In today’s ever challenging and volatile retail industry, investors are afraid of investing in retailers since some well-established retailers have declined by 15% to 20% in a day after reporting disappointed earning results. However, as investors throw in the towel in the retail sector, it indeed provides outstanding investment opportunities. Today, I will provide my analysis about Express (EXPR), which has healthy balance sheet to withstand today’s brutal retail environment and defensible 10.7x FCF/P valuation. In other words, Express can pay its shareholders back all their investment in about 10.7 years.
Express launched in 1980 as a division of Limited Brands and then became a stand-alone public company in July 2007. Nowadays, Express is one of the largest specialty apparel retailers in the North America. Its target customers are both women and men between 20 and 30 years old across various aspects of the lifestyles comprising work, causal, jeanswear, and going-out occasions, together with the curated point of view on sexy, sophisticated, and social. One of the main competitive advantage of Express is its “Go to Market Strategy.” The objective is towards front end of the fashion lifecycle curve, but not cutting edge. This is accomplished with its New York City based design studio to work in partnership with merchants and search for domestic findings supplemented by frequent travel to leading international fashion centers, in addition to the nimble and diversified supply chain. Express also tests approximately 75% of units before ordering to limit fashion risk. Its successful strategy is to keep open to buy dollars in order to chase proven items and move quickly into hot trends.
In addition, Express began to test the outlet strategy. In May of 2014, Express has planed to open 17 outlet stores, of which 15 stores are conversions from the existing fleet of stores. By the end of 2014, Express anticipates to operate approximately 30 outlet stores. If the outlet strategy is profitable and provides benefit for Express to clear out inventories, Express can become less promotional and increase profit margins by selling more products at full retail prices.
In order to drive brand awareness, Express made partnership with Kate Upton, an iconic American celebrity, to be its Brand Ambassador. Furthermore, Express recently opened its flagship Time Square store with 9,000 square foot LED screen on top of its store. The LED screen helps Express to make plenty of advertising impression and raise the brand profile as tourists visit the most important New York City landmark, Time Square, and watch the LED screen advertising of Express.
For e-commerce, Express launched its website in July 2008. It has rapidly grown from 5% in 2009 to about 15% in 2013.
Source: Company Presentation
For international expansion, Express has already had 26 franchise stores oversea with a plan to open between three and six new franchise locations in 2014. Its main focus is in both Middle-East and Latin America. Currently, Express offers shipping to approximately 60 countries. The international shipping expands the reach to customers without incurring the big investment in brick and mortar stores.
Michael Weiss has been the CEO of Express since 2007. In November 2011, he was appointed Chairman of the Board. He has more than 20 years experience at several apparel firms, including Guess, Limited Brands, Ann Taylor, etc. He previously served as a director of Borders Group, Inc., Chicos FAS, Inc., Pacific Sunwear of California Inc., and Collective Brands, Inc. According to the latest proxy statement, Michael Weiss held 3.1% of Express outstanding shares. In addition, the entire executive team has on average of 13 years tenure at Express, which includes time as a division under Limited Brands.
In regards to financial health, Express has a pristine balance sheet with $312 million cash at the latest quarter, and the revolving credit facility remained untapped. The long-term debt is $199 million, almost unchanged from last year. The consistency and health of the balance sheet illustrate the great financial discipline of the management team.
Since Express has a healthy balance sheet, it is anticipated to refinance its 8.25% notes to less than 4% in 2015. The refinancing is forecasted to save Express about $10 million of potential interest. However, I expect that the interest saving will be offseted by the brand awareness effort, such as Kate Upton payment and high rent expenses in both New York and California landmark stores.
Source: Yahoo Finance
For all the relevant valuation methods, Express has the lowest and the most attractive values compared to its peers.
Based on Peter Lynch chart, Express have the potential to rise by 50% from today's $13.81 to $20.7. Another way to see the value of Express is through the DCF model in Gurufocus.com. Express's DCF value is $20.21 with 32% margin of safety.
From Free Cash Flow ("FCF") perspective, the average 5 year operating cash flow is $220 million. For capital expenditure, I take the mid point of 2014 guidance resulting in $112.5 milion. The FCF should be $107.5 million. With Express trading at $1.16 billion, the ratio of FCF/P is 10.7x.
With a defensible 10.7x FCF/P valuation, this gives investors great comfort by owning Express. As I wrote in my Datalink article, catching the pendulum swing is very profitable for patient investors. Based on Express historical P/E multiples, it can range from 10x to 15x. If Express can trade at 15x PE multiple in the future with the expected $1.33 EPS in 2015, Express will be valued at around $20 per share, providing 45% upside potential.
First, the retail industry is volatile, and the ongoing promotional pressure from peers can continue and adversely affect all retailers' profit margins, including Express. Second, forward estimates show steady-to-growth in FCF and rising net incomes, which could end up being aggressive as revenues and margins could decline. Third, the management team is instructmental to the success of Express. If Express loses key management members, its competitiveness will be adversely affected.
The bottom Line
It is undeniable that the retail industry has faced severe headwinds. But fortunately, with a pristine balance sheet and an attractive valuation, Express should be able to survive today’s brutal retail environment and offer favorable risk/reward profile. For investors having faith in Express future earning potential with growing e-commerce sales, international expansion, outlet strategy to boost margins, the shopping in the stock of Express should begin.
Disclosure: I am not a securities broker/dealer or an investment adviser. You are responsible for your own investment decisions. All information contained should be independently verified with the companies mentioned, and readers should always conduct their own research and due diligence and consider obtaining professional advice before making any investment decision.