Chico’s FAS consists of 4 brands of clothing stores: Chico’s, White House¦Black Market, Soma, and Fitigues. The company's Chico’s flagship brand represents more than 80% of overall revenue. Over the last few years, the company has experienced significant growth, which investors rewarded with a rapidly growing stock price. As often happens with growth stocks, the stock price grew faster than earnings, with the expectation that management would deliver on investors’ rising expectations. Recent slowing and then falling sales at Chico’s flagship store, along with tempered earnings forecasts for the remainder of the year, has led to a rapid drop in stock price, halving the P/E ratio. Some investors may wonder if Chico’s is past its glory. This fall from grace may be premature.
Recent hiccups notwithstanding, the Chico’s brand is maturing well. This trend has been going on for several years and is a positive outcome that confirms the viability and success of the company’s business model as well as the acumen of its managers. The company has generally avoided pitfalls that might have slowed it down as it grew. The year over year growth in monthly sales for the company has been slowing and is a sign that the brand is maturing. Again, ignoring, perhaps at my own peril, the recent fall in same store sales, the trends are still positive, but getting smaller. Unfortunately, slowing growth can lead to the erroneous interpretation that the brand is failing.
While one might argue that the new brands that complement Chico’s are a distraction to a management team that should focus its efforts on maintaining the success of the flagship brand, this argument misses a fundamental point. Mature brands cannot grow as quickly as new ones. In fact, new brands are a requirement for CHS to maintain growth momentum in the middle and long term.
Lacking sales data broken down by brands, square footage is a useful measure of brand maturity. Looking at the growth in net selling square feet for Chico’s and White House¦Black Market is particularly interesting. The other two brands are too young for any meaningful analysis. The simplest estimate assumes organic growth up to a natural saturation point. In the case of Chico’s, the year over year growth in selling square feet points to a maximum of 1.6 to 1.7 million square feet of selling space. White House¦Black Market is a younger brand and quarter over quarter growth in selling square feet gives a maximum of 410 to 420 thousand square feet of selling space. The uncertainty in the estimate for White House¦Black Market is greater because it has a shorter history than Chico’s.
The following statements are based on an analysis of trends; specific years may vary a bit but the trends seem to hold quite well. From this, Chico’s, as a brand, experienced peak growth [in terms of numbers of stores opened in a given year] around mid-2002. Since then, the company has continued to grow, but at an ever slowing rate. Projected mature square footage for Chico’s stores is 35% greater than in 2005. Likewise, White House¦Black Market’s growth rate [in terms of number stores opened in a given year] appears to have peaked in 2005 and it will grow by about another 150% in size before reaching maturity. Again, because White House¦Black Market is younger than Chico’s trends may not be as strong yet, leaving some room in this estimate. Soma and Fitigues are too new to establish any trends yet.
Using the same type of analysis, historical sales figures suggest that on its present course the overall company will reach full maturity around 2010. Retail space will be about 20-50% larger than today. 4th Q 2006 selling space should be about 1.7-1.8 million square feet, and may increase to about 1.9-2 million square feet in the 4th Q 2007 and to about 2-2.1 million square feet in the 4th Q 2008. Around 2010, square footage may be in the low 2 million range while sales income and profits will be up to twice what they are today in inflation adjusted dollars, and about 1.5-1.7 times today’s in fixed year dollars. 2008 sales should be approximately 14-15% larger than 2007. 2009 sales should be approximately 9-11% larger than 2008.
New brands undoubtedly inject vitality into any company and play a key role in maintaining growth. Because new brands are generally smaller than mature ones in a company’s portfolio, their contribution to the bottom line may not always be sufficient to bring up the overall numbers for the company as a whole. With only a few brands, the largest brand, which is usually the most mature one, has an overwhelming contribution to the overall numbers. This is especially evident with Chico’s, which has grown so fast. Because it has been so successful, it is difficult to grow other brands within the company sufficiently quickly to significantly influence overall company growth.
Newer brands will need to grow faster and have greater market potential than existing brands to significantly influence the bottom line in the next few years. By the time new brands can affect the bottom line significantly, they may be nearing maturity themselves, so the effect will be short lived. The bottom line is that the brand Chico’s has been the growth engine that built the valuation of the company. The brand still seems healthy, but it will soon stop growing.
This is a reflection of natural growth potential rather than any other factor. To keep growing as a company, Chico’s needs to make continued significant investments in potentially valuable businesses that are growing and that will not mature too quickly.
While this may seem like a grim picture to some, it actually points to a potentially very exciting restructuring that could occur at Chico’s to capitalize on its successful shift to a mature brand. Consumers’ tastes change and sales do rise and fall over time, but mature brands have relatively predictable cash flow. The company can easily borrow against future earnings to make significant acquisitions to do this. Then again, it might not be too much of a stretch for the company to look for a way of taking itself private either.
Disclosure: Author is long CHS