Chico's Q1 comps gained only 6.4% year over year. For investors used to Chico's high-flying double-digit comps growth over the past nine years, this smaller growth was tacky enough to start dire predictions of a sea change in the business -- and a markdown to lower growth ahead.
Not so fast, I say: Chico's first quarter still has a pretty decent cut, with revenue and income rising 20% and 11%, respectively. Better yet, investors' panic has marked down Chico's shares 33% from their 52-week high of $49. That brings Chico's to a very attractive P/E of 19.8 times its projected 2006 EPS.
The upscale chain has always focused on dressing women 35 and older in trendy, fashionable clothes, without emphasizing the anorexic-looking styles that usually drive away shoppers in that age bracket. I don't think the words "form-fitting" appear anywhere in the company's marketing pitch.
Chico's figure-friendly fashions have made a bundle from its target market. The company has grown revenues by an annual 39%, from $378 million to $1.4 billion, over the past five years. In the same timeframe, net income surged 47% a year, from $42 million to $194 million. Along the way, comps have averaged more than 12% growth.
Naturally, this quarter's steep comps drop from the historical average prompts questions about whether Chico's merchandising was weak, or whether Chico's concept has begun to grow stale. In the company's 10-Q, management blamed the product mix at flagship Chico's for weaker comps. Analyst reports also suggest that Chico's reliance on black and white clothing, instead of its regular bright colors, led to lower comps this quarter. I don't believe that this quarter's comps drop takes much away from the company, though; it should continue to grow its three separate brands at different life cycles.
Three winning brands
Chico's namesake brand represents the majority of its 803 stores. With 75% of the company's sales and 513 stores, the Chico's chain grew new store openings at an average annual rate of 14.5% in the past five years, reduced a more sedate 11% in the last two. Management sees the market for flagship Chico's stores saturating at about 900 stores; at even a 10% annual growth rate, that's still roughly six years away.
White House/Black Market (WH/BM), the company's second brand, slightly expands its focus to cater to late-20s shoppers as well and operates at 70% the floor space of regular Chico's stores. WH/BM has been tearing the cover off the ball: With 93 stores acquired in 2003, these hot spots have expanded at a blistering annual pace of 32%. The chain, now at 196 stores, has also enjoyed average annual comps growth greater than 30% over the last two years.
Soma, Chico's cheeky attempt to compete with Victoria's Secret, is the company's smallest brand. It's positioned as an extension of the Chico's brand, combining standalone locations with boutiques within Chico's stores. Soma is a 15-store operation but expects to add 30 more locations this year.
Of the 150 new stores the company plans to open this year, only 45 will be additions to the slower-growing flagship brand. The sizzling WH/BM will open 65 to 70 new locations. Even at current store counts, Chico's FAS's overall 803 stores is still lower than Ann Taylor's
What's charming about Chico's
I'm most impressed by Chico's focus in its target market. Women 35 and older accounted for about half of the $101.6 billion spent on women's clothing between March 2005 and February 2006, according to the NPD Group, a consumer and retail information company. Chico's doesn't do men's clothing, and it doesn't tinker with a different demographic. It has a huge first-mover advantage, which should help it keep its customers loyal customers. That advantage should also help the company stay ahead of competitors, which are now shifting gears just to get a thimblehold in its market.
In addition, Chico's sports some of the industry's healthiest operating margins. Its 21% margin, up from 17% in 2001, handily outpaces Talbot's 7.8%, Ann Taylor's 8%, Christopher's 10.3%, and Coldwater Creek's
Furthermore, Chico's "permanent" customers (those who've spent more than $500 at Chico's) contributed 78% of last year's revenues, spending an average of $111 in each of the five to six times they visited. Now we know where the upbeat same-store-sales have been coming from! Even debutante WH/BM, in its second year under Chico's, gets 55% of its sales from "permanent" shoppers.
Causes for caution
Despite its current success, Chico's merchandise faces a fine line between success and failure. If it fails to keep up with changing fashion trends, it stands to lose a lot. Stores like Nordstrom
In addition, with the majority of its sales growing at low single digits, and more than two-thirds of its expansion coming from WH/BM and Soma, margins will get squeezed in the short run. The two smaller businesses have lower gross margins than the flagship store, which won't be growing sales fast enough to make up the difference.
Reasons for reassurance
Overall, neither management nor analysts expect more than 25% growth from Chico's until 2007. Besides, the company has shown foresight in planning for a sales slowdown at its flagship stores, and turning its attention toward developing WH/BM to compensate. It bought WH/BM in 2003, a year when Chico's stores had grown profits 51% and sales 45%. No complacency there!
Chico's sports 20% growth, an outstanding track record, a huge lead and strong branding in a growing over-35 market, margins that more than double its closest competitors', zero debt, and strong cash generation. At this price, it looks like a fantastic deal.
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