For years, satirical late-night-TV host Stephen Colbert has been running a series on his show called "Better Know a District," which highlights one of the 435 U.S. congressional districts and its representative. While I am no Stephen Colbert, I am brutally inquisitive when it comes to the 5,000-plus listed companies on the U.S. stock exchanges.
What Francesca's Holdings does
Francesca's is a specialty-boutique, mall-based retailer that sells women's jewelry, accessories, and apparel. It also offers products through its website and aims to target customers ages 18-35 with new additions to its stores up to five times a week.
In Francesca's most recent quarter, the retailer posted revenue growth of 44% to $72 million as comparable-boutique sales rose 16.7% and EPS growth popped by 71%. In the trailing-12-month period, Francesca's has opened 76 new boutiques, funded solely by positive cash flow from operations, which has boosted margins and allowed it to effectively leverage its occupancy costs in its favor.
Whom it competes against
As you might already have expected, the biggest concern for a company like Francesca's is that it's competing against an almost immeasurable number of peers. You can find fashion-jewelry accessories similar to the ones Francesca carries at department stores like Macy's (NYSE:M) and J.C. Penney (NYSE:JCP) which offer far larger selections, as well as at Zale (UNKNOWN:ZLC.DL)-owned Piercing Pagoda, which primarily offers silver jewelry and accessories under $100.
In apparel, the competition is even fiercer. From the low end up, Aeropostale (NASDAQOTH:AROPQ) caters to the younger generation with steep discounts while American Eagle Outfitters (NYSE:AEO) and Abercrombie & Fitch (NYSE:ANF) have the branded image that steers the younger crowd into its stores.
The overall health of the economy is another competing factor that works against (and sometimes for) the retail sector. Retailers are heavily dependent on strong levels of consumer spending, so any disruption to that (e.g., the fiscal cliff) could result in a serious decline in customer traffic.
Although my friend and colleague Rick Munarriz has taken a liking to Francesca's -- and who could blame him, with same-store sales growth of 16.7% in the third quarter -- I'm going to run to the other corner and make an underperform CAPScall on the company.
Now hear me out, because I understand that these growth figures would normally speak for themselves, but there are plenty of reasons to be cautious heading forward.
To begin with, fashion trends commonly change in the retail sector, and no matter how often Francesca's freshens its selection, it's bound to have a dud or two now and then. The company's current valuation at 20 times forward earnings doesn't properly factor in what I suspect will be a few growth hiccups in the next six-to-eight quarters.
Second, I'm not sold on the idea that Francesca's can keep up its torrid growth pace on cash flow alone, and its cash balance of just $13 million isn't enough to sustain the type of growth investors have become accustomed to. In addition, its rapid growth within malls around the U.S. has allowed it to leverage its occupancy costs in its favor. Without the ability to grow as rapidly as it has recently, I see the positive margin effects from these occupancy costs abating sooner rather than later.
Finally, it does come down to valuation. Having followed the retail sector for nearly 15 years, I've seen plenty of high-growth flashes in the pan that have returned to Earth shortly thereafter. I'm not debating Francesca's business model or products, and agree with Rick that they'll be successful over the long term, but right now, at 20 times forward earnings and with the fiscal cliff ready to rip billions of dollars out of the U.S. economy, I can't see Francesca's outperforming.
Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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