Description

Chico’s is a very cheap stock in a beaten down, structurally challenged sector: bricks and mortar retail. I hesitate to go here because these have been value traps and the fundamentals of the overall industry are not good, but I am going to do it regardless because I believe one of the brands in the Chico’s portfolio, Soma, could be worth roughly the entire enterprise value of the company if sold/spun, meaning that you are getting two other businesses in the portfolio, Chico's and White House Black Market (WHBM) for basically free. Combined Chico’s/WHBM did $1.6B in sales in 2018 (Chico’s: $1B; WHBM: $695mm). Soma did $337mm in sales in FY 2018.

            The market capitalization is $446mm, there is $185mm in cash and marketable securities and $57.5mm of long-term debt. The Enterprise Value is $320mm. In 2018, the business did $2.1B in sales and $130mm in EBITDA. The stock is trading .15x 2018 P/S, and ~2.5x 2018 EV/EVITDA. The business maintains a fairly strong balance sheet, and has demonstrated good cash generation for the last years, with healthy free cash flow. Based on the trailing multiples, the business is priced to go away.

             Chico’s has three separate brands: Soma/Chico’s/White House Black Market. The challenges facing bricks and mortar apparel retailers are well-known, as are the issues regarding slow legacy supply chains and uncompetitive cost structures. The reason that this may be interesting is because Soma appears to be fairly well-positioned in a good category: intimates. Over the last three years, Soma has posted sales of $344mm (FY 2016), $343mm (FY 2016), and $337mm (FY 2018)---the entire bussiness is trading at about 1x trailing Soma sales. Soma is not on a high-growth trajectory, but at 1x sales, I am only valuing Soma as a relatively healthy retail concept with a defensible market position in a good category. That math is illusory if the value is not unlocked, or the business is not separable. But there seems to be an emerging trend in apparel retail to spin/sell higher value retail concepts in order to unlock value (see GAP/Old Navy----Activist involvement in L. Brands). If Soma continues to perform well, and the other businesses do not, I would expect this to attract activist attention. Soma strikes me as a business that would probably benefit from the type of focus and attention that it is unlikely to receive as part of a larger company working to stabilize or fix more challenged businesses.

            The Soma brand, which began operations in 2004, primarily sells exclusively designed, private branded lingerie, sleepwear and loungewear products. The Soma brand's core franchises emphasize innovative styles that focus on fit and comfort, including vanishing back bras, vanishing edge panties, slimming leggings and cool nights sleepwear. Bras range in size from 32A-46H. The sleepwear and loungewear offerings range in size from extra small to extra-extra-large. Soma develops product offerings by working closely with a small number of independent suppliers to design proprietary products in-house and, in some cases, designs provided by its independent suppliers under labels other than the Soma brand. At the end of 2018, there were 277 total Soma stores, with 258 frontline boutiques, and 19 outlets.

            The intimates business should be one of the few categories of apparel retail where a physical store can provide enough value to the customer to draw the customer to the store. Fit matters a lot with underwear, and to the extent that the saleperson can help the customer find the right fit and product, the customer will have a reason to go the store and will remain brand loyal. Victoria’s Secret, a very different business from Soma, was one of the great retail franchises for a long time before falling on difficult times in recent years due to missed trends (bralettes) and being out-of-step culturally. With more of a focus on comfort and fit, and less on sexy image, Soma has not faced same difficulties as VS. There has been a wave of new, digitally native competitors enter the intimates category in the last few years; department stores, Amazon and Aerie have also upped the competition. To the extent that more companies want to enter the space because it is a good category, it should benefit a strong participant like Soma.

            I am not going to go into detail on the other two brands, WHBM and Chicos, but my sense is that WHMB has a loyal following, a good brand, and good prospects, despite some recent missteps. The Chico’s business is the albatross on the Company. It has struggled recently with product, has experienced management turnover, and has posted three consecutive years of negative comps: 2016: (-5.3%); 2017: (-7.2%); 2018 (-6.8%). In order for the stock to work in a big way, core Chico’s probably needs to be improved or sold. But at this valuation, I think the expectations have gotten so low, that any positive surprise, strategic alternative, activist involvement, or improving trends in the other brands would send the stock higher.

Catalyst

sale/spin of Soma

improving trends in core Chico's