Chico's Downgraded: So Buy More?
House favorite Chico's (CHS) was slapped silly (down to a hold) by Wedbush Morgan this morning.We agree to disagree; Chico's is a buy, as we asserted Tuesday evening:
Gap's (GPS) growing pains reflect a company hitting the maturity point of its life cycle -- we suggest investors look to more specialized retailers for consumer-driven investment ideas.Chico's revenue has grown an average of 47% annually over the past five years, comps have been in the double digits every year since 98, and operating profits have grown at an annualized average rate of 50% over the past 5 years. In other words, Chico's has been eating its detractors for lunch.
In the retail space, our favorite contender is Chico's, which has a stranglehold on the female/35 & older apparel niche and spits out 22% operating margins (compared to Gap's 11%). Chicos's also makes better use of its assets and shareholder equity. Not only is Chico's more efficient than Gap, it has much more room for growth -- Gap has 3,000 stores running, whereas Chico's has just 660. Lastly, we're big fans of Chico's new concept line, Soma, although we can't say we wear the stuff ourselves.
Chico's has a cost advantage and targets arguably the most appealing demographic extant.
Chico's doesn't just target baby boomers -- it targets female baby boomers, who are the most loyal customers in the retail arena. 75% of sales come from Chico's Passport Club, a unique concept that drives up repeat sales, the meat and bones of any good retail operation, in our opinion.
Risks to our aggressive assumption include tepid reactions to Chico's new concept lines, as well as a turnaround story coming from the Gap, which is pumping its new Forth & Towne stores into the marketplace (which could easily fail, given how saturated the space is). Competition from the likes of Ann Taylor (ANN) and Talbots (TLB) is always a concern.
Ultimately, our biggest concern is valuation-driven: Chico's market capitalization dwarfs its revenue profile. As a quintessential high growth stock, investors are blessing Chico's with lofty -- if not outrageous -- multiples. On an EV/EBITDA basis, Chico's trades at 25x; 7x on an EV/revenue basis. It trades at 37x forward earnings.
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