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Coverage Initiation: Francesca’s Holdings Corp.
Value Line has initiated coverage of Francesca’s Holdings Corp. (FRAN) in its flagship product, The Value Line Investment Survey. Francesca’s is a holding company with all of its business operations conducted through a wholly-owned indirect subsidiary that operates a national chain of retail boutiques, francesca’s. These outlets are designed and merchandised to feel like independently owned, upscale boutiques providing customers a “fun and differentiated” shopping experience. The primary strategy is to carry a broad selection but limited quantities of individual styles, thereby introducing new merchandise to boutiques five days a week to create a sense of scarcity and newness to help drive customer shopping frequency and loyalty. Headquartered in Houston, Texas, the company employs over 2,550 individuals. Francesca’s held its initial public offering on July 27, 2011.
The first retail location was opened in 1999 in Houston, Texas and initially focused on selling fashion jewelry, accessories, and selected home décor. As the boutique base grew across the United States, the merchandise offerings expanded to include apparel, which has now become the largest category. In 2012, the sales breakdown was as follows: Apparel (49%), Jewelry (23%), Accessories (16%), and Gifts (12%). (Gifts include such products as fragrances, candles, bath and body, home accessories, books, wall art, nail polish, and other miscellaneous items.) Like many retailers, the business in mildly seasonal, with demand generally highest in the final period of the year (years end Saturday closest to January 31st of the following calendar year).
The retailer’s target consumers are “fashion conscious women between the ages of 18 and 35.” It believes this demographic has moderate to high disposable income, enjoys shopping for the latest fashions, and spends a higher proportion of her income on fashion than the general population. That said, francesca’s broad assortment appeals to women of varying ages and diverse backgrounds, from value-conscious to the more affluent. All told, retail locations carry about 3,000 items at any given time and about 15,000 styles during the course of the year. The majority of the merchandise is sold under proprietary labels, with the remainder being a select assortment of third-party, nationally recognized brands. Customers can also purchase merchandise through the retailer’s web site.
The company believes it has five strengths that separate it from peers. First is its trend-right merchandise delivered at a compelling value. Because of its strategy to offer a broad assortment with limited quantities, the company can quickly react to changing fashion trends, while also avoiding fashion misses, which could lead to increased inventory markdowns and diminished gross margins. Second is the differentiated shopping experience. Not only does the retailer’s business model encourage more frequent visits by customers, thereby reducing the seasonal fluctuations, but francesca’s décor creates a “warm and inviting” environment. Third is the boutique economics and rigorous real estate selection process. Retail locations average about 1,385 square feet, which is meaningfully smaller than most specialty retailers. The performance of these boutiques and the flexible real estate format allow the retailer to secure prominent, highly visible locations in regional malls, lifestyle centers, street locations, and strip centers. Lastly are the company’s solid and scalable infrastructure, as well as its experienced management team.
This retailer has experienced explosive growth since 2009, though earnings have slowed of late. During the five-year period from January 31, 2009 to February 2, 2013, Francesca’s sales have risen from $52.3 million to $296.4 million. Over the same span, earnings per share advanced from $0.07 (pro forma) to $1.05. For fiscal 2013, the company estimates sales of about $342 million and share earnings to be stagnant, at $1.05. As a result of the expected flat earnings, the company’s stock has not performed too well. Indeed, since the IPO, these volatile shares have shed about a quarter of their value overall, with 2013 especially being a tough year.
To resume a high level of growth, the company is focused on adding more stores, driving comparable boutique sales, and expanding website penetration. In regards to the boutique base, the company has about 446 locations in 45 states throughout the United States (as of November 2, 2013), and intends to expand this number to 900 U.S. stores over the next seven years. To drive comps, the retailer intends to feature high-quality, trend-right merchandise at a compelling value and refine its boutique experience over time. Finally, the website not only generates incremental sales and profits but also builds brand awareness and boutique traffic, whiling accessing markets where there are no physical locations. Currently, sales through this platform make up roughly 2% of the top line.
Of course, growth is not guaranteed. The women’s apparel, jewelry, accessories and gifts market is large, fragmented and highly competitive. The largest competitors include national and regional department stores, specialty retailers, mass merchants and internet-based retailers. Francesca’s also competes with individual, often owner-operated specialty shops in each of the markets that it operates in, as well as broadly merchandised department stores and certain specialty stores. Barriers to entry are weak in this space, so new competition could emerge at any time. Success mainly depends on the ability to anticipate, identify, and respond quickly to new and changing fashion trends, customer preferences, and other factors.
In addition to competitive pressures, the business is sensitive to consumer and overall economic conditions. Moreover, growth mainly depends on the successful opening of a substantial number of boutiques each year for the foreseeable future. Factors important here are the abilities to find a sufficient number of suitable locations, recruit, and to scale infrastructure to successfully integrate the new boutiques. Further, as the store count grows, it will become increasingly more difficult to adequately stock retail locations with a sufficiently broad and shallow assortment of merchandise.
All told, investors interested in this growing women’s retailer are advised to consult Value Line’s quarterly reports for Francesca’s Holdings Corp., as well as any supplemental reports and relevant articles as important news items arise.
The author did not have positions in any of the companies mentioned at the time of this article’s writing.