Charming Shoppes CHRS
December 30, 2008 - 7:51pm EST by
ali79
2008 2009
Price: 2.35 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 268 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Charming Shoppes is a soft lines retailer that operates in a special niche of the retail market focused on plus sized women. Charming Shoppes is the dominant player in the market with about 25% of the market and is the biggest retailer focused exclusively on plus sized women. Plus sized women are the most underserved market in retail today. The plus sized woman has only a handful of stores that cater to her needs and the majority of department stores which carry sizes that range up to size 18, rarely carry those items.  As the larger department stores rush to reduce inventory, I believe the largest sizes (16-18) which are considered more “one off” for retailers will be the first to go. This will enable Charming Shoppes to take market share from the department stores in the current environment.

 
Over the last 10 years, the average size of a woman went from a size 8 to a size 14. Despite this increase in size, department stores have been extremely slow to react and new store openings have focused more on teens due to their spending habits than older women.  Given the combination of a limited choice from the plus size customer and the demographics of the population becoming heavier, I believe that Charming Shoppes will be well positioned over the long run.

 
In addition to a favorable market niche and customer base, Charming Shoppes is embarking on a large cost cutting plan which the Company believes will take between $100 and $125 million out of its cost structure (possibly more) and will increase both gross and operating margins to industry averages. The Company is going to do this by shutting down the money losing Lane Bryant Catalog, closing 250 underperforming (money losing) stores, cutting a significant amount of excess overhead and duplicative management, and stopping the spend of the former CEO’s projects that cost the Company millions per year. In addition to the SG&A savings, the Company is moving to a more vertical model where it will lower its reliance on third-party vendors and increase speed to market. This, along with a correct purchasing strategy and fewer purchasing departments should help increase gross margins by a few hundred basis points over the next few years (on top of normalized gross margins rather than sales discounted gross margins).

 
This large cost cutting opportunity exists primarily because the former CEO, Dorrit Bern, mismanaged the business for at least the last 10 years. Under her leadership, Charming Shoppes grew through expensive acquisitions and never centralized any of their operations. Instead, the Company ran all of the businesses separate from each other and placed management teams on top of each business to oversee the operations of those segments. To make it all worse, the Company allowed stores that lost a significant amount of money to continue to operate with the idea that revenue growth was more important than operating income. This resulted in Charming Shoppes having one of the worst operating margins in the industry (around 3%-4% compared to peers at 7%-10%) despite its enviable market positioning and growing customer base.

 
After the new management team finishes implementing the current cost cutting program, I believe Charming Shoppes will be in its best position ever to generate substantial earnings once the consumer spending market normalizes. After the cost cuts are complete, I believe Charming Shoppes will be able to earn operating margins of around 7-8% in a normalized retail environment. This would imply earnings potential of somewhere between $0.80 and $1.20 per share. At a 10x P/E multiple I believe Charming Shoppes could be worth between $8 and $12, or approximately 3.5x to 5x its current price.

 
Charming Shoppes is a multi-channel retailer with stores, catalogs and websites. The Company has three main brands, Lane Bryant, Fashion Bug, Catherines Plus Sizes and a retail catalog business Crosstown Traders (recently sold)

 
Lane Bryant – Largest of the Company’s divisions, targets plus-size woman ages 20-45 with an assortment of work, casual and active fashion. The stores are primarily in malls but in strip centers as well. Private labels make up the bulk of the assortment, including the Lane Bryant, Venezia and Cacique brands.

 
Fashion Bug – Caters to 20-54 year olds with plus sizes but also smaller sizes as well. The clothes are more value priced and the stores are located in strip centers. Given its value priced positioning, this customer is more economically sensitive than the Lane Bryant customer. Fashion Bug competes with moderate department stores and discounters.

 
Catherines Plus Sizes – Targets older customers ages 40-65 with classically styled merchandising. Targets a moderate income customer. The stores are primarily in strip centers and about 50% is private label and 50% national brands.

 
Crosstown Traders – Direct marketer of apparel, footwear, accessories and gifts under several catalog titles and websites. The titles are primarily apparel focused, but titles also include food. This segment has recently been sold for $35 million, except for the food catalog business called Figi’s.

 

Financials:

I am modeling Charming Shoppes same store sales decline of 10% in 2009 and 7% in 2010 before improving by 2% in 2011 and 5% from 2012 to 2014. The model assumes that Charming Shoppes can eventually attain 8% operating margins, which are around a normalized industry average. I am assuming gross margins improve by 400 basis points from the 2005-2006 time frame based on purchasing and less of a reliance on third party vendors. This also assumes no value for Figi’s which could be worth up to $30 million per year. Based on the Company’s stated cost cutting plan as well as Charming Shoppes ability to sustain and potentially grow its customer base, I believe the Company has the ability to execute on these assumptions.

 
 
 
      2005 2006 2007 2008E       2009E       2010       2011       2012       2013          2014
Total Sales $2,755.7 $3,067.5 $2,810.6 $2,492.1 $2,111.2 $1,879.7 $1,917.3 $2,024.5 $2,148.4 $2,279.6
Fashion Bug     1,049.0     1,058.3        983.2        880.0        742.5        690.6        704.4        739.6        776.6        815.4
Lane Bryant     1,057.4     1,202.3     1,260.3     1,129.6     1,004.6        934.3        953.0     1,010.9     1,082.9     1,159.5
Catherine's        346.2        367.7        351.4        311.9        274.0        254.9        260.0        274.1        289.0        304.7
Crosstown Traders/Direct        298.9        427.8        215.6        170.0          90.0
Cost of Goods Sold      1,910.1      2,141.9      2,041.9      1,877.4      1,562.3      1,334.6      1,294.2      1,336.2      1,407.2      1,493.2
Gross Income         845.6         925.6         768.7         614.6         548.9         545.1         623.1         688.3         741.2         786.5
SG&A Expense         683.0         753.1         720.3         684.6         600.6         564.0         560.8         566.9         582.1         597.9
Operating Income         162.6         172.5           48.4         (69.9)         (51.7)         (18.9)           62.3         121.4         159.1         188.6
Fashion Bug / Catherine's Operating $           64.4           54.6             6.5         (54.9)         (40.7)         (18.9)           28.9           50.7           69.3           78.4
Fashion Bug / Catherine's Operating %          4.6%          3.8%          0.5%          -4.6%          -4.0%          -2.0%          3.0%          5.0%          6.5%           7.0%
Lane Bryant Operating $           85.6           90.7           25.0         (21.9)         (15.1)               -            33.4           70.8           89.9         110.2
Lane Bryant Operating %          8.1%          7.5%          2.0%       -1.9%          -1.5%          0.0%          3.5%          7.0%          8.3%          9.5%
Crosstown Traders           21.8           27.1             1.1           (2.6)             4.1               -                -                -                -                - 
Crosstown Operating %          7.3%          6.3%          0.5%          -1.5%          4.5%
Income Before Extraordinary Items         153.8         166.1           46.7         (74.9)         (57.7)         (24.9)           53.3         112.4         150.1         179.6
Income Taxes           53.1           57.2             9.2         (12.9)         (21.3)           (9.2)           19.7           41.6           55.6           66.4
Net Income - Before Extraordinary Items         100.7         108.9           28.0         (71.5)         (36.3)         (15.7)           33.6           70.8           94.6         113.1
EPS (Operating)       $0.77       $0.81          $0.23         ($0.62)       ($0.32)       ($0.14)          $0.29          $0.62          $0.82          $0.99
 


Liquidity:
 
I believe Charming Shoppes has ample liquidity to sustain any downturn in consumer spending. The Company is expecting to end the year with approximately $90 million in cash. In addition to the Company’s cash balance, it has a revolver of $375 million which has no outstanding borrowings. The borrowing capacity at the end of the third quarter on the line was $255 million (due to a lower inventory balance). There are no financial covenants on the revolver until the Company has less than 10% of availability on the line. In addition, the Company is reducing capital expenditures for 2009 to below $30 million from over $130 million last year and will continue this low level of capex for the next few years. Depreciation and Amortization will be around $85 million, or $55 million more than capex which will give the Company a good amount of breathing room to be free cash flow positive next year. The Company believes that same store sales could fall as much as 15% in 2009 without the Company burning any cash. It is hard to imagine a scenario where the Company is in a dangerous liquidity position, even with the most draconian consumer spending outcomes.

 
Consensus says retail spending will not occur again for 4-5 years
 
 
I understand that the consensus from everyone is that the consumer will never spend again for the next 4-5 years. While I understand all of the reasons why this is possible, I also understand that if everyone believes this to be the case, it is rarely the reality. If it happens to be the case, then I want to be invested in a retailer who is better positioned with its customers and holds the preeminent market position in its segment who is also rightsizing its business so that when consumer spending does improve, it will have massive leverage to the upside. If on the other hand the consumer continues to spend and by next year or the year after we are seeing increases in same store sales, then Charming Shoppes will be in its best position ever to produce earnings well above the $0.80 it achieved in 2006.

 
Investment Summary:
 

Charming Shoppes is one of the best positioned retailers due to its loyal customer base, entrenched market leading positioning, ability to capture share from department stores, and the lack of plus sized options. This unique positioning should allow Charming Shoppes to outperform the broader apparel universe. With management finally focused on creating value with an eye towards free cash flow and improving margins, I believe Charming Shoppes has a limited downside with ample liquidity and the potential to generate significant returns over the next 5+ years.

Catalyst

Completion of cost cutting, valuation to normalized earnings, any consumer spending pickup
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    Description

    Charming Shoppes is a soft lines retailer that operates in a special niche of the retail market focused on plus sized women. Charming Shoppes is the dominant player in the market with about 25% of the market and is the biggest retailer focused exclusively on plus sized women. Plus sized women are the most underserved market in retail today. The plus sized woman has only a handful of stores that cater to her needs and the majority of department stores which carry sizes that range up to size 18, rarely carry those items.  As the larger department stores rush to reduce inventory, I believe the largest sizes (16-18) which are considered more “one off” for retailers will be the first to go. This will enable Charming Shoppes to take market share from the department stores in the current environment.

     
    Over the last 10 years, the average size of a woman went from a size 8 to a size 14. Despite this increase in size, department stores have been extremely slow to react and new store openings have focused more on teens due to their spending habits than older women.  Given the combination of a limited choice from the plus size customer and the demographics of the population becoming heavier, I believe that Charming Shoppes will be well positioned over the long run.

     
    In addition to a favorable market niche and customer base, Charming Shoppes is embarking on a large cost cutting plan which the Company believes will take between $100 and $125 million out of its cost structure (possibly more) and will increase both gross and operating margins to industry averages. The Company is going to do this by shutting down the money losing Lane Bryant Catalog, closing 250 underperforming (money losing) stores, cutting a significant amount of excess overhead and duplicative management, and stopping the spend of the former CEO’s projects that cost the Company millions per year. In addition to the SG&A savings, the Company is moving to a more vertical model where it will lower its reliance on third-party vendors and increase speed to market. This, along with a correct purchasing strategy and fewer purchasing departments should help increase gross margins by a few hundred basis points over the next few years (on top of normalized gross margins rather than sales discounted gross margins).

     
    This large cost cutting opportunity exists primarily because the former CEO, Dorrit Bern, mismanaged the business for at least the last 10 years. Under her leadership, Charming Shoppes grew through expensive acquisitions and never centralized any of their operations. Instead, the Company ran all of the businesses separate from each other and placed management teams on top of each business to oversee the operations of those segments. To make it all worse, the Company allowed stores that lost a significant amount of money to continue to operate with the idea that revenue growth was more important than operating income. This resulted in Charming Shoppes having one of the worst operating margins in the industry (around 3%-4% compared to peers at 7%-10%) despite its enviable market positioning and growing customer base.

     
    After the new management team finishes implementing the current cost cutting program, I believe Charming Shoppes will be in its best position ever to generate substantial earnings once the consumer spending market normalizes. After the cost cuts are complete, I believe Charming Shoppes will be able to earn operating margins of around 7-8% in a normalized retail environment. This would imply earnings potential of somewhere between $0.80 and $1.20 per share. At a 10x P/E multiple I believe Charming Shoppes could be worth between $8 and $12, or approximately 3.5x to 5x its current price.

     
    Charming Shoppes is a multi-channel retailer with stores, catalogs and websites. The Company has three main brands, Lane Bryant, Fashion Bug, Catherines Plus Sizes and a retail catalog business Crosstown Traders (recently sold)

     
    Lane Bryant – Largest of the Company’s divisions, targets plus-size woman ages 20-45 with an assortment of work, casual and active fashion. The stores are primarily in malls but in strip centers as well. Private labels make up the bulk of the assortment, including the Lane Bryant, Venezia and Cacique brands.

     
    Fashion Bug – Caters to 20-54 year olds with plus sizes but also smaller sizes as well. The clothes are more value priced and the stores are located in strip centers. Given its value priced positioning, this customer is more economically sensitive than the Lane Bryant customer. Fashion Bug competes with moderate department stores and discounters.

     
    Catherines Plus Sizes – Targets older customers ages 40-65 with classically styled merchandising. Targets a moderate income customer. The stores are primarily in strip centers and about 50% is private label and 50% national brands.

     
    Crosstown Traders – Direct marketer of apparel, footwear, accessories and gifts under several catalog titles and websites. The titles are primarily apparel focused, but titles also include food. This segment has recently been sold for $35 million, except for the food catalog business called Figi’s.

     

    Financials:

    I am modeling Charming Shoppes same store sales decline of 10% in 2009 and 7% in 2010 before improving by 2% in 2011 and 5% from 2012 to 2014. The model assumes that Charming Shoppes can eventually attain 8% operating margins, which are around a normalized industry average. I am assuming gross margins improve by 400 basis points from the 2005-2006 time frame based on purchasing and less of a reliance on third party vendors. This also assumes no value for Figi’s which could be worth up to $30 million per year. Based on the Company’s stated cost cutting plan as well as Charming Shoppes ability to sustain and potentially grow its customer base, I believe the Company has the ability to execute on these assumptions.

     
     
     
          2005 2006 2007 2008E       2009E       2010       2011       2012       2013          2014
    Total Sales $2,755.7 $3,067.5 $2,810.6 $2,492.1 $2,111.2 $1,879.7 $1,917.3 $2,024.5 $2,148.4 $2,279.6
    Fashion Bug     1,049.0     1,058.3        983.2        880.0        742.5        690.6        704.4        739.6        776.6        815.4
    Lane Bryant     1,057.4     1,202.3     1,260.3     1,129.6     1,004.6        934.3        953.0     1,010.9     1,082.9     1,159.5
    Catherine's        346.2        367.7        351.4        311.9        274.0        254.9        260.0        274.1        289.0        304.7
    Crosstown Traders/Direct        298.9        427.8        215.6        170.0          90.0
    Cost of Goods Sold      1,910.1      2,141.9      2,041.9      1,877.4      1,562.3      1,334.6      1,294.2      1,336.2      1,407.2      1,493.2
    Gross Income         845.6         925.6         768.7         614.6         548.9         545.1         623.1         688.3         741.2         786.5
    SG&A Expense         683.0         753.1         720.3         684.6         600.6         564.0         560.8         566.9         582.1         597.9
    Operating Income         162.6         172.5           48.4         (69.9)         (51.7)         (18.9)           62.3         121.4         159.1         188.6
    Fashion Bug / Catherine's Operating $           64.4           54.6             6.5         (54.9)         (40.7)         (18.9)           28.9           50.7           69.3           78.4
    Fashion Bug / Catherine's Operating %          4.6%          3.8%          0.5%          -4.6%          -4.0%          -2.0%          3.0%          5.0%          6.5%           7.0%
    Lane Bryant Operating $           85.6           90.7           25.0         (21.9)         (15.1)               -            33.4           70.8           89.9         110.2
    Lane Bryant Operating %          8.1%          7.5%          2.0%       -1.9%          -1.5%          0.0%          3.5%          7.0%          8.3%          9.5%
    Crosstown Traders           21.8           27.1             1.1           (2.6)             4.1               -                -                -                -                - 
    Crosstown Operating %          7.3%          6.3%          0.5%          -1.5%          4.5%
    Income Before Extraordinary Items         153.8         166.1           46.7         (74.9)         (57.7)         (24.9)           53.3         112.4         150.1         179.6
    Income Taxes           53.1           57.2             9.2         (12.9)         (21.3)           (9.2)           19.7           41.6           55.6           66.4
    Net Income - Before Extraordinary Items         100.7         108.9           28.0         (71.5)         (36.3)         (15.7)           33.6           70.8           94.6         113.1
    EPS (Operating)       $0.77       $0.81          $0.23         ($0.62)       ($0.32)       ($0.14)          $0.29          $0.62          $0.82          $0.99
     


    Liquidity:
     
    I believe Charming Shoppes has ample liquidity to sustain any downturn in consumer spending. The Company is expecting to end the year with approximately $90 million in cash. In addition to the Company’s cash balance, it has a revolver of $375 million which has no outstanding borrowings. The borrowing capacity at the end of the third quarter on the line was $255 million (due to a lower inventory balance). There are no financial covenants on the revolver until the Company has less than 10% of availability on the line. In addition, the Company is reducing capital expenditures for 2009 to below $30 million from over $130 million last year and will continue this low level of capex for the next few years. Depreciation and Amortization will be around $85 million, or $55 million more than capex which will give the Company a good amount of breathing room to be free cash flow positive next year. The Company believes that same store sales could fall as much as 15% in 2009 without the Company burning any cash. It is hard to imagine a scenario where the Company is in a dangerous liquidity position, even with the most draconian consumer spending outcomes.

     
    Consensus says retail spending will not occur again for 4-5 years
     
     
    I understand that the consensus from everyone is that the consumer will never spend again for the next 4-5 years. While I understand all of the reasons why this is possible, I also understand that if everyone believes this to be the case, it is rarely the reality. If it happens to be the case, then I want to be invested in a retailer who is better positioned with its customers and holds the preeminent market position in its segment who is also rightsizing its business so that when consumer spending does improve, it will have massive leverage to the upside. If on the other hand the consumer continues to spend and by next year or the year after we are seeing increases in same store sales, then Charming Shoppes will be in its best position ever to produce earnings well above the $0.80 it achieved in 2006.

     
    Investment Summary:
     

    Charming Shoppes is one of the best positioned retailers due to its loyal customer base, entrenched market leading positioning, ability to capture share from department stores, and the lack of plus sized options. This unique positioning should allow Charming Shoppes to outperform the broader apparel universe. With management finally focused on creating value with an eye towards free cash flow and improving margins, I believe Charming Shoppes has a limited downside with ample liquidity and the potential to generate significant returns over the next 5+ years.

    Catalyst

    Completion of cost cutting, valuation to normalized earnings, any consumer spending pickup

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