FRAN: SSSG Trends Since 2010 |
Unfortunately for Francesca’s Holdings Corp (NASDAQ:FRAN), the deteriorating operating performance has translated directly to a declining stock price and valuation. Since its IPO, after accounting for the customary pop that occurred on the day of the IPO, FRAN’s stock price has since declined by 47%. Also, FRAN’s EV/Revenue and EV/EBITDA multiples have tumbled to 1.8x and 7.5x, respectively, a far cry from the 8x EV / revenue and 31x EV / EBITDA valuation the day after its IPO.
FRAN: Valuation Decline Since IPO |
On its latest earnings call, Francesca’s Holdings Corp (NASDAQ:FRAN)’s management described the difficult retail environment as well as the challenges related to keeping ahead of trends for its targeted customer demographic.
Overall, the retail environment has been challenging since the beginning of the calendar year, withsoft traffic trends and competitively aggressive promotions. The cumulative effect of these trends has limited the effectiveness of our merchandise clearance strategies, and has created bottlenecks in inventory flow for newness.
Our customer demographic trends respond best to well-edited assortments, newness, and lower price point items with a higher perceived value. Although motivated, she is not heavily interested in clearance. Even with our short lead times, we struggled to effectively clear during extended periods of slow traffic, and have limited space to maneuver from an inventory perspective. – Neill Davis, Francesca’s Holdings Corp (NASDAQ:FRAN) President and CEO on Q1’14 Earnings Call
This commentary highlights the difficulty of managing merchandise for a fickle demographic. While Five Below Inc (NASDAQ:FIVE) has been fairly successful with its concept thus far, the company is still in the early innings of a long and difficult road to national expansion. We believe that Five Below is prone to missing a merchandising trend periodically and that a severe miss has the potential to trigger a significant valuation correction, particularly if Five Below mismanages a holiday quarter.
Overall, we feel that Francesca’s Holdings Corp (NASDAQ:FRAN)’s trends and history offer investors valuable lessons in what could go wrong with a fast-growing retailer. Like Five Below Inc (NASDAQ:FIVE), FRAN also benefited from high SSSG, high revenue growth and sell-side analyst optimism during its early part of the growth phase. As FRAN is now in the intermediate stage of its expansion plan, it is having a challenging time managing a significantly larger store base. New competition, the challenge of managing exponential growth, combined with being forced to enter 2nd and 3rd tier markets, has led to the declining revenue and SSSG growth trend that have severely impacted FRAN’s valuation. Interestingly, FRAN continues to rapidly expand store count (25% increase in FY 2013), but that has not masked other fundamental issues that we’ve outlined. We believe that Five Below’s recent trends imply a similar trajectory and that it’s only a matter of time before investors are less optimistic about Five Below’s overhyped potential.
Case Study: Denninghouse
Next, we’ll examine Denninghouse, a concept that operated in the same segment as Five Below Inc (NASDAQ:FIVE): discount retail. Just like Five Below is now a darling among sellside analysts who cover dollar stores, Denninghouse was once Canada’s hottest discount retail growth brand. Despite growing its store count and revenue nearly 1,000% over a 10-year period and achieving record financial results nearly every year, Denninghouse’s competitive position was quickly ravaged by competition, resulting in the company’s bankruptcy in 2004, only 2 years after it achieved its most profitable year in existence. The Denninghouse story offers instructive lessons for investors in easy-to-copy specialty retail formats.
Denninghouse: Stock Price Performance from 2001 – 2005 |
(Source: Denninghouse annual report)
Denninghouse was a Canadian discount specialty retailer that operated the “Buck or Two” stores – a line of small-format retail stores, averaging ~3,000 square feet, that sold a variety of seasonal and everyday items below a C$2.00 price point. Denninghouse started with a single store in 1987, and grew modestly until its management decided to pursue an aggressive franchising strategy in 1992.
(Source: Denninghouse public filings)
Over the next decade, Denninghouse’s growth exploded. Within only six years, Denninghouse become the largest discount retailer in Canada, with over 200 stores across Canada and system-wide sales of nearly C$130 million. As Denninghouse grew, shareholders benefited from its attractive unit-level economics. Denninghouse operated with a very small store format – approximately 3,000 square feet – and thus it posted strong sales per square foot of ~C$240.00. Given the minimal costs to open a store, Denninghouse was able to attract hundreds of franchisees, more than doubling its unit count again between 1998 and 2002, peaking at 328 stores in 2002.
During its growth years, Denninghouse had many stark similarities with Five Below Inc (NASDAQ:FIVE) today:
- Denninghouse was a Canadian discount retailer that went through a rapid growth phase, going from only a handful of stores in 1987 to 328 stores by 2003 (given the Canadian market is approximately 1/10th the US market, that is equivalent to a penetration of about 3,200 stores in the US. To further put that in context, FDO, DG and DLTR currently have approximately 8,000, 11,000 and 5,000 stores in the United States, respectively)
- Denninghouse also focused largely on selling seasonal items and close-out merchandise, rather than consumables and household items which correspond to a more recurring revenue stream.
- Denninghouse also sold its products at a relatively higher gross margin than its competitors (Denninghouse gross margins were in the high-30%’s, versus low-20%’s for Wal-Mart).
- Denninghouse also had attractive unit-level economics, with a small-format store (~3,000 square feet) and sales per square foot in line with industry levels at the time (C$240/foot).
Despite putting up incredible growth and record profits year-after-year, Denninghouse blindsided investors with an incredibly rapid deterioration in profits. Denninghouse went from hitting record profits in calendar 2002 to being bankrupt by 2004! So how did Canada’s leading national discount retailer go from setting record profits, to going bankrupt, in only 2 years?