Francesca's (FRAN +0.00%) has 30% of its stock short and is disliked by the market. Personally, I believe that Francesca's is a great company with a strong business model.
In fashion, staying fresh is key. Additionally, operating costs must be kept low. Indeed, many companies are hemorrhaging cash just keeping staff in stores even on minimum wage, but not Francesca's. The company's key business goals are:
- Small stores of less than 1,500 square feet.
- Lots of stock -- 3,000 stock-keeping units.
- Weekly inventory changes encouraging revisits.
- High inventory turnover. Ordering 30 days in advance keeps inventory levels low, minimizing the risk of falling margins and sales.
Francesca's also has a debt-free balance sheet and $33 million in cash and short-term investments. Inventory is kept low, as I have already mentioned, so the company's quick ratio stands at 2.2. That's high for the retail sector, where a ratio of about one is considered average. Earnings per share are expected to grow 24% this year, indicating that at a trailing-12 month P/E ratio of 22.8, Francesca's is trading at a PEG ratio of 0.9, offering growth at a reasonable price.
Furthermore, Francesca's is highly cash-generative. Free cash flow has averaged a nominal amount of $13.5 million per quarter during the past four quarters -- 29% of net income, leaving plenty of financial headroom for expansion and shareholder returns.
So, after these bull points, why is Francesca's still a favorite of shorts?
It appears that traders are betting against the company becaue they believe its valuation is too high based on slowing comparable-store sales. However, Francesca's is well placed for growth through other mediums, and its cash-rich balance sheet is supporting group expansion to 900 domestic locations, from 445 currently.
Indeed, the company is expecting to increase its number of stores by 23.6% this year and already has plans in place to open another 60 stores in 2014, boosting the bottom line. Overall, Francesca's looks attractive for the longer term. The business model is sound, and cash generation is strong -- a good company to buy and forget.
Demand for firearms is high
Sturm, Ruger (RGR 0.44%) has 28.3% of its stock short. Now let's forget about the ethical factor here -- if you want to short a company just because it makes guns, you have no place investing in the first place. A good company will make money no matter what.
Sturm, Ruger has a solid balance sheet, with no debt and $65 million in cash per share. Cash generation is strong, with a cash conversion ratio of nearly 100% during the second quarter of this year. The company's gross and net profit margins have been creeping higher, growing 10% and 20%, respectively, over the past four quarters. Additionally, the company recently reported that gun sales are reaching near-record levels.
Unfortunately, it would appear that these record sales are being driven by fear, and I believe this is where the shorts think they can make their money. Political wrangling brought about by several tragic events has driven speculation that gun sales could be capped, slowed, or stopped in the US. Obviously, the public has reacted to this by buying as many guns as they possibly can before any regulation comes into place. This raises concern in the medium term because any firearm regulation would immediately put the brakes on Sturm, Ruger's earnings.
However, due to the support in the country for the right to carry firearms, coupled with the fact that Congress is becoming increasingly useless, I'm led to believe the demand for weaponry and related items will not slow anytime soon. This makes Sturm, Ruger look quite attractive, considering the company's cash generation.
High-yield telecom
Lastly, we have much-maligned Frontier Communications (FTR +0.00%), with 23.5% of its float short. Frontier is a solid company, undervalued when compared to the rest of the telecom sector and producing strong free cash flow that easily covers the dividend and allows the company to pay down debt. Indeed, during the second quarter of this year, the company reduced its total debt pile by 3%, taking debt reduction so far this year to a total of 9%.
Free cash flow has averaged $100 million for the last four quarters, covering the dividend, which costs the company $100 million in total. Currently yielding 8.6% and well covered, the dividend is enough of a reason to buy the stock in itself.
Furthermore, Frontier is undervalued compared to the rest of the telecom sector on a price-to-free-cash-flow basis, trading at a ratio of 12.8 compared to the sector average of around 20.
Unless Frontier hits a major snag, the company does not look to be failing. Growth is slow, but cash flow is strong, the dividend is well covered, and management is repairing the balance sheet. If anything, Frontier is a good income play for the future.
In summary, these three companies are all short favorites because of short-term influences. In the longer term, the investment theses for all three companies are solid, and each business looks poised for future growth.
