Francesca's Amazing Growth
Board: Value Hounds
Francesca’s is a broad shallow semi-fast retailer that is in the midst of some rather amazing growth.
Broad shallow refers to a big selection of merchandise but a small inventory of each of the items. Francesca’s says the strategy creates a sense of newness and exclusivity. When the consumer does not see a six-foot high stack of the same polo shirts, but instead just a couple of tops in a particular style, they feel less like a cipher in a mass merchandising chain. The customer returns to Francesca’s to see what’s new and different. This type of retail sales requires a reliable cohort of vendors capable of fast turnaround times.
Francesca’s has to mesh trend-right clothes and accessories and short production lead times to support the broad shallow strategy. It takes only four to twelve weeks from the time an order is placed to the time merchandise is available on the boutique floor. With these short lead times, they react quickly to changing trends and tastes. There is new merchandise 5 days a week.
The company uses around 200 vendors. KJK Trading is interesting and their largest vendor in both 2011 and 2010. They are KJK Trading’s sole customer. KJK Trading is owned and operated by Ki Juing Gu. Mr. Gu is the brother-in-law of Ms. Insuk Koo – a founder and current executive vice chairman. KJK Trading designs apparel but does not act as broker or agent in the sourcing of merchandise. Stony Leather is the second largest vendor in 2011 and 2010 and is also run by related parties -- Chong Yi and Insuk Koo (two of the four founders and shareholders) own and operate Stony. Stony provides jewelry, accessories and gift items. Both KJK Trading and Stony have separate offices and employees as third-party vendors. Having related parties as the largest suppliers has the potential to create conflicts of interest. Insiders hold 45% of shares.
The Stony inventory purchases during fiscal years 2011, 2010 and 2009 were approximately $5.0 million, $5.0 million and $3.1 million, respectively.
The KJK Trading inventory purchases during fiscal years 2011, 2010 and 2009 were approximately $8.1 million, $6.6 million and $2.8 million, respectively.
The two largest vendors only account for $13 million in inventory costs. With any related parties there is always a chance that conflicts of interest arise. Francesca’s says they control selection and purchases.
In 2010-2011 FRAN opened 138 boutiques averaging 1,400 square feet. For stores open 12 or more months, sales were approximately $750,000 in the first year. The stores delivered first-year, pre-tax cash return on net investment in excess of 150% and paid back the net investment on a pre-tax basis in less than one year.
In 2011, the cost of build-out with fixtures and equipment averaged $180,000 per boutique with tenant allowances at approximately $81,000 per boutique. FRAN ‘s initial inventory per store was $45,000.
With new stores generating first year returns of 150% and pay back of net investment in less than one year, the high new store growth is paying its way and then some. High traffic locations combined with low capital investment and operating cost requirements is able to fund growth with cash flows. To date there is little evidence that the rapid growth is creating poor economics for the company. They benefit from both high same store sales comps and new stores that are adding more than marginal growth. As these new stores enter the comp base, they do not drag on results, but are doing good business and keep the comps high.
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With revenue growth exceeding the combined same store sales growth and store count growth, opening new stores even at a rapid pace is profitable.
In Q1 2012, FRAN sequentially grew stores by 44 units –a 15.5% increase. Fran added 78 stores and 31% growth in stores year-over-year, Comparable same stores sales in Q1 were 15.5%. Revenue growth was 49%. They were cash flow positive at $9.4 million and had free cash flow of $3 million.
Francesca’s expects to increase from 327 stores at the end of Q1 2012 to 900 boutiques over the next seven to ten years in the U.S. They opened 76 in fiscal year 2011 and plan to open approximately 75 stores in 2012 and 2013 and one outlet store in 2012. They have already scouted locations and have a sufficient number of shopping venues that meet real estate selection criteria.
The new locations are similar enough to their current stores that they believe new stores will generate first year cash return on net investment of approximately 150% and to pay back investment in less than one year. They are also expecting landlords will continue to pay construction allowances to cover a substantial portion of costs lowering capex. Recent expansion has been helped by higher vacancy rates, but they still believe future tenant allowances, while possibly lower, will be consistent with projections.
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FRAN has some of the better margins in the apparel sector; comparable to The Buckle and lululemon. FRAN is comparable to lululemon in its rapid growth and high comps as well. LULU is growing comps and revenue at an even faster pace. LULU’s sales per square foot are the best I have seen in clothing. Their clothes are pricey and they must sell a tremendous amount of product.
Francesca’s is a growth story in its early innings. In many ways, it is much like lululemon. Same store sales are consistently high, the number of stores is small and the concept has room to grow before saturation. Lululemon has no debt and finances expansion with cash flow. Francesca’s has only $12 million in debt and 28% debt/capital. It’s being paid down fast and new stores are funded with cash flow.
The price per share suggests both trade at a premium.
Francesca’s is not a value at current prices and trades at a premium in excess of even the mighty LULU in some metrics –PE, P/B. So far, FRAN is an impressive enterprise with its low capex, high comps and amazing profitability of new builds paying back investment rapidly. It has an equally impressive price tag.