Pop quiz: How does a skinny, funny-looking bald guy peruse a store meant for -- and full of -- teenage girls without running afoul of the mall's perve squad?
(a.) Lurk casually and try not to look like you're about to commit certain deeds.
(2.) Tell the clerks that you're there as part of a Fox reality-show challenge.
(C.) Clutch yourself, dance nervously on the balls of your feet, and ask repeatedly for the bathroom.
(IV.) Explain that you're doing investment research.
Answer: Trick question. The proper thing to do is say you're looking for a gift for your daughter or niece, or better yet, bring one along, because no one's going to believe No. 4, even if it's true.
This is a dilemma you may face if you are, like me, a male and a big sucker for a markdown, either at the mall or on the New York Stock Exchange. And the shiny retail bauble that's caught my eye today is Claire'sStores
I'll warn any dusty old fogies -- and I mean that in the kindest way -- that this isn't a traditional, brown-suit-and-wingtips, Inside Value pick like turnaround MCI, which has turned in a 40% gain. Nor is it a super-powered stalwart like Lloyd's
Claire's is hot stuff
I'm not big on the mall, but I try to use my time there wisely -- make that Foolishly. But since my wife pretends to enjoy trips to Home Depot
Claire's is one store that I have trouble staying away from. If you've never visited it, or its elder sibling Icing, you are missing out on an entire sociological phenomenon. It's a universe of sparkly fashion accessories for girls from 10 on up to women. And every location I've ever seen has always been busy -- very busy.
The reason is that women and pre-women of all ages can get fashionable accessories from bobbles to boots at very inexpensive prices. Need an $8 necklace to go with that $400 Coach
One thing I love is that this is a simple business for an investor to understand: Sell tons of inexpensive stuff and profit by staying on top of fashion trends and exploiting economies of scale. Yup, that's pretty much it. Of course, that doesn't mean it's always an easy thing to do, as we'll see.
Growth spurt?
Claire's has been around for quite a while. (I seem to remember getting an ear pierced at one during a youthful fit of indiscretion.) But lately, it's given the impression of going through a growth spurt, largely because of excellent comps performance over the past year. In fact, top-line growth has been fairly steady and robust, without being flashy enough to attract investors by the droves. The earnings picture has been much lumpier, partially due to a lot of one-time charges dating back to some tough times at the turn of the century. Things have smoothed out since then.
| TTM | Change | 2003 | Change | 2002 | Change | 2001 * | Change | 2000* | |
|---|---|---|---|---|---|---|---|---|---|
| Sales (millions) | $1,248 | 10% | $1,133 | 13% | $1,002 | 9% | $919 | -3% | $947 |
| EPS* | $1.41 | 21% | $1.17 | 14% | $0.80 | 90% | $0.42 | -38% | $0.68 |
*There were significant one-time charges in 2000 and 2001 that put actual EPS at $0.20 and $0.65. I've used the figure from continuing operations in these columns.
A knock-kneed stumble
Anyone with teenagers knows there's a time when things get a bit awkward. Back in early December, the firm reported slim, 3% comps growth for the month of November. No, not so great. But, to put things in perspective, the year-to-date same-store sales growth checked in at 9%, with 14% overall.
The stock tanked. You would expect such a response were the stock pricing in much higher growth and trading for a nosebleed-inducing price-to-earnings ratio, but Claire's was being swapped for less than 20 times trailing earnings. Not cheap, but come on, folks: Mature giants like Coca-Cola
Of course, this was about the same time that everyone was freaking out as the media's happy vultures gloated over Wal-Mart'spost-Thanksgiving screw-up. Today's news is similar. Investors seem disappointed with the 5% comps growth figure -- something many retailers would kill for -- and reduced earnings guidance. Management now expects $0.57 to $0.61 per share for the fourth quarter, which, accounting for a retirement charge in the prior-year period, leaves earnings looking flat for the quarter.
Slowing sales? Flat earnings. No wonder investors are jumping ship. The question for us bottom-feeders, circling slowly, watching, and waiting, is: Should we buy now? Many on the Street are saying, "like, totally," and it's easy to understand why.
Full piggy bank
Claire's is a major cash cow. The piggy bank held $230 million in cash at the last 10-Q, and there was no long-term debt, though, as colleague Nathan Parmelee noted a while back, you may want to count leases as a debt, kinda-sorta, when figuring an enterprise value. The firm has a good history of free cash flow, also commendable given its fairly hefty capital investments for expanding and upgrading its stores. For those who expect a little something for their trouble, a decent portion of that wealth comes back to shareholders. The dividend is more than three times larger than it was three years ago, currently yielding 1.8%.
Only daughter
Claire's is even more interesting because it's got no real competition. OK, I need to rephrase that. The competition is everyone and no one. It's everyone in the sense that other retailers, like clothiers, may offer similar products. But there's no one mall-based competitor that offers the whole range of merchandise in a single, fun-filled store. I believe this gives Claire's a distinct advantage and a broader customer base than you might at first guess. I've got a fashionable, Burberry-clutching colleague who's happy to pop by Claire's for a necklace that's more or less disposable.
In the meantime, there's plenty of evidence that the core audience of 'tweens and teens continues to spend big money to keep up with fashion trends. Claire's nifty, thrifty goods allow them to do that with minimal drain on mom and dad's finances.
But it's not all sparkle lotion and candy lip gloss here. Like any teenager in front of the mirror, interested investors need to keep an eye out for blemishes that may blossom into unsightly shankers.
Overbearing mother?
One thing I don't like is the caste system for shares -- discussed here -- that puts Claire's firmly in the control of a minority of stockholders. Balancing this worry about governance is the fact that stock-based compensation isn't a big burden for the little people, and Claire's financial statements are among the clearer you will find. This is probably one of the more friendly dictatorships you'll find.
Stale sales?
Management was candid in assessing the current sales situation, saying it did not think it had produced a major whiff on fashion trends. Keep in mind that the recent "disappointment" actually beat analysts' estimates. The front office indicated that it expects some of the holiday-season slack to be taken up with gift-card redemption in upcoming months. This may happen. On the other hand, much of the PR I've seen lately seems a little behind the curve in terms of the edginess that pervades today's fashion, even for younger girls. Check out the website for examples of photos that look like they come from a Podunk, USA, Sunday shopping circular. I'm not suggesting that the firm skank it up -- like Christina Aguilera's heinous Skechers ads -- but it's clear that there's room for improvement. While I think things will improve, investors also need to keep in mind that this year's fast comps growth is going to make for tough comparisons in the upcoming months.
Price tag
It should already be clear that I think Claire's deserves to be cut a little slack. And now that slack has been cut in the stock price, the getting might be good. Management has proven adept at staying on top of its market, and I anticipate that sales will get back on track. Gross margins have improved steadily all year, with operating and net margins following suit until a stumble last quarter. Returns on assets and equity have been trending well, too.
| TTM | 2003 | 2002 | 2001 | 2000 | |
|---|---|---|---|---|---|
| ROA | 16.6% | 14.9% | 11.5% | 3.1% | 9.5% |
| ROE | 20.9% | 20.3% | 17.2% | 4.9% | 16.3% |
So, what should you pay? Should you buy at all?
By the market cap and balance sheets, the enterprise value is $1.75 billion. That yields an EV-to-free cash flow ratio of 13, which looks good compared to the market as a whole, and appears to be a discount to the industry. But adding back a thumbnail capitalization of usual lease commitments (six times $169 million) brings a "truer" EV of $2.77 billion, and an adjusted EV-to-FCF ratio of 20.
If you're expecting a comparison of this adjusted figure to industry averages, you'll need to be disappointed. Since these lease obligations lurk in the footnotes of the annuals -- not on the sheets, where the world's financial data providers can easily drop them in the databases -- you really can't get a good picture of the industry or sector overall. The adjusted figure does make for a fair comparison to overall market figures, and although that 20 is a discount to the overall market, I'm not sure it's a big enough sale to make me put my own cash down for Claire's shares. At least not yet. Given the likelihood of continuing growth, Claire's looks like an 80- or 85-cent dollar to me. I'd rather pick one up for 65 cents.
Final word
What? All that yakkity yak, you mean you're going to say, "Don't buy." Alas, that's how it goes with the hunt for value. But I do urge anyone interested in a growth bargain to keep Claire's on the watch list, and don't be afraid of more short-term negativity. In fact, you should be praying for it.
In general, the methods we try to follow at Inside Value require investors to look past the misleading headlines about general "softness" or whatever they're calling it today in "retail." These headlines are often the result of shoddy, slanted reporting, as I've complained here. (OK, here and here, as well.) But for all the fun we might have shaking our heads at misinformation, that's exactly what we need to get bargains. And often, you have to wait until there's been enough of it to make that business an absolute steal. If you're interested in finding solid companies that already measure up to our standards of cheap, or want to get feedback on a potential bargain you've found, go ahead and take a free trial. It doesn't get any cheaper than that.
For related Foolishness:
- Take advantage of bobbleheads and the beast.
- Know what you need? Some Sominex for your portfolio.
- Retail's the one place you might want to pay full price rather than dive the dumpsters.
- Bask in the memory of the Golden Age of Value.
It should, by now, come as no surprise that Seth Jayson has rarely paid full price for anything. At the time of publication, he had positions in no company mentioned. View his stock holdings and Fool profile here. Fool rules are here.
