Any investor in Express (EXPR) has been severely disappointed with its historical performance as a public company. After IPO'ing in 2010 at $17 share, it reached highs in the mid $20-range in 2012, fought off a buyout attempt by Sycamore Partners in 2014-2015, and its shares traded at an all time low this week.
With the S&P 500 near all time highs in spite of the trade war with China, the question for any investor considering Express is: Why invest in this historical loser, especially near an all-time low? Isn't the market punishing its share price for a reason? While there are many justifiable reasons for the market to punish Express, the punishment is far too extreme given the broader context of the company. In fact, I will argue there is a compelling contrarian case to invest in Express, especially because of how much the market has punished its share price. It now trades at a level where there is an asymmetric risk/reward opportunity on the long side.
The reason to invest in Express at its current share price is because it is trading at a deep discount to intrinsic value, has ample cash reserves to execute on a turnaround plan, and has a range of underappreciated operational strengths. In addition, there are several potential catalysts that could lead to a sharp repricing of its shares, especially if a quality CEO is appointed in the near-term future. Its share price is too cheap to ignore and there are several ways Express could turn around and reverse its current struggles.
Examining Express's core business demonstrates there is the possibility of a turnaround depending on the action its management team takes. Although Express may continue to under-perform in the near-term, taking a deep dive into Express's financials and examining a few possible positive catalysts will illustrate how a contrarian investor could benefit from its severely dislocated share price.
Express is a specialty apparel retailer founded in 1980 in the U.S. that targets consumers in the 20 to 30 year old demographic. Its primary sales focus is women who account for about ~60% of net sales. Over the past several years, it has been executing on building out its omni-channel capabilities to reach consumers wherever they shop.
Express has had a challenging couple of years adapting to changing consumer shopping behavior and preferences. This has led to negative sales growth for the past three years, all of which has led the market to punish its share price. However, it has underappreciated operational strengths in its growing e-commerce business, factory outlet store strategy, and pricing power in regards to store leases.
Express has been laser-focused on developing its online shopping experience. Starting in 2013, Express made this a primary area of focus to drive sales. That year they did around ~$340 million worth of online sales, which accounted for about 15% of total net sales. in 2018, they did ~$609 million worth of online sales, or about 29% of total nets sales. They have essentially doubled their net sales online in only five-years all while getting 150 million customers to visit their e-commerce site last year. As a point of comparison, they only had 130 million customers visit their brick and mortar stores, demonstrating the importance of a strong e-commerce platform. With e-commerce growing for Express by 20% in 2018 compared to 2017, it has been very successful in adapting to the increase in e-commerce demand from customers.
Another shift for Express has been an increasing focus on factory outlet stores. Express has converted many of its retail stores to factory outlet stores in recent years and its focus has been on opening new outlet stores. For 2019, Express projects it will have 630 total stores divided between 417 retail and 213 outlet stores.
Express FY-2018 10K
There are two reasons why Express has focused its growth on outlet stores as opposed to retail stores. The primary reason is to drive incremental sales while saving on costs (both product and leasing). Although Express does not explicitly break down comp sales by retail versus outlet, it's clear based on their focus on outlet growth that this is a highly productive sales format, especially compared to their traditional retail stores. This matches the broader secular trend of profitable outlet stores.
The other reason Express focuses on outlet growth is because of lower rental costs. CFO Perry Percleous explained in the last earnings call that when they complete a retail to outlet conversion at lease expiration, this allows Express to get significant "rent concessions from the landlord as we renegotiate our leases."
Express has strong pricing power when it comes to its leases. 60% of their leases are up for renewal over the next three years and, because of challenges in the broader mall environment, Express is able to consistently renegotiate its leases on more favorable terms.
But the big challenge Express has had over the past three years has been a decline of comp sales. While their online sales channel has seen explosive growth, their brick and mortar business continues to contract. Express has not been able to get enough customers in stores compared to online, and has not been able to get these customers to purchase more goods. Figuring out a way to increase in store customer traffic and purchasing volume is the central business dilemma Express faces today.
Financials and Valuation
Although figuring out a growth strategy is always a challenge, Express has substantial financial strength to be able to tide itself over while it figures out a way to return to growth.
Here I want to do a deep dive into Express's historical financial data. From this analysis, I want to highlight three primary points: 1) Express has always generated positive free cash flow; 2) historically it has had an extremely high return on invested capital (ROIC); and 3) and it has a rock solid balance sheet. Going forward, focusing on these three factors illustrate how, from a valuation perspective, it is dirt cheap. I'll also provide a share price range for where I think it should trade at through both a discount cash flow analysis and by comparison to comparable companies.
There are a few points worth highlighting from this reorganized historical balance sheet. On the asset side, working cash has stayed in the $36 - $45 million range each year, which allows Express to operate with a healthy amount of excess cash. On the liability side, Express has generally kept its accounts payable low, averaging between 7-8% of sales. On the equity side, Express has been active in buying back shares, having repurchased $341.60 million over the past eight years.
The biggest point jumping out to me from the reorganized income statement is the flattening of overall sales growth. Whereas sales growth remained in an upward trajectory until 2015 (with a slight dip in 2014), sales growth has been going in the wrong direction for the past three-years. After seeing sales growth of 8.5% in 2015, Express has seen sales contract by 6.7% in 2016, 2.5% in 2017, and 1% in 2018. Express is having a hard time figuring out how to effectively grow and is currently stuck around the ~$2.1 billion range for net sales. Negative growth is ultimately why the market continues to punish the stock.
Another point worth highlighting is the gradual increase in SG&A expenses over time. After peaking in 2015, the management team looked to decrease overall SG&A to reduce costs. While there was a dip in 2016, this has been followed by a gradual increase in 2017 and 2018. Although an increase in SG&A would be fine if these expenses were being utilized for growth, the higher SG&A expense has not translated into an increase in overall sales. Unless higher SG&A expenses drive higher incremental sales volume, this is an area where the management team should focus on controlling more carefully to ensure an efficient deployment of capital.
Retained earnings continue to grow as Express generates positive net income. However, net income has been in a precipitous decline for the past three years, all of which encourages a sell-off of its shares.
Invested capital continued to rise as Express was growing, but has decreased in the past three years alongside an increase in share buybacks. In terms of long-term debt, it owes ~$65 - $70 million which accounts for the long-term lease obligations for its stores. This number continues to remain low as Express maintains maximum financial flexibility with its store leases.
Express has maintained positive net operating profits less adjustment for taxes ((NOPLAT)) every single year it has been a public company. However, with the past three years of negative sales growth, NOPLAT has decreased from $127 million in 2015 to only about $16 million in 2018. This dramatic decline has reduced both free cash flow and the overall rate of return on invested capital.
FCF and ROIC, Author's Calculations based on historical 10Ks
There are two points to highlight from this. Express has always been able to generate positive free cash flow alongside a high ROIC. High ROIC firms tend to remain high ROIC firms over time even as growth slows, but we haven't seen this with Express. Although it has been generating positive FCF these years, its inability to deploy capital efficiently is hindering its overall performance. Express has to figure out a way to deploy capital in a more efficient way if it wants to increase FCF over time.
Past performance, of course, is no indicator of future results. But looking at the past provides a barometer for what to expect in the future. Looking to the future, utilizing a 10-year DCF model provides one way to find a fair value for its shares. With a DCF model, being as explicit and reasonable with assumptions is critical to building out a good model. To build a reasonable model, I first have to make several assumptions.
The assumptions I built into my DCF model are based on ratios from 2018. As the 2018 ratios are pretty similar to historical ratios, the 2018 ratios provide a meaningful baseline for future projections. Most of the ratios are based on dividing by sales.
With the income statement, the most important assumption is projecting sales growth of 3% per year. I came to the 3% growth assumption based on a few factors. The first is that in the absolute aggregate, Express has grown an average of 1.5% per year, including four years of negative growth. For the four years of positive growth, it had two years of +8% growth and two years of +3% growth. Since whenever it has grown, it has grown by at least 3% a year, this is a decent starting point to use.
But does utilizing a 3% rate for the upcoming year make sense given the poor Q1 guidance from the management team? It's important to note the management team declined to give full year guidance because of the CEO transition, but I still think a 3% growth rate for the upcoming year is achievable for two reasons.
The primary reason I believe this is still possible is the explosive growth in its online sales channel. If Express is able to achieve 20% growth in online sales this year - which would match last year's rate - this would bring in an additional $122 million in net sales for the year. Assuming Express is able to match the $2,116 million in net sales it did last year, the $122 million increase in net sales online would bring total sales to $2,238 million for FY 2019, or an increase in total sales of 5.8%. But given Q1 guidance of comp sales decline between 9 - 11 %, projecting a sales decline of $45 million for the quarter at the midpoint range would bring the full year sales total down to $2,193 million. But this would still mean a total increase of 3.6% for the year.
The other reason why I think it is achievable is because Express tends to beat EPS and revenue expectations. In the past 8 quarters, it has beat EPS and revenue expectations a total of six times. So while pessimism abounds, Express tends to do better than anticipated.
Utilizing a 3% growth rate model is one way to value the company, especially given that it has been able to achieve at least that amount during periods of growth, and given that it is currently in a period of negative growth. I use this as a bull model for Express and will also show the results of a bear model of 0% growth.
Using these assumptions, I projected the following balance sheet, income statement, and statement of retained earnings.
Two points to be noted about these projections. First and foremost, the basic model is predicated on an assumption of 3% growth, including in 2029 which is used for the terminal value. The assumption of steady state growth isn't going to be fully accurate, especially since positive growth does not necessarily go up in a straight line. However, this at least provides a baseline set of projections to work with and helps simplify the model to come up with a value for its shares today.
Next, the assumption here is that Express will not buy back any more shares, even though this is unlikely given that they have bought back ~$341 million worth of shares in the past. However, I'm assuming no buybacks to take as conservative an estimate as possible, particularly because of how low the Street is pricing its equity today.
Using these projections, the projected invested capital, NOPLAT, FCF, and ROIC are as follows:
Projected FCF and ROIC, Author's Calculations
Based on these projections, Express will continue to generate positive cash flow, albeit lower than historical projections because of higher costs. ROIC rebounds a little bit and stays above ~6%, which is low historically for Express, but better than its recent performance.
Based on all of these assumptions and using a WACC of 8%, this gives Express a value of $7.74 per share. But say my assumptions of growth are wrong and Express has zero growth going into the future. Changing this would give Express a value of $6.59 per share as seen below.
But since this analysis doesn't account for potential share buybacks, it is worth at least considering the potential valuation impact for its share price given its recent aggressive buyback program. In 2018, Express bought back ~$86 million worth of shares under its 2017 $150 million share repurchase program. This reduced the share count by 10.3 million, and the average price paid per share was ~$8.32.
Given that Express still has ~$50 million authorized to buyback shares in the current share repurchase program, it could reduce the total shares outstanding by ~11 million assuming an average repurchase price of $4.3 per share. Using these assumptions, this is what the potential share buyback impact would look like:
Potential Share Buyback, Authors Calculations
Using 56 million shares outstanding instead of 67 million would give Express a value of $9.32 per share assuming a 3% growth rate, or $7.93 per share assuming no growth.
Intrinsic Value, Authors Calculations
The zero growth and 3 percent growth models demonstrate how undervalued its shares are from a pure value perspective. I believe Express shares should be trading anywhere between $6.59 and $9.32, which is more than double where its share price stands today.
Looking at comparable firms, Express is priced below where each of the others are trading on a price/sales, EV/sales, and price/book basis. Although Express ties executive compensation and benchmarking to fifteen other firms, the three closest comparable firms from this list in my opinion are Urban Outfitters (URBN), Abercrombie & Fitch (ANF), and Ascena Retail Group (ASNA). I've chosen these three firms as comps primarily because of their shared customer demographic and because each of these firms has struggled with growing sales in the past few years.
Based on the average of comparable firms valuations, Express should be trading at between $10.71 and $15.67 per share.
A few points to note about the above data. Above all, Express is incredibly cheap based on all of these metrics, thought it trades closest to ASNA. ASNA has also been selling off the past few months. However, Express has a much stronger balance sheet (ASNA carries over $1.3 billion in long-term debt) and considerably more financial flexibility, and yet the market is punishing Express as much as ASNA.
Express has tremendous flexibility on how to deploy capital given the strength of its balance sheet. Having excess capital also provides a cushion of time to implement a successful turnaround strategy. Based on the calculations above, Express shares are trending well below both intrinsic value and the average of comparable firms valuations. The market is taking an overly pessimistic view of its overall prospects all while ignoring its significant financial flexibility.
Regardless of whether I apply a DCF model to arrive at a value for Express shares or compare it to similar firms, it is trading at a steep discount. On the low end of the spectrum, using a 0% growth DCF model should give Express a share price of $6.59 per share. On the high end of the spectrum, using average comps EV/sales would give it a share price o $15.67 per share.
Express is incredibly cheap based on other metrics as well. Its book value is $8.73 per share and, and with $172 million in cash on had, it has $2.54 per share in cash. With almost $50 million left to spend on its share buyback plan, it should be aggressively repurchasing shares at its current share price and deploying any excess cash towards accretive growth.
With its share price so far disconnected from where it is trading at today, what will it take for a rebound? There are three potential catalysts that can help lead to a rebound including: 1) the appointment of a new CEO; 2) effective execution on its strategy; and 3) a possible buyout.
On the CEO front, former CEO David Kornberg did a poor job of leading the firm during his three-year tenure. He was the first new CEO of Express since it became a public company in 2010. Prior to becoming CEO in January 2015, Express had been led by Michael Weiss. Weiss had run the firm almost since its inception, becoming President in 1982 and then CEO. Although he retired in 2004, he came back in 2007 after it was purchased by a PE firm. Before Weiss handed the firm over to Kornberg, Express had performed decently as a public company, having grown sales every year except 2014. But since Kornberg has taken over, the firm has been stuck and looking for direction. What Express needs now is someone who understands the brand like Weiss, but can provide a new direction for the firm. A new externally hired CEO with a track record of success in the retail sector would help provide a relief rally for Express shares.
But beyond a relief rally from the appointment of a new CEO, Express has to be able to deliver on its strategy. In addition to whatever new strategy the CEO puts in place, Express needs to continue to grow its e-commerce business at a double digit rate. This has been an area of consistent growth over time and one that Express needs to further develop. The push towards more factory outlet stores should continue. This growth should come through the creation of additional new stores, rather than primarily converting existing retails stores. This would help provide growth from the outlet side while still figuring out a way to make current retail stores more productive.
A wildcard catalyst is a potential buyout. Sycamore Partners seriously considered purchasing Express when it had a market capitalization of over $1.2 billion. Since it failed to acquire Express in January 2015, its market cap has continued to shrink and is barely 1/5 of what it was valued then. Although it has been treading water in terms of business performance since then, its balance sheet remains incredibly strong all while total shares outstanding continue to decrease.
When considering the likelihood of a possible buyout, there are a few salient points that make this a distinct possibility.
One is the length of the CEO search. Former CEO David Kornberg left the firm on January 22 and it has been nearly four months without the appointment of a new CEO. A possible reason for the delay is buyout discussions are taking place.
Another issue is the seeming pause in share buybacks. With the share price continuing in a precipitous decline since last earnings, there appears to have been little buying support for its shares in spite of the sharp share price decline. Based on the last 10-K filed on March 19, there were 66,506,657 shares outstanding as of March 2 this year. Based on the DEF 14A filed on May 2, there were 67,175,361 shares outstanding as of April 16. The total number of shares outstanding increased by 668,714, or 1% of the total float. While the share increase is likely because of the exercise of employee stock options, it appears Express has not been buying back shares to offset this increase, at least during this time period. This, in spite of the fact they bought back shares at an average price of ~$8.32 last year, leads me to wonder whether the management team has stopped buying back shares because they are negotiating a buyout offer. After all, why stop buying back shares when they are 60% cheaper than what they paid last year?
Of course, the management team may be buying back shares right now, but the sellers then would be far outpacing the buyers. However, we won't know for certain until we hear from the management team at the end of the month.
Buyout discussions would have to be approved by major shareholders. The current 5% stockholders are:
5/2/19, Form DEF 14A
Over 25% of Express is owned between the two largest investing management firms in the world. Contrarius Investment - a large, deep-value, contrarian investment firm - owns 9.1% of the firm and demonstrates that individual contrarian investors have a larger institutional firm that shares their sentiment about the long-term value of Express.
If Sycamore - or a firm like it - were to try and take the firm private, they can come to a reasonable purchase agreement given where Express currently trades. If a buyout were to occur, I'd expect a significant premium to where it's currently trading at. Negotiations with Sycamore Partners broke down 3-years ago when shares were trading in the $14 - 16 per share range. Although Express is a different business than it was 3-years ago, it still has significant value, and I would peg a negotiated buyout offer somewhere between $8 - $10 per share based on both its book value of $8.73 per share and the overall difficulty of negotiating a go private deal had last time.
A contrarian investment in Express comes with many risks and caveats. The most significant risks include: near-term performance challenges, CEO selection, committed short sellers, and macroeconomic headwinds.
First and foremost, investors are bracing for a terrible first quarter. On the March earnings call, CFO Perry Pericleous noted:
For the first quarter of 2019, we currently expect comparable sales in the range of negative 9% to negative 11%; net loss in the range of $18 million to $23 million; and loss per diluted share in the range of $0.27 to $0.34. This compares to last year's diluted EPS of $0.01.
Although this is going to be a kitchen-sink quarter, the firm can sustain losses like this for some time before it becomes a serious issue. Plus, much of the downside has already been priced into its shares. However, without full year guidance (deferred because of the ongoing CEO search), it's impossible to know for certain whether or not this will be the rock bottom for Express. It won't be until earnings on May 30 that investors will be able to get more insight into its future direction.
We do know that there will be 630 total stores in operation by the end of the fiscal year, which is down from 631 in FY 2018. The total composition will look different with 6 retail store closures, 5 new outlet openings, and 24 retail to outlet conversions. This will give Express a total of 417 retail stores and 213 outlet stores, or about 2 retail stores to every 1 outlet store. Given the higher productivity of these outlet stores, this should help with sales even as total store count essentially remains flat.
An additional operational risk is that the e-commerce and outlet stores may be cannibalizing retail store sales. E-commerce provides an easy way for people to shop without having to leave their homes, and if customers become accustomed to primarily shopping for their Express goods online as opposed to in store, this could continue to hurt in-store sales. On the outlet store front, this is where growth has been happening for the past several years. Having so many options to buy at less expensive outlet stores could be another reason retail store sales comps have been in decline.
One additional point to note is the management team did provide some guidance on FY 2019 expenses. Capex is expected to be between $40 - 45 million, which is down from $50 million in FY 2018. Assuming SG&A costs also decrease, savings on these expenditures should help mitigate losses.
Another major risk is Express picks the wrong CEO. A seasoned leader with a demonstrated track record of success is needed to right the ship at Express. Express needs to get a Lawrence Culp Jr. type CEO (a straight-shooter with a track record of success), not a John Flannery (an insider with an inability to make sharp changes). The need for hiring a successful external candidate is important to help correct course.
Short sellers continue to bet heavily against the firm. There are currently 15.2 million shares sold short, or about 23% of all shares outstanding. With the share price already so depressed and shorts continuing to pile on, this demonstrates a lot of investors out there still think there is more downside ahead. On the flipside, the sheer amount of short interest could lead to a short squeeze in the event of any positive developments
Broader macroeconomic risks are plenty. The retail sector continues to be challenging, with the retail apocalypse in full swing. The China trade war is bringing a new round of pain for retailers. And there continue to be numerous warnings of a potential recession in the next two-years. While these macro challenges are worth monitoring, the real challenge for Express will be its ability to demonstrate growth.
Making a contrarian investment in an unloved stock in an unloved sector is a tough position to take. But it is a lot easier to make if there is a silver lining.
The silver lining I see with a contrarian investment in Express is that cash is king. With a sterling balance sheet, continuous generation of positive free cash flow, and $2.54/share in cash on its balance sheet, what's not to like? Having deep pockets during a period of stagnation will allow for the new CEO to take risks to get the business back to growth.
Beyond just cash, Express has shown real strength in the e-commerce space. With nearly ~30% of sales coming online, this is a retailer that is both embracing and succeeding at e-commerce.
Wall Street hates uncertainty and there remains a lot of uncertainty around who will lead Express next and if it can restart growth going forward. The uncertainty around the company's future prospects has emboldened bears to put tremendous downward pressure on its share price.
Although it is tough to win in the retail sector, specialty retailers have seen plenty of turnaround stories. CEO Jane Elfers of The Children's Place (PLCE) has turned around a struggling children’s apparel firm into a leader with growing sales in a declining market. Ms. Elfers faced significantly greater challenges than what the management team at Express faces, but her example demonstrates turnarounds can occur even in the cutthroat retail sector.
Express has been beaten down too far much by Wall Street and its share price makes little sense based on any standard valuation metrics. For a company that does ~$2.1 billion in sales annually, is aggressive about buying back shares, and has $172 million cash on hand, the market is taking far too pessimistic a perspective on its outlook. With a booming e-commerce platform and a new CEO on the horizon, taking a long position in Express offers contrarian investors an asymmetric risk/reward opportunity.
Disclosure: I am/we are long EXPR. 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.