Seeking Alpha
Profile| Send Message| ()  
Chico's (CHS) released results on Tuesday that were more or less in line with the reduced expectations we've been forced to adopt for the women's fashion retailer.

Management continues to be quite honest in noting the disappointing results, as noted in this TheStreet.com article, which is always refreshing -- and they have consistently admitted over the last six months that their troubles have had as much to do with poor merchandising and marketing decisions as anything else.

But as Marek Fuchs writes in that article, honesty only takes you so far. We need to decide as investors whether Chico's is broken permanently, or only temporarily bent and undergoing appropriate repairs.

Most of what I know about the company makes me want to give them the benefit of the doubt. They've done such an excellent job of building a customer base and growing in the past that it would be unusual if they just suddenly stopped knowing how to merchandise. And if what I've seen at my house is any indication, their marketing efforts have only recently (the last two days) stepped up for the holidays, with special holiday receptions for frequent shoppers at every store planned for next week.

Two things make me want to keep holding my shares:

  • The company is continuing to grow rapidly as they ramp up their store base. Sales are growing well and the cash flow is funding new store openings and expansions -- the problems show up in same/comparable store sales, not in overall sales (overall sales for November were up 14.3%, comparable store sales down .4%).
    White House Black Market
    Contrarians will point to that and say that the declining same store sales mean they've saturated their market and have nowhere to go but down, but I disagree. I think they have the potential for continued solid growth in Chico's stores, and dramatic growth in the Soma and White House/Black Market lines that are still really in their infancy. There are still a lot of high quality malls in the US that don't have any of the Chico's brands yet.
  • Management remains firmly in place and recognizes that they are having problems. This is the same management team that built the company and developed their distinctive niche, so I have some faith that they will be able (with the addition of more management talent, something they've already done) to restore the luster.
  • But there is one really big problem lurking, one with the potential to make me bail (though I'm not going to sell now).

    Those of us who believe that Chico's can remain a strong grower know that the main growth driver going forward is going to be White House/Black Market, their smaller chain that appeals to a somewhat younger woman and that has had a couple years of truly dramatic growth in both store base and same store sales. In essence, the bet is that WHBM will become the kind of powerhouse that the core Chico's brand has been for ten plus years.

    That means we have to see WHBM continue to be "special" and different from other women's retailers. No one has been able to touch Chico's for profit margin or customer loyalty for many years, and we need for WHBM to follow in those footsteps. And to some extent, that is happening: The company reports that members of the loyalty programs for both brands are climbing well (Passport Club for Chico's, Black Book for WHBM), and clearly since acquiring the brand Chico's has done an excellent job of driving same store sales growth and maintaining good (though not as good as Chico's) margins.

    But this earnings release called attention to a little problem at White House/Black Market, and if that little problem becomes a big problem than a large part of my investment thesis in CHS may fall apart.

    That problem is well stated by Scott Edmonds in the earnings release:

    Although the Chico's November same store sales were essentially in line with guidance, our overall November same store sales were below guidance mostly because the White House ¦ Black Market same store sales fell short of plan. We are currently finding that the combination of the more promotional retail environment along with our own fashion errors have resulted in a higher than anticipated markdown rate.

    After WHBM has consistently helped to buttress the problems in the Chico's brand during a difficult year which has seen two seasons of poor sales at Chico's, they're now dragging down results ... at least a little bit.

    Now this isn't necessarily dire -- it looks like WHBM has suffered from an overall trend toward markdowns in the sector during November, probably particularly in the early days of the holiday shopping season. And that might be OK, since prior to the markdowns they had had some success in driving average prices a little higher.

    But if this is a chink in the armor, and WHBM is going to be like any other women's retailer with frequent markdowns that cut into margins ... that means this brand is not "another Chico's." That's definitely something to keep an eye on, even if I'm not yet letting it worry me too much.

    CHS 1-yr chart:

    Chico\'s chart

    Source: Are Chico's Inc.'s Diasappointing Results Cause for Concern?