quarters of positive comps, Chico’s first comped flat in Q1 2013 and then –ve in Q2 2013 …

 

 

The stock tanked in Q2 2013 to around $15.8. After a small recovery to the $19 level, CHS comped -3.4% in Q4 2013 and it tanked again – to around the same level. Management’s explanation of the –ve comps has been “weather”, promotional environment, traffic and merchandise.  They believe that Chico’s is a warm weather brand so perhaps we can believe some of that “weather”/macro story. The environment is promotional – a quick look at other retailers will verify these trends as also traffic. ANF comped –eve in all those 8 quarters, AEO in the last 4 quarters whearas ANN (a more direct comp) was more or less mid-single digit +ve (with a few -1% or -.5% thrown in).

 

So I believe it was a combination of factors as well as perhaps some merchandise issues. With their past record, I am willing to take the bet that management will be able to fix these issues in the next year or two.

 

In the meantime, CHS throws of a huge amount of FCF and we get a dividend of 1.89% to boot. If we assume CHS can grow EBIT at 15% the next three years, forward EBIT = $326 million. That growth rate is reasonable considering the growth profile of this company as well as the historical rate. Or we can buy this beast today at 7.72x normalized EBIT 2-3 years out. CHS has debt-free, is buying back shares by the boatload and has a strong management team.

 

A quick run of the numbers is below -

 

 

 

At a recent price of $15.84, CHS has a market cap of $2.47 billion and Enterprise Value of $2.52 billion ($200 million as w/c cash so not excess, as stated by management). This year there was excess promotional activity and possibly a fashion miss as traffic declined. So if we take FY 2012’s figures as “normal”, we get to a normalized EBITDA of $399 million and EBIT of $290.7 million (excludes impairment charges). Or we are buying the company at an EV/normalized EBITDA of 6.32x. Management does not disclose maintenance capex. However ANF’s m-capex is $100 million. CHS has averaged D&A at $103 million the last 5 years. ANF’s stores are considerably (2-3x) bigger and it is also a “higher end” retailer. So $90 million seems like a good estimate for maintenance capex. This implies FCF = $202 million (using a 35% tax rate). A conservative 16-18x multiple on this yields a stock price of $20.7-$23.4 today or about a 30-47% return if things normalize in 2 years. A 16-18x multiple is conservative because, a govt bond at 6.25% implies a 16x earnings multiple. This company had ROC (defined as EBIT/NWC+FA) of 20% on average in the last 5 years (on a pretax basis, a govt bond yields about 10%). So this “security” is definitely worth more than a govt bond. It should be priced at a much higher multiple than 16x. As a cross check if we apply a 8-10x EBITDA multiple (JOSB recent offer for MW was at 8x), then we get $20 - $25.27 which is 25-60% above the stock price today. These EBITDA/FCF values are definitely not peak values considering the growth profile of this company.

 

Their target consumer is very sensitive to the economic environment, so that is a risk.

Execution risk – always in a fashion retailer – they might miss more fashion cycles.