Francesca's - Shares Fall On Too High Expectations

| About: Francesca's Holdings (FRAN)

Shares of Francesca's (FRAN) ended the week with losses of over 8%. The operator of retail boutiques reported its third quarter results on Wednesday before the market open.

Third Quarter Results

Francesca's reported third quarter revenues of $72.0 million, up 44% on the year before. Growth was driven by a 16.7% increase in comparable store sales, with the remainder of sales being driven by 76 new store openings compared to the third quarter last year. Revenues were in line with consensus estimates of $71.2 million.

Gross profit growth surpassed revenue growth, coming in at 47%. Consequently, gross margins rose 96 basis points to 52.6%. Margin expansion was mostly driven by leveraging occupancy costs. Selling, general & administrative costs fell 355 basis points to 27.5%, again on strong positive sales leverage.

Net income for the third quarter came in at $10.2 million, or $0.24 per diluted share. Last year, Francesca's earned $4.7 million, or $0.11 per diluted share. Net margins rose sharply from 9.5% to 15.0%. Adjusted earnings of $0.24 per share, beat consensus estimates by two cents.

CEO John De Meritt commented on the results, "We delivered another quarter of strong results, demonstrating the appeal of our business model of a differentiated merchandise strategy in a boutique environment. Our scalable, high margin merchandise model combined with productive new boutique economics provides a runway for boutique growth and gives us confidence in Francesca's long-term growth potential."

Outlook

For the current fourth quarter, Francesca's expects sales to come in between $82.5 and $83.5 million, based on mid-single digit growth in comparable boutique sales, and the opening of one new store. Diluted earnings per share are expected to come in between $0.27 and $0.28 per share.

Analysts expected Francesca to guide for earnings of $0.28 per share, on revenues of $83.3 million.

Full year sales are expected to come in between $292.2-$293.2 million. Diluted earnings per share are expected to come in between $0.99 and $1.00. Adjusted earnings, which exclude relocation expenses and costs related to the secondary offering of shares, are expected to come in a penny higher.

Valuation

Francesca's ended its third quarter with roughly $12.9 million in cash and equivalents. The company operates without debt, for a small net cash position.

After last week's declines the market values Francesca's at $1.05 billion, which values operating assets at roughly $1.04 billion. This values operating assets at 3.5 times annual revenues and roughly 23-24 times annual earnings.

The company currently does not pay a dividend.

Some Historical Perspective

Year to date, shares of Francesca's have risen some 38%. Shares started the year around $17 per share and rose to highs of $36 in August. From that point in time shares have lost roughly a third of their value, currently exchanging hands at $24 per share.

Francesca's went public in the summer of 2011, for a price of $17 per share. Shares still trade with decent gains, despite the sizable pull back in recent months.

Investment Thesis

Francesca's results and the corresponding outlook were a bit disappointing, thereby causing last week's sell-off. The fourth quarter revenue guidance of $83 million, at the midpoint of the guided range, implies that revenues would rise 11.5% on a quarterly basis. Revenue growth would come in at 34.6% on an annual basis, down from the 44% growth rate in the third quarter.

The company remains upbeat about the prospects for the business, especially in the earnings conference call. Francesca notes that weakness from Sandy was more than offset by very strong Black Friday sales, partially the result of a lengthened season. Francesca was forced to close 60 stores for at least one business day as a result of the hurricane. Key for 2013 is to further develop the company's e-commerce strategy. Currently e-commerce sales make up just a low single digit percentage of total revenues, and a new website is expected to be completed in the first quarter.

Francesca's sees potential for 900 stores eventually. The company plans to open 77 stores during 2012, followed by another 80 openings in 2013. Assuming 80 new boutique openings in 2013, and same store sales growth coming in around 10%, revenues for 2013 could come in around the $400 million mark. Despite the significant margin improvements, I expect long term net margins to stabilize around 15%, resulting in net earnings of $60 million. This would value shares at 2.6 times annual revenues and 17-18 times annual earnings.

I would be a buyer if shares were to fall to levels in the low twenties.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.