Francesca's: Strong Comps And Visible Unit Growth Offer A Compelling Investment

Jul. 3.12 | About: Francesca's Holdings (FRAN)

I believe Francesca's (NASDAQ:FRAN) is one of the most compelling specialty retail growth stories in the market today. The stock offers investors a trifecta of double-digit comp growth, 20%+ new unit expansion, and solid 32% fully-capped unit level ROIs. Further, sentiment in the name is low given the recent termination of the former CFO and subsequent ~20% decline in the stock price since March. I believe this is an attractive entry point.

Upward Bias To Comp Guidance And EPS: Francesca's comps have grown on average 11.8% over the past three years and show no signs of slowing. Notably, comps increased a whopping +15.5% with its most recent Q1 results (ending in April), on top of +14.7% last year. Further, the two-year trend accelerated sequentially from +29.2% to +30.2%. Given the solid trends, management increased its full year comp guidance to high-single-digit expectations from mid-single-digit prior. I believe this is very conservative guidance given FRAN is lapping easy +5.4% and +6.5% comparables in the coming two quarters. Extrapolating the two-year trend implies comps could increase in the mid-to-high teen rate this year, likely leading to full-year EPS closer to $1.00 versus guidance of $0.89 to $0.91 and street estimates of $0.90.

New Unit Expansion Is Compelling: Management believes it can grow its store base to 900 units (compared to 327 today) over the next 7 to 10 years. Some investors have questioned this growth, as it implies a heady mid-single-digit CAGR. That said, the company is adding 75 units this year, or 26.5% growth, and I believe 20%+ unit growth should persist for the next few years. The concept is still new, and the smaller square footage (avg 1,400 sq ft. vs. 9,000 for Urban Outfitters (NASDAQ:URBN) or 5,870 for American Eagle Outfitters (NYSE:AEO)) means Francesca's has more options for real-estate. These include outdoor and indoor malls, as well as boutiques in up and coming neighborhoods and urban areas. Put another way, Francesca's currently has only 455k square feet of total selling space. Its mature competitors like URBN and AEO have 1.8 and 5.1 million square feet. This, coupled with FRAN's solid unit level economics (which I discuss below), and strong comp trends, should increase new unit visibility.

Favorable Unit-Level Economics And A Unique Concept: Management has often mentioned its new boutiques offer a pre-tax cash return on net investment of 150%, meaning a new store pays back the net investment in under one year. However, Francesca's leases its stores, so it's important to look at fully-capped unit level ROI, which is a solid 32%. For perspective, other high returning concepts include market darlings Chipotle (NYSE:CMG) (37%) and Starbucks (NASDAQ:SBUX) (30%). Francesca's boasts solid unit level ROIs because 1) its smaller format stores require less lease expense and start-up inventory, 2) FRAN utilizes a unique inventory approach with short lead times (only 4-12 weeks) and fewer quantities of product, thus fewer markdowns. Additionally, FRAN's product mix consists of 50% apparel and 50% accessories, which helps buffer against potential fashion mistakes. Finally, it's important to emphasize the uniqueness of the Francesca's concept. Store managers and staff are encouraged to infuse their personalities into their respective stores, meaning each store is slightly different. This offers customers a breath of fresh air given the saturation of cookie-cutter concepts today.

Shares Look Attractive At 20% Below Their March High: FRAN currently trades at 30x forward EPS of $0.90. While seemingly expensive, the stock traded as high as 40x earnings in March, prior to the CFO's termination for inappropriate use of social media. More importantly, management expects EPS to grow 55% this year, driven by high single-digit comps and 26.5% unit growth. Given the comp momentum and 30.2% two-year trend, I believe full year comps could come in at a mid-teen pace resulting in EPS closer to $1.00. Longer-term, the outlook looks solid for FRAN. The concept has grown comps at double digit pace for three years and is showing no signs of stopping. Further, management continues to open stores at a 20%+ annual pace, with the company's unit-level ROI of 32% suggests new stores are very profitable. Overall, I believe FRAN is a compelling growth story and would be adding shares at the current price.

Disclosure: I am long FRAN.