Is Francesca's planning too much growth?

The boutique chain's expansion looks good but might take away its edge.

By InvestorPlace Jun 28, 2012 10:17AM

By Alyssa Oursler

 

If you hadn't heard of retail stock Francesca's Holdings (FRAN) before the company's last earnings report, I'm guessing you've heard of it by now.

 

The fashionable boutique chain, which went public in 2011, flaunted impressive numbers last quarter and saw shares skyrocket as a result. But in case you missed it:

  • Earnings have surpassed expectations in the last three quarters.
  • First quarter earnings per share doubled year-over-year to 20 cents and is expected to increase to 23 cents in the second quarter for another 53% year-over-year increase.
  • Revenue was up nearly 50%, jumping from $41.3 million to $61.3 million.
  • Store count increased 33%, while same-store sales increased 15%.
  • Shares gapped up 30% in just a few days, and now FRAN stock is up about 46% since Jan. 1.
Any old guy on Wall Street can look at those numbers and nod his head, as many have been doing: 7 out of 10 investors rate it a buy or strong buy, according to Thompson Reuters.

 

What I'm assuming that old guy on Wall Street doesn't quite understand about Francesca's, however, is … well, much else.

 

One analyst from The Motley Fool, for example, wrote:

Part of Francesca's success comes from its mix of offerings. Rather than just selling apparel, Francesca's has borrowed a page from Coach (COH) and Michael Kors (KORS) by also including jewelry and accessories within its collections. By having a wide range of merchandise available, Francesca's has built up its appeal to trend-seeking shoppers.

Well, yeah, Francesca's does have a mixed offering (I bought a watch and a dress there), but in reality, there are very few stores that target female shoppers and don't carry at least a small collection of jewelry and accessories. Head to Aeropostale (ARO), Gap (GPS), American Eagle (AEO), Charlotte Russe -- you name it -- and you'll find some bling and belts mixed in with the clothing.

 

Without really understanding Francesca's, it's also hard to understand why the company, although booming right now, might not actually be so well-off in the long run.

 

See, what really sets Francesca's apart is this: It started as one store in Houston, and now, despite having 327 stores in 43 states, it's exactly the same -- small, unique, probably family-owned and definitely privately owned -- or at least that's what it feels like. I tagged along with friends to Francesca's several times before I even realized it was a chain, much less a billion-dollar publicly traded company.

 

This is appealing, but seems incongruent with the mass expansion Francesca's has planned -- a grand total of 900 stores, almost triple its current number -- which would put its store count in the range of the American Eagles and Aéropostales of the retail world.

 

Stores like that draw in shoppers with a brand name, uniformity, high quantity and wide selection. Francesca's sets itself apart with a simple philosophy: "broad but shallow."

 

While other retailers plaster their names and logos on the front of every tee, stack piles of shirts in every color on huge displays and have countless more tucked away in the storeroom, Francesca's stocks a wide variety of styles in limited quantities and limited square-footage (an average of just 1,400 square feet per store).

 

And while other retailers receive clothes in giant periodic shipments (trust me, I worked a glorious summer at Aero, helping to fold and organize those shipments), Francesca's receives new clothes five days a week. This strategy ensures both scarcity and newness, which, when combined with reasonable prices, creates an appealing niche in the retail market.

 

The company's website says, "Shopping at Francesca's is like finding a gem. Because we're a boutique, we only carry limited quantities of specially handpicked items so you don't have to worry about bumping into someone at a party with the same dress as you."

 

But what happens when those "gems" are available on just about every corner, in every shopping center?

 

Nevertheless, Francesca's plans to stick its collection in Main Streets, malls, outlet centers and plazas left and right.

 

The company is clearly going "all in" on expansion, increasing its liabilities as it searches for growth and bleeding down its cash to a paltry $8 million on hand as of April. Compare that with other retail stocks like Aeropostale, which has $200 million in cash. Or worse, compare that with Abercrombie & Fitch (ANF), which had $740 million in cash on hand last spring but now has almost zero thanks to poor sales and a recent spate of store closings that gutted the company's balance sheet.

 

Francesca's is doing fine as sales continue to grow, but Abercrombie's ugly performance (-37% year to date and -53% in the last year) shows what can happen when a retail stock runs out of momentum.

 

Francesca's indeed has some qualities that set it apart from other big-name retailers, but it needs to consider that those actually might be reasons not to follow in their expansion footsteps. If the whole point is to create feelings of scarcity and specialty, expanding to every corner of America doesn't seem to make much sense.

 

And if Francesca's does keep growing? Well, investors need to be careful to know when to say when. Shares of FRAN are up 46% in 2012 … but off 20% from April valuations.

 

In short, retail stocks often fall in and out of fashion as quickly as the clothes they sell.

 

As of this writing, Alyssa Oursler did not hold a position in any of the aforementioned securities.

 

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