FRANCESCA’S HOLDING, INC. (FRAN) – REPORTS 2ND QUARTER, HURDLES… AND OPPORTUNITIES !!
CONCLUSION:
There aren’t too many publicly held retail stocks that offer an attractive risk/reward relationship, especially since so many have rebounded from pandemic created low points. We would be happy to learn about any other retail companies, with no net debt, that were profitable with a high return on invested capital just a couple of years ago, whose Enterprise Value is about $.03 of the pre-pandemic annual sales dollar. While Francesca’s (FRAN) remains a “workout”, to be sure, and we can’t predict if, and to what extent, the current balance sheet will need to be strengthened (and what form it will take), we have been impressed with new CEO, Andrew Clarke, and his team, as they have navigated through recent challenges. As we describe below: The upside possibility, at some point in the next few years, provides a uniquely positioned chain of 6-700 retail boutiques doing something like $400M of annual sales, generating perhaps $6.00/share or more of annual earnings. It obviously wouldn’t take much of a P/E multiple to generate a handsome return from this starting point.
THE OVERVIEW
Francesca’s Holdings, Inc. (FRAN) reported an expectedly poor 2nd quarter, ending 8/1/20, obviously still coping with the effects of the coronavirus pandemic. Since just under 50% of their 700 stores are located in covered malls, the balance including 92 outlet malls, unpredictable mall traffic remains the single largest impediment to renewed success.
Over the last two years, the stock performance mirrored the poor operating results, as described in our report dated 6/25/20…
FRAN, trading post the July’19 1:12 reverse split, now in single digits ($3.82/share) is down from the equivalent of over $400/share, providing investors with an enterprise value of under $12M. There are only about 3 million shares outstanding, and no “net debt”, so this unusual situation, with sales just three years ago well over $400M and very profitable (over $13.00/share on the current shares), becomes a bet on the Company’s ability to ride through the pandemic (combined with their own fundamental recovery) without the necessity of meaningful dilution of the current share base.
As described in our report in June, referenced above, new management is well qualified and there is a great deal of low hanging fruit. We summarize below the Positives and Negative points at the current juncture.
THE NEGATIVES
- Nobody knows how long it will take (if ever) for mall traffic to come back. With 339 locations, out of 700 in covered malls, this obviously remains a major question mark.
- While there is no net debt, it remains to be seen whether inventory, labor, rents and payables can be managed through the second half of ’20, traditionally (especially Q4) the busiest time.
- Margins have been under pressure for the last 2-3 years, especially the last six months, as management has promoted their way out of store level inventory that included merchandise frozen on the shelves during the pandemic closings. It is uncertain how much of a recovery in margins can be produced, and when.
- Women’s apparel, especially that to be sold to young women, is an obviously fickle business.
- Though vendors and landlords have been willing to work with the Company, the extent to which this will remain the case remains to be seen.
- The 2nd quarter, ending 8/1/20, looks dismal on the surface, though progress (as described below) was also evident. The pretax loss was $13.2M, with a merchandise gross margin of 17.5% vs. 38.2% YTY. While the cash position was $20.2M, up from $14.3M at the end of Q1, this was largely a function of inventories being down about $12M (promotional clearance) and Accounts Payables being up by about $7M. As we indicated above, how far vendors will go in terms of supporting a new inventory build remains to be seen.
- “Going Concern”, “Evaluating Strategic Alternatives”, “Restructuring Under Bankruptcy” are not terms that investors like to read about, and have again been provided in the Q2 release.
THE POSITIVES
- Comp sales, excluding stores that were closed for four days in a week during the pandemic, were down a modest 5% in Q2. Since covered malls are just under 50% of locations, and traffic was worst there, it seems likely to us that off-mall location comps were positive. Considering that the sales were highly promotional, and the Company indicated that conversion and Average Unit Retail Sales were higher, anything like positive comps would indicate that the Brand is still a draw, and we make that suggestion after watching young women continue to visit some of the mall stores even during the last few months. Furthermore, if 339 locations are in enclosed malls, many of those are no doubt in “A” malls, so far from all are at long term risk. We suggest that a maximum of perhaps 100 locations might be at risk over the next few years, still leaving 600 nationwide, and providing a unique localized boutique shopping experience. If sales can be rebuilt over time, with a higher online presence offsetting possibly lagging mall revenue progress, this can still be a chain with $400M of revenues or more. If margins rebound in the course of that to only half of those three years ago, and the shares outstanding are the same, that would be something like $6.00 per share.
- Only time will tell to what extent management can successfully navigate the early stage of FRANs fundamental rebound. There are positive signs, though, which can encourage landlords, lenders, vendors and even equity investors. Ecommerce sales were up 27% in Q2. This continues to be a major long term opportunity, and new CEO, Andrew Clarke, has a strong background in this area. Considering that the major marketing focus in Q2 was clearance of store level inventory (frozen in late March, April and May), a 27% increase is admirable and this is just the beginning of the effort in this area.
- Relative to margins: Management indicated that customers are reacting well to fresh merchandise, which is selling closer to full price (with margins predicted to improve in H2), lounge wear and leggings and joggers are among new best sellers, new “tween” customers are newly targeted, and merchandise is being localized relative to climate and style preferences to a much greater degree than ever before. Moreover, management indicated that gross dollars and gross margin percentage improved in July, though sales were still impacted by restrained traffic trends.
- Fickle though women’s apparel is, the Francesca’s brand was created based on a trend following, a “read and react” approach. Departure from that discipline created most of the problems, and management has returned to their merchandising roots. The localized nature of this national (small footprint) brand is a unique asset, and is further supported by a most impressive store level sales culture that we have described in our previous report.
- The degree to which vendors, landlords and lenders will “stay the course” remains to be seen, but what is their choice? If the merchandise moves within reason, the product will be sold before the vendors need to be paid, so the “read and react” principle should keep the goods flowing. The landlords can’t find anybody more able to fill that 1,400 square foot box, so why not stick with Francesca’s? The current lenders don’t want to run 700 apparel boutiques, and will largely be paid back from the tax refund, in any event. New debt can likely be raised, the terms of which remain to be seen, since there are hundreds of billions of dollars searching for a yield.
- We have already discussed above most of the initiatives that the Company is putting in place. The degree to which they will succeed remains to be seen, but management seems to have managed well through the last six months, negotiating with landlords and vendors, managing inventory liquidation to generate the cash for new merchandise, upgrading online sales and setting the stage for a new mobile app.
- Most of the civilized world is in a “workout” mode, and more companies (and countries) than we can count are illiquid, insolvent, bankrupt or all three. The whole planet is living off the accommodations provided by central banks. “Going Concern” language, and the such are provided by lawyers on a routine basis, whether or not that concern is justified, all part of the CYA routine.
CONCLUSION: Provided at the beginning of this article