Express: This Looks Like The Bottom

|
About: Express, Inc. (EXPR)
by: SKK Investments
Summary

Express (EXPR) has struggled mightily as of late due to weak operational performance, declining profitability, and weak top-line numbers.

Shares have considerable upside if newly appointed CEO Timothy Baxter can get the company back on track.

With new operational strategies in place and a healthy balance sheet, we are confident in the company’s future and believe that there is excessive pessimism currently embedded in EXPR's share price.

Business Overview

Express, Inc. (NYSE: EXPR) is an Ohio-based fashion retailer that markets clothing and apparel to young men and women. The company sells products in retail outlets across the country and through a website (express.com).

Shares have cratered by 80% over the past 12-month period due to negative sales, comps, and profitability trends. The company has faced severe headwinds from weakness in mall traffic and fierce competition from other brick-and-mortar and online retailers. These issues have been compounded by the company’s failure to establish a clear brand identity and focus in regards to its product selection.

Although there are significant headwinds affecting the business, shares have considerable upside potential if management is able to stabilize operating performance. The company has consistently generated ~$2 billion in net sales over the past several years and has maintained a net cash position while doing so, which provides it with several levers it can pull to get back to profitability. In addition, we believe that there is excessive pessimism priced into shares at current levels.

Capitalization Table as of September 5, 2019 (in m USD)

Share Price (EXPR)

2.10

Shares Outstanding

67.25

Market cap

141.43

Debt

0

Cash

153.96

Lease Obligations

993.31

Enterprise Value (incl. lease liabilities)

980.6

(Source: Yahoo Finance)

Clean Balance Sheet and Lease Flexibility

As you can see from the above chart, Express does not have any long-term financial debt and has a net cash position of $154 million. The company has does a good job of avoiding leverage, which has provided it with a cushion during recent quarters of underperformance. The company’s net cash position is currently greater than its market capitalization, which makes the company’s valuation look absurdly cheap.

However, this is slightly misleading because the company has $993 million in long-term lease liabilities associated with its physical stores, which under new FASB rules are now accounted for as long-term liabilities.

For purposes of assessing the company’s valuation, we don’t think it is appropriate to include all of this amount in its long-term debt because a portion of these lease commitments have early cancellation clauses. Per page 15 of the company’s most recent 10-K:

Some of our leases have early cancellation clauses, which permit the lease to be terminated by us or the landlord if certain sales levels are not met in specific periods or if the center does not meet specified occupancy standards.”

This provides management with significant flexibility if its retail stores continue to underperform, which was mentioned on the Q1 earnings call:

We have significant lease flexibility with an action date on over 60% of our leases in the next three years.”

Valuation

Below is a chart that shows the company’s cap structure as well as valuation multiples including and excluding the effect of considering the company’s lease liabilities as part of its long-term debt.

(Source: EXPR 10-K filings)

We believe including half of its lease liabilities as long-term debt is the fairest way to analyze the company’s valuation because of the lease flexibility described above.

Using this approach, EXPR’s current EV/Sales and EV/EBITDA multiples are 0.2x and 4.2x, respectively. However, traditional valuation metrics are difficult to use when assessing Express as a potential investment because the company’s P&L and cash flows have fluctuated considerably (towards the downside) over the past few quarters.

From a high-level perspective, if the company can return to a 2% operating margin on $2B of sales (and adding back annual D&A expenses of ~$90 million), it will be generating $130 million of annual EBITDA. To put this into perspective, in 2018 the company generated $2.1 billion of revenue with a 1.3% operating margin and traded around $5 at year-end.

(Source: EXPR 10-K filings)

There is room for bottom-line improvement if the company can bring back SG&A levels down as a percentage of net sales and improve gross margins by reducing promotional activity (by stoking consumer interest and product demand).

Cash Flow Analysis

The company has been able to continue generating positive free cash flow due in part to high depreciation and amortization charges.

(Source: EXPR 10-K filings)

Free cash flow for 1H 2019 was slightly negative but the company expects positive free cash flow for FY 2019, according to comments made on the most recent earnings call. FCF has remained positive (albeit declining) over the past three years, which is a positive sign given how operating performance has deteriorated since then.

1H 2019 Summary

YoY Performance

1Q 2019

2Q 2019

3Q 2019 Guidance

Comps

(7%)

(6%)

(6-7%)

Net Sales

(6%)

(4%)

Retail Store Comps

(9%)

(7%)

Outlet Store Comps

(2%)

(2%)

(Source: EXPR 10-K filings)

The above chart shows the company’s operating performance over the first half of this fiscal year. Needless to say, management has a lot of work ahead of it to reverse sharp declines in comparable sales and net revenues. Outlet stores have performed better relative to the company’s retail stores (retail store comps include e-commerce sales), which is likely due to increasing demand for off-price merchandise (which companies like TJX has benefited from).

Baxter To The Rescue

Timothy Baxter was recently appointed CEO, replacing David Kornberg (who had risen internally within the company’s ranks for the past 19 years). Baxter brings a fresh perspective to the business, as he spent 12 years at Macy’s in various roles of increasing responsibility (most notably as Chief Merchandising Officer) and one year as CEO of Delta Galil Premium Brands, a company that is responsible for 7 for All Mankind and several other well-known clothing brands.

We are cautiously optimistic about Baxter for several reasons: one, he has an outsider perspective, which we believe Express needs to turn things around. Secondly, he has done an excellent job of identifying the company’s core problems and addressed them candidly on the company’s most recent earnings call. Below are a few snippets from the call addressing the most glaring issues the company is currently facing:

Lack of clear brand identity

Alongside our corporate strategy work, we have also been refining the strategy for our brand. Most people know Express, but many don't know what we stand for or how we fit into their lives today. We must clarify our brand message and more closely connect it to our product strategy. We have more than 280 million visits to our website and stores, each year.”

Declining brand recognition and fashion credibility

Express was once seen as a fashion authority and a trusted resource to help customers build their wardrobe. We've lost some of that credibility due to product misses.”

Poor merchandise selection and organization

Another example where we've taken decisive action is to rethink the brand's traditional way of categorizing product into four lifestyles based on wearing occasion. Today, people want one wardrobe with great pieces that are versatile enough to work for multiple occasions, and our approach has been out of step with this shift. The most immediate way we are addressing this is by changing the way customers experience our product in stores.”

Although only time will tell if Baxter will be able to turn things around, we appreciate his candor and honesty when describing the mistakes the company has made. We wrote about several of these issues in our last article on the company and are enthused that he has been able to identify them quickly and has taken action to address them.

There is clearly considerable demand for the company’s products, as evidenced by quarterly revenue run rates of ~$500 million. If the management team is able to effectively address the problems described above, we are confident that the company can return to pre-2017 levels of sales and profitability, which would ignite shares.

Conclusion

With positive free cash flow generation, a healthy balance sheet, and a new CEO hellbent on turning things around, we believe Express is near a bottom (both in terms of operational performance and share price). There is also a tremendous amount of pessimism currently embedded into the company’s current share price, which offers shareholders an attractive risk/reward profile should operational performance and investor sentiment start to turn around.

We will continue to monitor the situation closely and keep readers posted through subsequent articles. Thank you for reading and we welcome all comments and feedback!

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.