It's Still Too Early To Buy Into The Story At Francesca's

| About: Francesca's Holdings (FRAN)

Summary

Specialty retailer Francesca's struggled to find profit growth in FY2014, hurt by an increasingly promotional selling environment in its stores.

The company's relatively poor financial performance has led to downward pressure on its stock price over the past year.

With an adjusted P/E multiple of approximately 20, Francesca's stock price seems to more than account for its profit growth prospects and investors should avoid the story.

Shares of specialty retailer Francesca's (NASDAQ: FRAN) have encountered a bit of turbulence over the past year with very little net progress to show for its trouble, registering a roughly breakeven return. The company was hurt by relatively weak customer traffic flows at its stores in FY2014, which forced it to offer marketing incentives in order to drum up sales, culminating in a reduced level of adjusted operating profitability, down roughly 620 basis points. On the upside, though, Francesca's posted a better-than-expected profit performance in its latest fiscal quarter, thanks in part to a return to positive comparable store sales growth, sparking hope that better profit growth may be in the offering for the future. So, at current price levels, is the company a good bet for investors?

What's the value?

Francesca's is a niche player in the specialty retail space, operating a network of more than 500 stores that cater primarily to a fashion-conscious, young adult demographic with an eclectic mix of products, increasingly focused on the jewelry category. The company has anecdotally benefited from a growing base of brand loyalists over the past five fiscal years, a favorable trend that has led to rising sales tallies, up 179.2%. The net result for Francesca's was a corresponding rise in operating profit during that time period, funding a more than doubling of its store footprint around the country.

In FY2014, it was a continuation of the growth story for Francesca's, highlighted by a 10.9% top-line gain that was a function of a double-digit increase in the size of its overall store base. On the downside, though, the company was negatively impacted by an average 4% drop in the volume of customer transactions at its typical store, a trend that necessitated more price discounting in a bid to move merchandise off of its shelves, helping to push its gross margin down by roughly 470 basis points. Not surprisingly, Francesca's adjusted operating margin also faded sharply during the period, as previously mentioned, culminating in a 20.4% decrease in adjusted operating income.

Looking into the crystal ball

The question for investors is whether Francesca's can find its way back to profit growth in the foreseeable future, thereby providing a foundation for a higher market valuation. Unfortunately, things don't look so promising on that score at the moment, judging by the company's 18.5% decline in adjusted operating profit in its latest fiscal quarter. While Francesca's posted solid top-line growth, much of that sales momentum appears to have been generated on the back of price cuts, a fact that appears to be corroborated by management's notation of heavy clearance sales activity during the period. More importantly, a seeming lack of current pricing power would appear to be a headwind for future profit growth, as a likely continuation of margin pressure offsets an expected rise in overall sales.

A better way to go

Given the profit growth challenges at Francesca's, investors looking for gold among the jewelry-focused sellers should probably stick with an industry player that continues to drive solid profit gains in the current operating environment, like Signet Jewelers (NYSE: SIG). The company enjoyed a solid financial performance in FY2014, posting a 36.3% rise in overall sales that leveraged a continued improvement in per-store sales productivity, as well as the positive effect of its acquisition of competitor Zale, a purchase that gave it more scale in fashion jewelry. While Signet Jewelers' operating profitability was pressured by the addition of Zale's generally lower-margin businesses, it took advantage of an ability to drive overhead cost savings across the larger merged enterprise, which allowed it to generate solid growth in adjusted operating income, up 19.6%, a performance that has underpinned favorable stock price appreciation over the past year.

The bottom line

Francesca's found its way to sales growth in FY2014, but profit growth was another matter, evidenced by its double-digit drop in adjusted operating income. Unfortunately, barring a change in the promotion-oriented selling environment, it is hard to see profit growth making an appearance in FY2015, something that management would seem to implicitly agree with, based on its earnings per share forecast for FY2015 that is not materially different from the result in FY2014. As such, Francesca's seems to be relatively richly priced at an adjusted P/E multiple of approximately 20 and investors should probably avoid the story at current prices.

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.

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