Francesca's - Implosion Of Comparable Store Sales Continues

Sep. 4.13 | About: Francesca's Holdings (FRAN)

Shares of Francesca's (NASDAQ:FRAN) are taking a renewed beating after the national operator of boutique clothing stores announced a poor set of second quarter results, accompanied with an even softer outlook.

As comparable store sales keep deteriorating, the latest sell-off is warranted, even after shares have lost some 40% of their value over the past four months.

I remain on the sidelines, worried about the violent nature of the deterioration of the business which still generates really fat profit margins.

Second Quarter Results

Francesca's generated second quarter revenues of $89.6 million, up 17% on the year before. While topline growth seemed healthy, it was entirely driven by store openings as comparable store sales actually fell by 1%. Revenues fell way short on consensus estimates of $94.5 million.

Net earnings rose by 15% to $14.6 million as earnings per share rose by five cents to $0.33 per share. Earnings fell short on consensus estimates of $0.35 per share.

The board of directors has authorized a $100 million share repurchase program, to take advantage of the recent decline in the share price.

CEO Neill Davis commented on the past quarter's performance, "While we posted high teens increases in second quarter and year to date sales and earnings, our second quarter sales performance was softer than we anticipated. We were able to maintain strong profitability with operating income margins only modestly below the prior year levels. "

Looking Into the Results

Sales for the quarter rose 17% which was entirely driven by 79 new store openings since last year, and driven by performance in jewelry which offset weakness in gifts.

The real shocker was comparable sales which fell by 1% after reporting 21% growth in the quarter last year. The number of transactions fell by 4%, only partially made up by a 3% jump in the size per transaction.

Sales from online operations nearly doubled, as they rose by 92% on the back of an increase in traffic, conversion rates and average transaction values. Excluding these sales, comparable sales in the stores fell by 3%.

Gross margins fell by 150 basis points to 53.3% on higher promotion activities and negative leverage of fixed occupancy cost. Margins compression was somewhat offset by a full 100 basis points drop in selling, general and administrative expenses.

All in all, earnings grew slightly slower than revenues on the gross margin compression.

Looking Into The Remainder Of The Year

Francesca's sees third quarter revenues between $78 and $80 million. This assumes a 2 to 5% decrease in comparable sales, as well as the openings of 11 new boutiques. Diluted earnings per share are seen between $0.19 and $0.21 per share.

For the current third quarter, analysts were looking for earnings of $0.30 per share on sales of $89.7 million.

Full year sales are between $343 and $349.5 million, assuming a 2% fall in comparable sales and 87 store openings. Adjusted earnings per share are seen between $1.10 and $1.16 per share.

Valuation

Francesca's ended the second quarter with $39.5 million in cash and equivalents. The company furthermore operates without the assumption of debt, for a modest cash position.

Worrying is the 32% increase in inventories, although they only amount to $25.6 million, or less than a month's worth of sales.

Revenues for the first six months of the year came in at $168.6 million, up 22% on the year before. Earnings rose by 19% to $25.6 million.

Trading around $18 per share, the market values Francesca's at $800 million, or its operating assets around $760 million. Based on the full year outlook, operating assets are valued at 2.2 times annual revenues and 15 times annual earnings.

Francesca's does not pay a dividend at the moment.

Some Historical Perspective

Shares of Francesca went public in July of 2011 in a hugely successful offering. After bankers and the firm initially offered shares in a $14-$16 price range, shares were sold to the general public at $17 per share. Shares quickly rose to $28 on their opening day and rose to highs in their mid-thirties by the summer of last year.

Ever since, shares have been falling from $30 in May of this year to current levels around $18 as comparable store sales have plunged and are actually falling at the moment.

Between the fiscal year of 2009 and 2012, Francesca's has roughly quadrupled its annual revenues to $296.4 million on the back of store openings and solid growth in comparable sales. The company has steadily grown earnings to $47.1 million last year.

Investment Thesis

While the second quarter results were already weak, the outlook for the third quarter was even weaker as Francesca's sees challenging traffic trends, just like many other US clothing retailers.

Besides lower traffic, CEO Davis also blamed "the lack of a dominant apparel fashion trend" which seems like an excuse to me. One tiny bright point is the improvement in traffic trends in the final week of August.

As a result, Francesca's cut its full yea adjusted earnings target from $1.27-$1.30 per share to $1.10-$1.16 per share. The widened guidance just shows the increased uncertainty the business is facing.

At the same time the board has earmarked a $100 million to be used in share repurchases to be employed when the stock trades below management's estimates of intrinsic value.

Comparable store sales are simply falling off a cliff, especially in light of last year's high growth rates and the positive impact of direct internet sales. While online sales grow at an impressive pace, they still hardly contribute to the bottom line.

Adjusting for online sales, revenues in stores might actually fall by over mid single digits in the third quarter. In order to restore some traffic growth, Francesca has resorted in promotions which hurt gross margins by only 150 basis points over the past quarter. Yet given the increasing inventory levels, this has not been enough and more pricing cuts, with margin consequences are needed in the current third quarter.

In June of this year, I concluded that Francesca's sell-off following the first quarter results was warranted as same store sales have imploded. At the time comparable sales were still up by 2%, and they have fallen to -1% over the past quarter, expected to fall between 2 and 5% gong forwards.

I was worried about the long term prospects for the relative fat margins of the business, especially in light of a valuation at then 20 times annual earnings, suspecting that competition would eat into profits. Even in the second quarter, Francesca earns an unheard sixteen cents on each dollar of revenues. The double whammy of lower earnings growth and a lower price multiple attached to that is killing current shareholders.

The continued compression on sales has only accelerated since that moment. After shares have fallen by some 40% in merely 3-4 months time, shares are not an obvious buy given the deteriorating in the fundamental business. I remain on the sidelines for now.

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.