- Francesca's appointed a highly talented and accomplished new CEO, Andrew Clarke, on March 9, 2020.
- I was very impressed with Andrew's May 1, 2020 conference call, where had articulated his reasons for taking the job and his vision for executing a turnaround.
- Despite Friday's going concern label (by E&Y), in its 10-K, I like the risk/reward profile.
These days, I feel like a kid in a candy store. Given the maximum uncertainty surrounding the direct fall out from COVID-19 combined with the future unknowable consumer behavior post eventual re-start, and we have an environment where stocks prices are on sale. The market simply hates uncertainty and market participants have no way of gauging probabilistic outcomes. When this happens, many investors simply throw up their hands and rush to hit the bid. Moreover, not only are there more sellers than buyers, you get a dynamic where buyers are reluctant to bid, for fear of catching a falling knife.
That said, for intrepid investors willing to attempt surfing the outer edges of the risk frontier, this is a sunny Socal day. Think of the classic movie: Point Break.
Deep value and contrarian investors were made for these types of markets because this is where the opportunity to cut through the noise can lead to outsized profits. However, I do fully acknowledge that you have to take a portfolio approach of adding a number of these lottery ticket type bets, as not all of them will survive the high calorie burning triathlon. For example, you might want to risk 20% to 30% of your overall portfolio in a basket of ten of these names. If you size them at 2% each (or 3% if you are risking 30% of the portfolio) then two or three very well could go bankruptcy, but if you hit one or two home runs, you could still generate a great return, on a portfolio basket basis.
This leads me to today's idea, Francesca's Holdings Corporation (FRAN). An investing friend of mine, a fellow deep value investor, and former hedge fund analyst (he now trades his PA for a living) bent my ear over the weekend on FRAN. As I track and follow north of fifty consumer names, I was vaguely aware of Francesca's, but got up to speed over the weekend. As an aside, had I been working for Steve Cohen, he would have expected a full model by 7am on Monday. Good thing I am not. However, per my friend's suggestion, I listened to the company's Q4 FY 2019 conference call, held on Friday afternoon, May 1, 2020.
Let me cut to the chase, this business silly cheap and priced for bankruptcy. Only I'm not so sure they will go bankrupt. Let me explain.
On March 9, 2020, Andrew Clarke became the new CEO. He has an awesome retail pedigree and I was super impressed by his conference call.
HOUSTON, Feb. 13, 2020 (GLOBE NEWSWIRE) -- Francesca's Holdings Corporation (Nasdaq: FRAN) today announced the appointment of Mr. Andrew Clarke as the Company's President and Chief Executive Officer ("CEO") and as a member of the board of directors, effective March 9, 2020. Mr. Clarke will replace Mr. Michael Prendergast who has served as Interim CEO since February 4, 2019. As part of the Company's consulting agreement with Alvarez and Marsal ("A&M"), Mr. Prendergast will remain with francesca's for a period of time to ensure a seamless transition. In addition, A&M's merchandising, planning and allocation consulting services will continue until those roles are replaced.
Mr. Clarke brings 25 years of specialty retail experience to francesca's, including five years of c-suite leadership positions with U.S. retailers and 20 years spent at three of Europe's largest retail groups. Most recently, he served as President of LOFT, a women's specialty apparel retail brand owned by Ascena Retail Group. Prior to that, Mr. Clarke was EVP, Chief Merchandising Officer at Justice, also owned by Ascena Retail Group. In both roles, he delivered strong sales growth in stores and e-commerce channels through leading digital technology and customer insights initiatives, successfully building a more agile, customer-centric organization. Previously, Mr. Clarke held various merchandising leadership positions at Kmart, Pimkie, a $1 billion women's fashion brand owned by French retail conglomerate, Mulliez, Marks & Spencer, and New Look Retailers, a $3 billion fast fashion apparel retailer in based in Europe.
On that conference call, he articulated how he and the team have already taken decisive action. Despite the mandated shuts downs, he quickly identified a number of issues and put in motion plans to resolve them:
- Too much inventory
- Fashion misses
- Weak e-commerce
- Poor execution
He has already course corrected by cancelling the remaining open Q1 2020 open inventory receipts as well as Q2's open receipts. He has shifted the model to more of a just in time strategy, where the company can quickly see what is selling and only commit to new fashion and risk inventory dollars based on evidence of demand. This put the company in the catbird seat given its agility to pivot and sets them up to buy quality inventory at better prices, post COVID-19, again based on clearer demand signals.
If executed well, and the devil's in the details, this should dramatically enhance gross margins.
As part of the CARES act, the company has filed for a $10.7 million tax refund, and will defer payroll taxes, also allowed under the CARES act. They also quickly furloughed all retail employees and many corporate staff members to preserve precious liquidity. Moreover, to shore up liquidity, the company has sold through a good chunk of its existing inventory (which was an overhang) via its e-commerce channel, albeit at lower gross margins, to bring in cash flow. Per FRAN's CFO, the company has received bank waivers from its lender base and deferred rent payments for April 2020 and May 2020, as it negotiates with its landlord. By the way, its store base is 711 boutiques (342 malls and 369 strip and outlets). So not all malls, as people might fear.
Just to reiterate, at the 20,00 foot level, Andrew painted a very optimistic picture of what could be, when the world restarts and normalizes. This includes a younger core demographic that enjoys the treasure hunt and new fashions. This is the sweet spot of apparel given younger woman's spending pattern and value on fashion freshness. FRAN's prior missteps were largely self inflicted.
As of April 15, 2020, there were 3.04 million shares of Francesca's. With shares trading at $2.50 in pre-market, we are talking about a market capitalization of only $7.6 million.
As of February 1, 2020, the end of its fiscal year, the company had $17.8 million in cash and no long term debt (but $9 million in short term debt). Working capital (excluding operating leases) was positive $33.5 million (but this includes $9 million of short term/current debt).
Now besides the uncertainty, FRAN's auditors were kind enough to embroider a "going concern" label on its 10-K. This created the immediately rush to hit the bid atmosphere and explains why FRAN shares are getting dinged in pre-market, this morning.
I fully appreciate and understand the fearful reaction. And I get why Ernest & Young had to slap the 'going concern label' to cover themselves as the fall out from COVID-19 is tricky. That said, for discerning intrepid deep value investors, this labels also could mean a great buying opportunity.
As such, and mostly based on Andrew Clarke's very impressive conference call where he articulated a bold and smart vision, I am taking a flyer on this company, at $2.45 per share. I am risking 2% of my portfolio.
Given that the company expects to get back $10.7 million from the CARES act combined with the decisive actions of selling out inventory via e-commerce and cancelling most FY 2020 Q1 & Q2 receipts, this should give this company enough of a bridge to be a going concern, and make it to the other side of the shark infested waters, when the economy restarts. Moreover, as of February 1, 2020, the company had cash of $17.8 million and availability on its revolver.
Please note, as Andrew suggested on the call, a full store portfolio review and optimization is in the works. Expect all 4 wall negative EBITDA stores to be culled from the herd upon natural leases expiration or perhaps via one off buyouts (maybe pay 3 or 6 months rent to get out) with landlords.
Putting it all together I think your upside is a double to a 4 bagger depending, of course, on the trajectory of the U.S. economy recovery and how quickly businesses reopen. In terms of downside, unlike an oil's future contract that went negative, for a stock, it is only zero. Perhaps there is a 30% to 40% chance of a zero and a 60% to 70% chance of a double or a 4 bagger. I like that back of the envelope payout profile. Therefore, as I said, I'm willing to risk 2% of my portfolio as $2.45. Again, I just want to share what I think is a compelling idea, in real time, as I love trying to help SA readers make money uncovering ideas that are completely under the radar.
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Analyst’s Disclosure: I am/we are long FRAN. 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.
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