|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||378||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
Charlotte Russe is a mall-based retailer focused on fast fashion for the junior market. Their target customer is in her late teens to early 20s and searches for low-priced clothing items that reflect current trends. It’s sort of disposable clothing – buy it, wear it 2-3 times, and move on. This customer doesn’t want to wear the same outfit on a Saturday night twice. Average unit retail is around $12 and the average transaction at the register is around $32. Unlike other retailers, fast fashion stores turn their inventory every 35-45 days, or about 8-10 times per year. The frequent restocking of the stores to reflect current trends causes CHIC and its peers to do the bulk of its buying domestically, unlike almost all other retailers who directly source from
Key Metrics on consensus estimates: Note: CHIC is on a September 30 fiscal year.
FY 2007E EPS / PE:
52 Week Range:
$14.19 - $32.93
FY 2008E EPS / PE:
$1.55 / 9.6x
FY 2007E PE – ex cash:
FY 2008E PE – ex cash:
EV / FY 2007E Sales:
Net Cash per share:
EV / FY 2007E Sales:
Key Metrics on consensus estimates:
Note: CHIC is on a September 30 fiscal year.
· Valuation, valuation, valuation – It’s hard to not eventually make money long-term in a stock that is 3-4x EBITDA which is cash flow positive and has a good balance sheet.
· Room to grow – CHIC currently has 410 stores (7/25/07) and will end the year with 432, but they think they have room for 600 in the
· Strong cash on cash returns from new stores – They claim to have 80% cash on cash returns for new stores and that new stores mature quickly, doing about 85-90% of the sales level of a mature store in their first year.
· Limited inventory risk in the fast fashion model – While they can be “on” or “off” at any given time with their assortment, the fact that inventories are typically held at less than 40 days of sales mitigates the financial impact of any one fashion miss, because they just don’t hold that much of anything.
· Recently authorized share buyback program - $25 million authorization in place, equivalent to 7% of market cap and 9% of EV.
· Current negative business momentum yields earnings risk as well as earnings revision risk – Short term momentum in the junior fast fashion space is terrible, as indicated by WTSLA’s disappointing September comp. CHIC even acknowledged on their Q3 call on 7/26/07 that things started getting much worse in terms of traffic and transactions towards the end of June and that the July comp was negative (CHIC, unlike many of its peers which report monthly, only publishes quarterly comps).
· Will miss Q4 (September quarter) earnings estimates – They predicated their Q4 guidance on improving results in August and September relative to July, which seems unlikely to happen since things got so much worse for WTSLA from August to September. They also guided to the promotional activity level being higher, but the environment is possibly worse than even they expected on the promotional front, which will put margins, as well as sales, at risk.
· Operating margin risk – They are currently at an operating margin of 8.7% and they are targeting a 10% run rate as a goal by the end of FY2008. It should be noted, however, that while the company has done an operating margin over 10% four times in the last ten years, the last time they did it was 2001. Over the last five years, the operating margin has averaged 6.9%, so there is a risk that margins, especially in a weak environment, revert to recent historical averages.
· Geographic risk – 13% of store base in
· Surging capex hurts free cash flow – Capex for the 5 years prior to this one averaged $44 million, yet initial guidance for 2007 capex was $65-75 million but it is likely to come in at an even higher $80 million. It’s not 100% clear where all this money is going. D&A is around $37 million, so assuming that is a maintenance capex spending level and adding $350K per store for 50 new stores would account for $55 million in capex. They are doing a bunch of things with IT, but $25 million sounds a bit steep for what they are doing, and while they haven’t yet given 2008 capex guidance, it didn’t sound like they were planning a dramatically lower number. The company has never been great at converting net income to free cash flow but with this increase in spending, free cash flow will get knocked almost all the way to zero. This doesn’t make sense given their claim the cash on cash return on new stores is 80%.
· Inherently a lower return business model within retail – A fast fashion focus leads to structurally lower gross margins because of an inability to source much product from
· Economic risk – It remains to be proved, but it seems we are in the middle of a mild consumer recession. And their customer is near the bottom of the economic food chain.
· Q4 and FY07 earnings release – expected around 11/9/07 give or take a week
· WTSLA October comp report – 11/8/07
The potential for 15%+ earnings growth for several years (through a combination of square footage growth of 10%+, small comp gains, slight margin improvements through leverage, and stock repurchase) needs to be weighed against the less attractive structural economics in fast fashion versus other specialty retail categories. Putting this together, an appropriate multiple might be a 12-13 ex-cash p/e on earnings power of around $1.50. This math yields a $22.20 target (+49% from the current quote). If people got excited about this company again (comps were positive and operating margin crept towards 10%), the stock could easily trade in the mid to high $20s. On the downside, if they comp negative mid single digits next year and have margins revert back to 6.9%, they would probably make only around $1.35. At a 10 p/e on that, there’s maybe downside to $13.50, which is less than 10% down.
Looking at it from an EBITDA perspective, they should do around $100 mm this year. 5x EBITDA yields $23. 6x EBITDA yields $27.50. If EBITDA margins contracted to the 5 year historical average of 11.9% and they comped down mid single digits, EBITDA would be around $95 mm in 2008, and the stock at its current quote is just over 3x that EBITDA.
I would recommend buying this company as a deep value investment. The only reason to not buy a retailer trading at 3x EBITDA that is profitable and has a good balance sheet would be if you thought their business was permanently impaired and could be displaced from the market. I don’t think that’s the case here. It’s not that their consumer is shopping elsewhere; they just aren’t shopping much right now. With a long-term view, you will make money, and likely very quickly make money, when there is evidence that their consumer has gotten better. That said, that day is not on the visible horizon. This is a stock without any near-term positive catalysts and with a plethora of potentially negative ones (likely negative comps and earnings revisions downward). Hopefully, at this price, a lot of that bad news is priced in, which is why I would say buy it despite the horrible short-term outlook. It’s just too cheap.
|Entry||10/15/2007 10:05 PM|
|Bailey - |
I have a two-part theory about the disconnect between 80% cash on cash return and the so-so ROE shown over the past several years:
1. The calculation does not include central costs. This is one reason they are so eager to keep growing stores.
2. The stores themselves go out of style fairly quickly. This is why they are spending a lot on remodels, and also why the CEO speaks lovingly of backlit walls to showcase footwear in the new "bright store" model.
The conference calls suggest that a remodel costs as much as a new store, but that there is no landlord allowance to offset 1/2 the cost.
So the 80% return they quote probably doesn't reflect (i) full cost accounting and (ii) the need to remodel after some period of time at twice the price of a new build.
The docs show that they have modeled 40 stores since beginning of fiscal 06. They show every sign of wanting to remodel most of the stores, and they aren't even 10% done.
Playing a role here is the incentive plan, which awards the CEO a bonus based on growth in EBITDA, irrespective of capital employed.
This goes to my main point, which is that valuing this on an EV/EBITDA basis is tricky, since the net cash is likely to be spent on remodels, and the capital intensity of the business is unclear (is it D/A, or D/A plus remodels?)
|Entry||10/16/2007 02:49 AM|
|You said: "It’s sort of disposable clothing – buy it, wear it 2-3 times, and move on."|
How far back in U.S. history do we have data on SSS of apparel that is thrown out after 2-3 times?
|Entry||10/16/2007 10:08 AM|
|I agree I am skeptical of the 80% cash on cash return on new stores. I think I even alluded to that in the write-up.|
I think central costs are high and leveragable. This is the same with all retailers...it's why operating margins go up as store bases increase. I think the fact they have room to grow is a positive, and they will get leverage.
On the remodels, I think we are in a period of catch up capex. I don't think they need to remodel 370 stores...some of those stores are pretty new. I think there is probably 1-2 more years of elevated capex related to remodels, and then free cash flow should start tracking net income more closely. In the meantime, the stock is pretty cheap on P/E, if not on free cash flow (which is typical of a company in growth mode). Often with retail, by the time the cash flow gets really high, the move in the stock is done because the growth is gone.
Also, there has been a ton of IT spending this year, which won't repeat.
I agree though that cash generation should be better...but that's the reason this is valued so cheaply. It's fixable in the intermediate term.
|Subject||Yes - WTSLA is cheap too!!!|
|Entry||10/16/2007 10:30 AM|
|I own that as well. WTSLA is more expensive on EBITDA but cheaper on FCF bc it doesn't have the elevated capex issues that CHIC has. I love WTSLA here...the work on WTSLA actually led me to look at CHIC too. WTSLA is similarly macro-challenged but has a bunch of interesting things going on. First, it has a division that called Arden B which is about 20% of sales that loses money. It is more like a BEBE - higher priced than CHIC and Wet Seal stores, aimed at post-college women, more sophisticated, (should be) sourced from Asia. There is a turnaround there that has to do with increasing overseas sourcing as well as better merchandising. I think it is in the early stages of a turnaround. As for the Wet Seal division, they are in the process of opening stores and returning to growth. There was a near-death experience for this company after overexpansion...now that their balance sheet is fixed, they have the opportunity to methodically re-enter some of the real estate they vacated when their backs were against the wall. The company is $3 with $1 net cash and 30c+ of earnings power, that is converting into free cash flow nicely. Dirt cheap. Main overhang is new ceo (old one was there for turnaround and was a planned departure) and new cfo (old one got a bigger/better job - cfo of Old Navy). Am happy to answer any questions you have on WTSLA.|
To answer your questions, CHIC and the Wet Seal division of WTSLA aren't materially different in any way that I can tell. Direct competitors.
Forever 21 is a private company. Rumor is it performs better but I have never actually seen any numbers attached to that.
I think the comp will be in the -5 to -10% range given that WTSLA did a -7% in September. Given the stock is down 50% in 4 months, I personally think a bad comp is priced in. SHOO is up 5% today on a -15% comp and an earnings miss that everyone in the world knew was coming.
I think 600 stores is totally reasonable based on the store counts of other retailers. And I am usually a skeptic on store count projections. 550-600 is generally reasonable for anything that is not too niche or expensive. When they push it to 1000, I get suspicious.
|Subject||this is going to be flippant b|
|Entry||10/16/2007 10:54 AM|
|I am guessing you are not a woman!!!|
Seriously though, I was being flippant when I wrote about disposable clothing. But in all truth, many women in their 20s never want to wear the same outfit on a Saturday night twice.
H&M has a USD$50+ bn market cap I think, largely based on this idea of "wear it a couple of times, and then it falls apart". Evidence that young, single women in Europe behave similarly to those in the US on this disposable fashion thing.
|Entry||10/16/2007 10:18 PM|
|you said, "On the downside, if they comp negative mid single digits next year and have margins revert back to 6.9%, they would probably make only around $1.35. At a 10 p/e on that, there’s maybe downside to $13.50, which is less than 10% down."|
I assume you are talking operating margin here, and the downside is a 0% operating margin or worse. They've come close enough in their history and there is no reason a prolonged downcycle couldn't bring them that low. This isn't an ANF who knows how to manage the business with negative comps or sales pressure. And like you, I stand with confusion at that CapEx number, esp. in this environment. Just an opinion.
|Subject||re: flippant, disposability|
|Entry||10/17/2007 04:47 AM|
|I have no quarrel with "disposable fashion" and no view as to how long clothes should be worn for. This is purely a question of fashion. However, I do have a strong view about the ratio of fashion disposability to physical disposability. I view this ratio as mean-reverting in the long term. |
For the typical item, what prompts a "downgrade to junk" (i.e. item converted into rag, worn around the house, thrown in trash or donated)? How often is the downgrade fashion-related and how often is it damage-related? And if these girls are indeed throwing out perfectly wearable clothes, is there a way to produce similar clothes even cheaper without sacrificing esthetics, so as to bring the ratio back down?
|Entry||10/17/2007 11:01 AM|
|I'm not sure what you are asking. The ratio of fashion disposability to physical disposability?|
Here's what I can tell you...if I'm not answering your question, then let me know.
These clothes last longer than they are desired to be kept. That doesn't mean they will last forever...this isn't an Armani suit or Burberry sweater. They are designed to last a season I think, given multiple washings and normal wear and tear. I can't speak specifically to the clothes at CHIC, but I have had friends buy stuff at H&M, wear and wash them a half dozen times, at which point they are "falling apart" which could mean fading, fraying, pilling, etc. But my friends don't care...the expectation is not that they last forever, so the expectations are met, and the customer returns to H&M even though they make low quality clothes. If you want a black sweater that will last 10 years, go to Bergdorfs. Two years, Bloomingdale's. Just this winter, you're fine with CHIC, H&M, WTSLA, etc.
Why do girls throw out perfectly wearable clothes? We need to go back to why they are wearing them. They are buying them for Fri and Sat nights (maybe Thursday too), to wear to clubs, bars, and dates. They are primarily wearing them attract men. These aren't prim clothes. Their secondary motivation would be to look cool and fashionable to their girlfriends. At that age, you don't want to have the guy you like see you in an outfit twice, and you want your friends to envy your endless wardrobe. If the $35 dress you bought gets you asked out by the guy you are eye-ing, and you never wear it again, it was still a fantastic $35 investment. I can't believe I am typing this, but this is the psychology that keeps these stores in business. Seems obvious to me, but if you were never a 22 year old girl, then maybe it's not obvious to you!
As to someone coming in cheaper...well, this is among the cheapest stuff in the mall. It's possible that someone could come in lower, but these guys are pretty good...TGT and WMT would have bigger buying power, but I think the fast fashion has been tough for them to get a handle on. They are about sourcing from Asia with long lead times. This fast fashion business is about trolling the ranks of the garmentos in LA, and possibly NY, who are small operators nimbly ripping off whatever Jessica Simpson, Nicole Ritchie, or the cast of High School Musical wore on the red carpet last week. Different business model than plan/order/put it on a boat, etc.
Not sure I answered your question but gave it my best shot.
|Entry||10/19/2007 05:00 AM|
|Yes that was very helpful, though I'm still left curious enough to ask a few girls when I get the occasion. I don't think it's an obvious issue at all. I ask these questions because recently I had two cases of older women (60+) telling me they don't get this "larger wardrobe, lower quality" thing. And actually, I also grew up in a world where wardrobes were complimented for quality, not quantity... and I'm not old.|
|Subject||one other comment|
|Entry||10/23/2007 09:21 AM|
|you said, "I would recommend buying this company as a deep value investment. The only reason to not buy a retailer trading at 3x EBITDA that is profitable and has a good balance sheet would be if you thought their business was permanently impaired and could be displaced from the market."|
minor quibble, but the stock won't trade at 3x EBITA after Q4 which is likely going to be a mess and won't have the extra week (so trailing figures are grossly inflated). Also, my guess is that we are going to quickly find out that margins were at peak levels anyway (and let's be honest - consensus estimates don't mean zippo in a business like this one). If you use 17m in NI as in two and three years ago, they could generate 50m in gross cash flow but will apparently outspend it in CapEx so cash levels will be lower too. In short, I think we are going to find that 'deep value' is a misnomer, though it will be interesting to see if they follow up with the buyback.
That doesn't mean that CHIC can't be $28 three years from now. However, given what's happening over at Wet Seal I believe we are more likely in the short run to see single digits at CHIC than the 20s...
|Subject||one other comment comment|
|Entry||11/14/2007 06:43 PM|
|looks like I was wrong; negative comps didn't do nearly the damage I expected - nice call.|
|Subject||this is completely an age thin|
|Entry||12/27/2007 01:49 PM|
|Sorry...I have been away from VIC awhile.|
Yes, most of our mothers and grandmothers emphasized quality over quantity. This is even more true if you grew up either 1) wealthy, or 2) WASPy. But this has no bearing on how 18 year olds think.
This is completely an age thing. I am in my 30s and would never wear this disposable crap anymore (although I have friends who make in the $75K-125K range and are my age who do). But I am not the target market, it is for 18-24 year olds. When I was that age, I used to buy total crap disposable clothes at the mall with my friends, who were largely upper middle class ivy league girls who went to private high schools. My friends who grew up on Park Avenue or Beacon Hill didn't buy those crappy clothes with us, but that is a very small percentage of the population and CHIC doesn't need these very rich girls in order to thrive.
Of course someone in their 60s wouldn't get this. They wouldn't get why someone who makes 100K+ per year ever goes to Old Navy or Target for clothes either, but I assure you there are loads who do. It has to do for shopping for the occasion. Why do I buy a $500-1000 designer suit to wear to work then buy crappy t-shirts at the Gap for $20 when I could buy quality for $100 at Neimans or Nordstroms (or $300 at Prada)? I can afford the better quality t-shirts but the marginal expenditure does not seem worth it to me for either the appearance or the psychic pleasure of the purchase. It's all about the very personal perception of the relationship between price and value depending on the occasion. The most extreme example of this would be women who spend $5000 on a wedding dress who have never paid more than $300 for a suit they wear to work weekly. Does this make sense? No. Does it happen all the time? Yes.
Hope this helps.
As a side note, investing in consumer stocks isn't just about the math...these aren't steel or oil companies selling a commodity...there's a little art here as well as science in predicting what people will care about, how people will shop, what is sustainable and what's a fad, etc.
|Subject||response to eps risk|
|Entry||12/27/2007 02:00 PM|
|At a 5% operating margin, they will earn $1.13 and do 79 mm in EBITDA and burn about 10 mm in cash. At current levels ($16.08), then EV would be about 350 adjusting for the burn, which is 4.4x EBITDA. I think this is a very dire scenario given they did 7.3% in 07, 8.7% in 06, and the lowest EBITDA margin in the last 6 years is 5.2% in 2005. I think it is more likely in a bear case they do 6% EBTIDA margins, which will mean 87 in EBITDA and 4 mm cash burn and implies an EV/EBITDA of about 3.9x. Whether it is 3x or 4x, I think the multiple implies financial distress and.or permanent negative growth, neither of which we have here. I think 4x for anything not in secular decline with some growth prospects and the capacity to generate cash if the capex is contained to maintenance, is inherently deep value.|
Re: WTSLA btw, results have stabilized since this conversation was going on, November was better than October. Also, WTSLA's margins are being weighed down by their money losing Arden B division, which does not compete with CHIC. Backing out Arden B, I think WTSLA margins, even given the terrible comps lately, are running ont he full year around where CHIC's are for the Wet Seal dicision when you back out Arden B.