Express Update: Management Certainty Amidst Bad Comps

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About: Express, Inc. (EXPR)
by: Detroit Bear
Summary

Express shares have declined 20% since my bullish write-up.

However, we have clarity on a new CEO and results were better than expected, though still bad.

I remain long as the company has yet to undertake any massively value destructive actions.

Shares of Express (EXPR) declined 20% since I wrote a bullish overview of the company just a month ago. Undoubtedly, this is not ideal, nor is it surprising considering China is Express's second most important manufacturing hub, with over 20% of inventory coming from China, so Express is getting hit hard by tariffs. Express also posted poor Q1 results, though the results were slightly better than anticipated.

More importantly, Express named Tim Baxter as CEO, providing clarity on the management team. Baxter starts next week, and ahead of his tenure, I remain confident that shares of Express are undervalued. Let's take a look at Q1 results and why I like the new Express CEO.

Q1 Results: Bad, but Better than Expected

Undeniably, Express posted poor Q1 results, with total sales down 6% y/y to $451 million with comp sales down 7% y/y. Express posted comp growth of only 1% in Q1'18, so the company was not lapping a tough comparison, and the two-year stack is down 6%.

Interestingly, the company started to break out revenue by retail versus outlet as well as other revenue, providing greater clarity on the distribution of the business. Retail comps, which include e-commerce, were down a whopping 9% y/y to $328 million. Management did not comment on e-commerce sales, but I suspect e-commerce may have been negative. Outlet comps were also negative at 2%, though overall sales in the segment were up 18% y/y to $106 million Express shifts more of its business to outlets.

After the company initially guided to comps declining 9-11% y/y, the 7% comp decline also leads to better than anticipated margin performance. Gross margin fell 280 basis points y/y to 27.1% of sales with merchandise margin down 100 basis points y/y and buying and occupancy expense up 180 basis points y/y. This decline in margin is about 70 basis points better than management originally anticipated.

Similarly, SG&A expenses increased 70 basis points y/y to 30% of sales, though actual SG&A spending was roughly $5 million lower at $135.4 million. Depreciation was up $1 million y/y to $22.2 million versus capital spending of only $4.1 million, supporting my thesis that depreciation charges currently greatly exceed capital expenditure requirements, allowing the company to generate tax-free cash flow.

That said, operating cash flow was poor in Q1'19 with the business burning $16.9 million in cash. Coupled with $4.1 million in capex and roughly $6.4 million in repurchases, the company's cash balance fell by $27 million in Q1. However, this compares favorably to Q1'18 when the company burned through $52 million in cash, with $24.7 million coming from an operating cash flow deficit.

Unfortunately, inventory management was not particularly effective, as inventory increased 3% y/y to $286 million, far exceeding sales growth. Express will have to discount and take a margin hit throughout the next few quarters; however, this reality is already baked into my numbers. Management also commented that they think inventories will be in much better shape in Q3, with inventory growth more likely to reflect sales growth. Undoubtedly, this is positive.

Overall, the quarter was messy, which I anticipated. Fortunately, management did not waste too much liquidity on share repurchases, which helps the company maintain flexibility. Still, the firm bought back $4.9 million worth of stock at an average price of $5.44 - not a great move considering the current share price.

Enter Tim Baxter

New CEO Tim Baxter will join the company on June 17th, bringing with him a wealth of experience from running Macy's (M) e-commerce business and serving as a chief merchandising officer before leaving to become CEO of Delta Galil's premium brands, which owned such brands as 7 for All Mankind and Splendid. Sales in Delta Galil's premium segment were up only 3% y/y in 2018, but I can hardly consider that an indictment of Baxter's abilities, given his brief time at the company.

Frankly, I have no idea how to evaluate Baxter's performance at Macy's, given the size and complexity of the organization. Nevertheless, I believe the Express role was a relatively attractive job, given its solid balance sheet and e-commerce position, so I will watch Baxter over the next several quarters and see how his strategy comes into place.

Importantly, Baxter will have tremendous store footprint flexibility. Express has action dates in 60% of its leases over the next three years, which means Express can transform its store footprint without facing significant lease exit cost penalties.

No Material Thesis Change

Overall, the first quarter went about as expected. Express's balance sheet remains in great shape with $144 million in cash and a $250 million untapped asset-backed revolver. Shares of Express could easily double on improving performance, and the company has the ability to generate close to $1 in cash earnings simply by achieving a 1-2% operating margin. I remain long, optimistic that the business will turn.

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.