With Sycamore Partners Hot On Its Tail, Express Is An Intriguing Bet

Aug.10.14 | About: Express, Inc. (EXPR)


Express had a disappointing start to 2014, hurt by declines in customer traffic volumes and comparable store sales.

Express' financial performance has led to a sagging stock price.

The company's sagging stock price has brought suitor Sycamore Partners knocking on its door.

Shareholders in specialty retailer Express (NASDAQ: EXPR) are probably second guessing themselves, given the poor performance of the company's share price, which has been stuck in reverse over the past year, down more than 30%. Express has anecdotally been hurt by the negative effects of a highly promotional selling environment, a trend that has also hit the fortunes of many of its competitors, including American Eagle Outfitters (NYSE: AEO).

However, Express' share price showed some life in June, after retail-focused investment firm Sycamore Partners unveiled a 9.9% stake and an interest in a buyout of the company. Despite management's subsequent defensive posturing, highlighted by the initiation of a shareholder rights plan, a buyout seems plausible, especially in light of the company's sagging stock price. So, is Express a good bet at current prices?

What's the value?

Express is a major player in the specialty retail space, operating a network of more than 600 stores that sell a range of apparel and accessories to a target demographic of people in their teens and 20s. The company has done a reasonably good job of leveraging off of the power of its brand name, which has kept its gross margin above 30% in each of the past five fiscal years. The net result for Express has been a consistently profitable business model, with a 10.4% average operating margin over the five-year period, providing a solid financial foundation for an expansion of its store base.

In its latest fiscal year, it was a similar story for Express, evidenced by a gross margin of 32.3% and an operating margin that fell just shy of the five-year average, coming in at 9.7%. Not surprisingly, the relatively healthy profit margin led to solid cash flow generation, helping to fund a strategic expansion of its store base, including a move into the outlet arena.

On the downside, though, Express' gross margin did noticeably contract for the second straight year, down roughly 210 basis points, due to the need to engage in promotional activity to counteract a decline in customer traffic volumes. More importantly, the contraction in gross margin has continued in the fiscal first quarter of 2014, a prime cause for the big drop in operating income during the period, down 74.5%.

A tough slog for everyone

Of course, Express is just one of many sector players that are currently struggling with declining profit margins. American Eagle Outfitters, another company that targets the twenty-something demographic, has likewise seen its gross margin fall sharply in FY2014, down 390 basis points in its fiscal first quarter, due to heavy promotional activity in response to declines in customer traffic volumes and comparable store sales. The negative trend impacted the company's results even more so than it did at Express, culminating in an 81.7% decline in operating income. Not surprisingly, the corresponding decline in cash flow generation had a profound impact on American Eagle Outfitters' growth ambitions, leading to the decision to close up to 150 stores in North America.

Even sector standout Urban Outfitters (NASDAQ: URBN) has succumbed to competitive pressure in FY2014, reporting a 200 basis point decline in gross margin in its fiscal first quarter. While the company's wholesale business remained strong during the period, its retail business was negatively impacted by declines in comparable store sales, led by a 12% drop for its Urban Outfitters brand. The net result for Urban Outfitters was a rare drop in operating profitability, producing an 18.1% decline in operating income and tempering management's optimism for another year of annual profit growth.

The bottom line

Express' financial results are clearly on the slide, as illustrated by its sharp drop in operating profitability in its latest fiscal quarter. That being said, management seems to be on the case, recently unveiling a profit improvement plan, including the closure of up to 50 underperforming stores over the next 36 months. Also attractive is Sycamore Partners' significant stake, which could lead to a bona fide buyout offer or, at the very least, help to incentivize management to focus on shareholder value. Profit growth may be off in the distance for Express, but with a current, below-market P/E multiple of roughly 14, it looks like an intriguing bet at current prices.

Disclosure: The author is long EXPR. 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.