Try Not To Get Sucked In To The Action At Chico's

Aug. 6.14 | About: Chico's FAS, (CHS)


Chico's revenue growth has slipped lately, thanks to overall declines in its comparable store sales.

Chico's operating profitability has also slipped, due in part to the negative effect of promotions on its operating margin.

The company's sagging stock price has potentially put it in the crosshairs of would-be acquirers.

Shareholders in women's retailer Chico's (NYSE: CHS) have been waiting for a spark to ignite the company's share price, which has had difficulty finding positive momentum over the past twelve months, down roughly 8%. Chico's has been hurt by slowing top-line growth, due in part to weak mall traffic, a trend that has also impacted competitors, like Ann (NYSE: ANN). Case in point was Chico's sub-optimal performance in its latest fiscal quarter, highlighted by a 2.6% decline in overall comparable store sales.

However, Chico's seemed to receive that elusive spark in June when media speculation surrounding a potential buyout of the company led to a solid pop in its share price. So, does the company look like a good bet at current prices?

What's the value?

Chico's is one of the major players in the women's specialty retail space, operating a network of nearly 1,500 stores, predominantly in the U.S. The company has built a consistently profitable enterprise, thanks to an operating strategy that has seen it diversify beyond its trademark store base, with forays into the upscale and intimates-focused product areas through its White House/Black Market and Soma brands, respectively. The net result for Chico's has been solid cash flow generation, fueling investments in a larger store base that have allowed its total revenues to expand by 51.0% over the past four fiscal years.

However, that favorable growth trajectory exhibited a significant slowdown in Chico's latest fiscal year, highlighted by a modest 0.2% increase in total revenues that was hurt by lower comparable store sales, its first negative annual comp performance since FY2008. More importantly, the company's profitability was negatively impacted by a meaningful decline in its gross margin, anecdotally due to competitive pricing pressures, as well as the rising support costs of its growing store base, which is expanding both north and south of the border. Not surprisingly, Chico's suffered a drop in operating cash flow, bringing into question the wisdom of expanding its physical store base at a fast clip in the current selling environment.

Of course, Chico's is not alone in its business challenges, as competitor Ann, owner of the Ann Taylor and Loft brands, has been exhibiting similar profit pressures. While the company posted an increase in adjusted operating income in its latest fiscal year, up 2.0%, the gain seems to have partially been the result of cost savings initiatives that have succeeded in reducing the relative size of its corporate overhead. Like Chico's, Ann's gross margin continued to contract during the period, down 90 basis points, a negative trend that led to a decline in its operating cash flow.

What's an investor to do?

The question for investors is whether now is a good time to bet on the story at Chico's. Unfortunately, based on the company's weak performance in its latest fiscal quarter, the answer seems to be no, especially given the fact that Chico's seems to be having trouble growing its customer traffic volumes. As such, investors panning for gold in the apparel sector should probably stick with a company finding better growth in the current environment, like G-III Apparel Group (NASDAQ: GIII).

The company has come a long way from its roots as an outerwear licensee of the Calvin Klein brand, with a diverse current stable of product lines, including a major presence in the team sports apparel arena. G-III Apparel Group has used a relatively lean, outsourced business model to create consistent profitability, which has afforded it the flexibility to make timely acquisitions, highlighted by its 2008 purchase of Wilson's Leather Outlet, a transaction that gave it an overnight retail presence. The net result for G-III Apparel Group has been steady growth in operating profit, up 30.9% in its latest fiscal year, the linchpin behind its strong stock price performance, including a more than 45% gain over the past twelve months.

The bottom line

Chico's could certainly be in the crosshairs of a would-be acquirer, given its debt-free balance sheet and its history of profitable operations. However, in the absence of a transaction, there seems to be little current momentum at the company, evidenced by recent declines in comparable store sales and operating profitability. As such, there doesn't seem to be a solid foundation for a higher market valuation at Chico's and investors should probably avoid buying into the rumors.

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