Apparel retail industry is always susceptible to tough competition due to low barriers of entry and high bargaining power of customers. Creating and maintaining a competitive advantage in terms of brand pricing and cost cutting is almost impossible unless you have an advantage of being a large scale concern and well recognized brands. High sustainable growth in both revenues and profitability is the life blood for creating long-term value for the stakeholders. For investors, it is very hard to find companies with high long-term growth in their business. However, such companies do exist in the market and they provide good investment opportunities.
One of such companies is the Francesca's Holdings Corporation (NASDAQGS: FRAN) that is well-positioned for high double digit growth in earnings for the long-term. The company's earnings have been growing at above 20%, on average, since the last five to six years and they are expected to grow at the mid-teen rate in the next five years. Additionally, the valuations look cheaper suggesting a buy recommendation for the company. The stock of the company has shown impressive performance in recent weeks at the consequence of better than expected results in the third quarter. The stock still has above 30% upside potential, according to my valuations, to catch my modeled target price of $25 in the next 12 to 18 months.
FRAN is a holding company in the apparel retail industry operating through its subsidiaries in over 48 states and District of Columbia. The specialty retailer operates nationwide with a chain of 669 boutiques. The company's strategic plan is to increase the number of boutiques with each passing year. The company's products fall under four broader categories including apparel, jewelry, accessories, and gifts. It operates with boutiques and direct-to-consumer e-commerce website.
FRAN is on the rising trend with strong growth in revenues, profitability, and cash flows, as shown in the below graph. According to the most recent quarterly (third quarter) results, the company recorded 15% growth in topline ($119.5 million vs $103.7 million) and 7% growth in comparable sales as compared to the same period last year. Diluted EPS increased to $0.26 from $0.16, a 63% increase from the same period last year. The main catalysts behind such an impressive performance were the surge in number of transactions at boutiques resulting from net increase of 50 new boutiques as compared to the same period last year, as well as increased traffic at the e-commerce platform. FRAN is observing increased online shopping activity and reported 47% growth in comparable e-commerce sales. The company is very confident about the better than expected results in the upcoming quarter. The company raises its fiscal 2016 diluted EPS outlook from $1.03 to $1.07. Analysts too are optimistic about the company's better prospects and they have increased their estimates number of times in the recent past. The management of the company is very positive in their strategic moves and they are looking at the holiday season a major catalyst for the fourth quarter results. President and CEO Mr. Steve Lawrence commented at the third quarter results and future strategy as:
"We are very pleased with our third quarter results, as we achieved double digit growth in sales and EPS exceeded our expectations. Our strong performance was the result of a 7% comparable sales increase as well as better than expected gross profit margin and operating margin. We had a good start to the quarter with a successful back-to-school season and the strong trends continued in September and October as our merchandise and boutique experience resonated well with our guests. Looking ahead, we will continue to execute on our strategic initiatives and believe we are well-positioned for a successful holiday season and beyond."
Now look at few of the fundamentals of FRAN as compared to its peers. The company looks fundamentally very strong as almost each of the fundamental measures (listed in the below table) higher than the peer's average numbers. FRAN has competitive advantage both in terms of profitability as well as management efficiency in use of its assets. I will not go in detail for every measure; however, I would like to mention few of them here. FCF margin, ROE, and ROIC are the very important measures the investors should be concerned about. These three measures of FRAN, as compared to its peers, are really impressive and indicates that the company some sort of economic moat over the competitors. FRAN is well-positioned to maintain this competitive advantage going forward as the expected earnings growth (shown in the graph to below the following table) is just under mid-teens, on average, for the next five years. All of these fundamental measures along with high expected earnings growth rate indicate that the stock of the company is a good buy candidate for the long term investment horizon.
Source: Author Calculations/ Stockrow.com
Stock of the FRAN is undervalued according to the relative valuation of the company. First of all, look at the P/E multiple which is a benchmark relative valuation measure. The P/E ratio of FRAN is 17.80 as compared to the industry's P/E ratio of 24.10 which indicates that the stock of the company is trading at cheaper valuations. Using company's fiscal 2016 EPS of $1.07, the intrinsic value of the stock comes to $25.79 ($1.07*24.10), a solid 36.95% upside potential from the current price level.
The company is expected to grow at a high double digit earnings growth rate in the next five years, hence, the denominator of the P/E ratio is expected to grow at a high growth rate as well. Therefore, it is expected that the P/E ratio will move towards its south in the next few years, making it more attractive to invest, as shown in the second to the below PE graph.
My second valuation model, EV/EBITDA model, makes my investment thesis even stronger. The EV/EBITDA multiple of the FRAN is 7.85x as compared to the industry multiple of 10.84x, indicating that the stock of the company is undervalued. Using the EV/EBITDA valuation approach, as shown in below table, the intrinsic value of the stock comes to $25.87, an upside potential of 37.37% from the current price level.
Source: Author Calculations/ Stockrow.com
Based on the fundamental analysis and valuation models applied above, I set my target price for FRAN to $25 which is a solid upside potential of above 30% in the next 12 to 18 months investment horizon. This is a good buy for long-term investment horizon.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.