Description

CHRS is in the women apparel retail business. It targets the plus-size woman market. It primary merchandizing strategy is to offer apparel to the plus-size woman that "fits". Outside of Walmart, CHRS is the largest retailer of plus-size woman apparel. CHRS trades under three brands.
Lane Bryant Stores, purchased from Limited Brands, Inc. in August, 2001, targets plus-size women ages 25-45 with proprietary brands and fashion forward styles at a moderate price range. It has 650 stores, mostly in mall locations. Catherine’s Plus Size Stores, purchased in January, 2000, targets plus-size and extended size women ages 40-65 with casual and career styles at a moderate price range. It has 467 stores and an e-commerce site. Fashion Bug Stores, targets women 20-49 in plus-size (42% of sales), misses and junior with fashionable apparel in a low-moderate price range. It has 1,208 stores, mostly in strip malls. It intends to continue to extend the plus-size market.

CHRS intends to grow Lane Bryant and Catherine’s to approximately 1,000 and 800 store, respectively, while realigning Fashion Bug to focus more on plus-size within its target group. CHRS also intends to close or convert under performing Fashion Bug to the Lane Bryant or Catherine’s format.
Another strategy is to focus future expansion on stores located in strip centers as the cost is lower and CHRS has more expertise in strip-center based stores

Financials and TTM results:

CHRS
Price per share (2/21) $3.25
Shares outstanding (8/3) 122.3 millions
Market Cap $397 millions
Debt to equity ratio 30%
Operating Margin (TTM, 11/2/02) 3.7% (excluding restructuring)
EPS (fully diluted) $0.13 (excluding restructuring)
-$0.04 (including restructuring)
Sales (TTM) $2,300 million
Price to Sales (2/21), TTM 0.17

The results for the last 12 months, ending 11/2/02, were poor. CHRS committed a major merchandising error at Lane Bryant, resulting in a same store sales of -4% for the quarter ended 11/02/02. CHRS guided a $0.34 EPS, before accounting changes and credits for the year ending 2/03. Free cash flow, however, is expected to be in the range of $40 million. The merchandising error will take at least 6 to 9 months to work through as the lead time for re-positioning merchandise is between 6 to 9 months. Meanwhile, we can expect that gross margin will be eroding as CHRS attempts to clear inventory through discounting. This will hurt margin for at least the first half of calendar year 2003. Replacement of the manager for merchandising at Lane Bryant is on-going and senior management is paying much attention and time at that division. A generally tough retail environment during the 2002 holidays did not help either.

Guidance for FY2004

CHRS recently issed guidance for FY2004 for EPS in the range of $0.33 to $0.35 per share, net sales at $2.4 Billion, and FCF at $20 millions. FY2004's first half is forecasted to be dragged down by the turn-around of the merchandising at Lane Bryant. The second half shows a pick up of the momentum. CHRS will be focusing on the development of the Lane Bryant and Catherine format for future growth, especially the Lane Bryant brand. Lane Bryant has a revenue of $200/sq ft compared to $140/sq ft at a Fashion Bug store. Gross margin is higher at the Lane Bryant brand as well. There are opportunities to convert a Fashion Bug store with modest capital investment of $100k to $150k. However, only a fraction, perhaps less than 20%, has the potential for conversion due to demographics.

Reasons that the company will continue to increase in value overtime:

The plus-size market is a growing niche and CHRS is a leading retailer focusing on that market. Its primary competitor is Walmart, who is not a leader in fashion. Growth opportunity exists. Management feels that there are room to grow Lane Bryant and Catherine’s from 650 to 1,000 stores and from 467 to 800 stores, respectively. Gross margin expansion is likely as the profit margin in Lane Bryant is higher. Cost savings is expected as integration of the acquisitions are completed, the completion of the restructuring of the low-performing Fashion Bug stores, the resolution of the short term merchandising issues at Lane Bryant and the leveraging of expenses as same store sales expands and provide expenses leverage. Management feels that an operating margin of 7% to 8% is achievable.

Valuation Estimates:

The following table compares the key financial ratios for CHRS, Ann Taylor (ANN), Talbots (TLB) and Dress Barn (DBRN):

CHRS ANN TLB DBRN
Sales (Billions) 2.3 1.4 1.6 0.7
Price/Sales 0.17 0.64 0.93 0.53
Price/Earnings 36.8 14.5 12.6 13.0
Operating Margin 3.7% 7.9% 12.7% 7.7%

Based on this comparison, management’s goal of achieving 7% to 8% operating margin appears to be within the norm of the industry and hence, should be achievable. Based on conservative PE estimates and different sales growth scenarios, CHRS can easily fetch $10 to $12 per share in 2 to 3 years, if it can execute and gets close to returning 6 to 7% operating margins.

Risks:

Execution risk: Management has not, in the last 5 years, demonstrated an ability to reach an operating margin of 7% or 8%. The best that it has been able to do is 6.7% in the year ended Jan 29, 2002.

Financial leverage: CHRS has $150 million 4.75% convertible note due 2012, approximately $22 millions in mortgage note and $29 millions of capital leases. Because of the extended due date of the convertible note, and positive cash flow from operations less capital expenditure, the risk in liquidity is low.

Proprietary credit card default risks: approximately $300 millions of credit receivables outstanding. Should the default rate increases, it will hurt earnings and reduce liquidity.

Turn-around at Lane Bryant: The guidance for FY2004 is back-end loaded. Increasing the risk of disappointment.

Catalyst

Catalyst for price appreciation:

Turn around of merchandising situation at Lane Bryant and more consistent same store sales growth. Margin expansion due to positive same store sales growth and realization of cost savings discussed above. I do not expect prices to move much until there is evidance in the turn-around in Lane Bryant. However, the up-side potential far out-weigh the down side risk at this price point, if we take a 3 to 4 year horizon view.