NOTE TO READER: ALL NEW COMMENTS SINCE LAST REPORT HIGHLIGHTED
Overview
The business of Charlotte Russe Holding (CHIC) is expected to remain challenging in the coming quarters because of the turnaround at Rampage combined with deteriorating sales trends at Charlotte Russe. Although business remains challenging and sales in the month of January have been primarily clearance selling, the company is capable of adjusting its assortments relatively quickly due to its high inventory turnover / domestic sourcing structure. Most of the analysts have rated the stock as Neutral because they still see a challenging outlook with the repositioning of Rampage yet to take hold, weaker performance at Charlotte Russe, and more difficult comparisons in FQ2:05 (March) and FQ3:05 (June).
Positive and Neutral analysts are encouraged by: 1) the company's cash position which can be used to continue its expansion plans; 2) the potential for a Bohemian fashion trend resurgence, which fits in well with the CHIC merchandise mix; 3) the strength of the private label Refuge denim line; and 4) the initiative to improve presentation and top-bottom coordination throughout stores. However, the potential risks that CHIC faces include: 1) risk of having larger stores, which could cause productivity issues; 2) a very competitive market for the junior customer; and 3) fashion/merchandise assortment risks.
Charlotte Russe Holding, Inc. (CHIC), is a specialty apparel retailer. The company currently operates 368 stores (301 Charlotte Russe stores and 67 Rampage stores) across 39 states in the U.S. and Puerto Rico, under two mall-based retail chains: Charlotte Russe and Rampage. The company carries both branded and private-label merchandise and targets women in their teens and twenties. The retailer offers a broad assortment of fashionable, quality merchandise at prices lower than those charged by most other specialty, mall-based retailers. Charlotte Russe offerings include apparel, jewelry, handbags, cosmetics, and other merchandise that provide customers the luxury of one-stop shopping. The Rampage stores offer the latest in emerging fashion trends, while the Charlotte Russe merchandise reflects more established trends. The outlets also sell accessories, which complement CHIC’s high-end merchandise. Rampage targets higher price points than the Charlotte Russe stores.
Positive Factors /Negative Factors
·Rampage division has the potential to exploit a void in the marketplace for similar style merchandise to Arden, at a significantly lower price point. / ·1Q05 comps declined 9.9% -- its worst comp since FQ4 2003.·Charlotte has adopted several initiatives to drive sales growth. / ·Gross margin decreased by 363bps and SG&A ratio deteriorated by 188bps.
· A new GM (not yet hired) at the core Charlotte-Russe division may be able to improve the merchandising. / ·Increased competition may lead to higher markdowns, pressuring the company’s margins.
- / ·Merchandise improvement could be delayed beyond the spring season.
- / ·Though turnaround initiatives are yielding results, some analysts believe that sales are still below plan.
Of the ten analysts following this stock, three rate it positively, four are neutral on the stock, and the remaining one is negative. One analyst has not rated the stock.
Sales
Fiscal year ends September 30, 2005($ in million) / 4Q04A / FY04A / 1Q05A / 2Q05E / 3Q05E /4Q05E
/ FY05EDigest High / 138.3 / 539.4 / 150.0 / 141 / 150 / 178 / 620
Digest Low / 138.3 / 539.4 / 150.0 / 123 / 144 / 156 / 579
Digest Average / 138.3 / 539.4 / 150.0 / 128 / 148 / 161 / 587
Zacks Consensus / 138.3 / 539.4 / 150.0 / 129 / 149 / - / 606
One analyst (B.Riley) believes that going forward, Rampage (one of the divisions of CHIC) has the potential to exploit a void in the marketplace for similar style merchandise to Arden, at a significantly lower price point. The company has effectively rewritten most of its orders for spring merchandise and has made efforts to correct the processes that failed in 1Q05. Looking forward, they noted that there is currently a resurgence of ‘bohemian’ styles, which has historically been a strong fashion trend for the company to exploit.
One analyst (Pacific Growth) believes that without a GMM in place at Charlotte Russe and the departure of consultant Kathy Bronstein after only a few weeks, merchandise improvement could be delayed beyond the spring season.
Analysts believe that the new pricing strategy of expanding the price range, which will have no impact
on net average unit retail, but will offer a greater variety of product and price points to customers, will enhance the sales volumes in the coming periods. The range of prices has generally been quite narrow with roughly 4 price points (particularly in tops), but will now offer about 7 to 8 price points.
1Q05 total sales were $150mn with same-store sales declining 9.9% -- its worst comp since FQ4 2003. Comps at the Charlotte Russe turned negative in November and December after posting positive comps since January 2004. Management attributes the sales shortfall to a merchandise miss in knit tops and bottoms, and woven skirts. Sweaters were also a disappointment, but were related to late receipts. Rampage continues to struggle to reposition itself and comps were down mid-20's. Average unit retail declined 5.0%, while units per transaction increased 3.0%. Transactions per store were down 8.0%.
Margin
Analysts believe that the 2Q05 gross margin will decline by 160bps to 19.4% from 21% in the same period last year because of the slowdown in sales momentum and the challenges persisting at Rampage. They also believe that 2Q05 SG&A ratio will deteriorate by 110bps to 22.4% from 21.3%y-o-y.
1Q05 gross margin decreased to 22.6% from 26.2% in the same period last year. Of this 363bps drop, the product level component declined by 58bps, as slightly higher initial markups were more than offset by higher markdowns. The rest is attributable to store occupancy expense, which rose over 3% as a percent of sales.
1Q05 SG&A expenses were $31.3 million compared to $28.4 million for the same period of the prior year. The 188bps increase in SG&A was due to store payroll as well as higher supplies and other expenses. Total inventories were at $37.9 million at the end of the 1Q05, compared to $34.2 million in the same quarter last year. Store inventories were down 3% at the end of the quarter compared to the end of 4Q04, and strong selling since quarter end has brought this metric down further.
1Q05 operating income decreased to $2.6 million compared to $10.8 million for the same quarter last year. Operating margin for the quarter was 1.7% of net sales compared to 7.2% of net sales for thesame quarter last year. The difference in operating income can be attributed to both lower gross margins and higher SG&A.
Earnings Per Share
Fiscal year ends September 30, 2005 (In $) / 4Q04A / FY04A / 1Q05A / 2Q05E / 3Q05E /4Q05E
/ FY05EDigest High / 0.13 / 0.64 / 0.07 / (0.08) / 0.24 / 0.29 / 0.52
Digest Low / 0.13 / 0.64 / 0.07 / (0.11) / 0.16 / 0.16 / 0.30
Digest Average / 0.13 / 0.64 / 0.07 / (0.10) / 0.20 / 0.21 / 0.40
Zacks Consensus / 0.13 / 0.64 / 0.07 / (0.09) / 0.21 / - / 0.40
The company gave earnings guidance for Q2 2005 in a range of a loss of $0.07 to a loss of $0.11. This guidance is below the current consensus estimate of a loss of $0.04. 1Q05 EPS of $0.07 was a bit short of Street expectations of $0.08, but at the low end of the $0.07-0.11 guidance.
Majority of the analysts have reduced their FY05 and FY06 EPS estimates to primarily reflect: 1) Negative low single digit comps, 2) Softer than expected Q1 results & a reduction in store openings, and 3) Disappointing earnings and challenging business.
Target Price/Valuation
Of the ten analysts following this stock, three rate it positively, four are neutral on the stock, and the remaining one is negative. One analyst (SG Cowen) has not rated the stock. The highest target price assigned is $14 (B.Riley & Co. – Buy) while the lowest one is $6.5 (Wachovia - Underperform). The average target price assigned by the positive analysts is $13.0. Most analysts have computed the respective target price by applying P/E multiple to forward EPS estimates. Multiple ranges from 14x to 20x. The analyst with the lowest target price (Wachovia) has valued it by using ‘14-16 x CY 05 EPS of $.0.44’, while that with the highest target (B.Riley & Co.) has used ‘18x FY2006 EPS estimate of $0.67’ to value the stock. One analyst (Banc of America) has raised the target price, while another analyst (Wedbush) has lowered the same.
Long-Term Growth
The company opened eight stores in the quarter and ended Q1 with 368 stores including 301Charlotte Russe stores and 67 Rampage stores. Total gross square footage at the end of the fiscal quarter was 2,584,000 square feet. The company expects to open up to 50 new stores during the fiscal year ending in September 2005. Of the remaining 42 stores to be opened in Q2 through Q4, only one will be a Rampage store. Capital expenditures were $6 million in the quarter with $25-$29 million expected for all of 2005.
One analyst (Deutsche Bank) believes that if business trends do not turn to a sustainable positive level, there will be a further square footage growth reduction in subsequent years.
Individual Analyst Opinions
POSITIVE RATINGS
B.Riley & Co. - Report Date: January 21, 2005 – Buy ($14) - “The core CHIC business suffered primarily from a weak merchandise assortment. Based on normalized EPS, particularly excluding the losses from Rampage, the valuation remains compelling in our opinion. We believe the prospects for a turnaround are favorable and we reiterate our “Buy” rating.”
Piper Jaffray – Report Date: January 21, 2005 – Outperform ($12) - The analyst has maintained their Outperform rating because they believe that a turnaround is under way on the basis of near-term earnings growth potential of the company.
Suntrust RH – Report Date: January 20, 2005 –Buy ($13) - “Despite the possibility of three more quarters of poor fundamentals and EPS estimate reductions, we are maintaining our Buy rating. We believe a new merchant (not hired yet) at the core Charlotte-Russe division will be able to improve
the merchandising, particularly given the multi-year decline in the sales base. In addition, we expect continued improvement in merchandising in the Rampage division where management is trying to return Rampage to its historical merchandising strategy.”
NEUTRAL RATINGS
Banc of America – Report Date: January 21, 2005 – Neutral ($9) - “Improvement that has been slower to materialize than we had originally anticipated and a key management vacancy, which clouds the timing of any stabilization, are the basis for our Neutral rating.”
Pacific Growth Equities – Report Date: January 21, 2005 – Equal Weight – “We believe there is significant value in the Charlotte Russe brand, despite the slowdown in sales momentum. We anticipate
renewed sales momentum in the 2H of CY05. Nonetheless, CHIC faces difficult SSS comps in the coming quarters.”
Wedbush – Report Date: January 21, 2005 – Hold ($8.5) The analyst has rated the stock as Hold because of weak 1Q05 results. In addition, they are skeptical about the turn-around at the two divisions of CHIC.
WR Hambrecht – Report Date: January 20, 2005 – Hold – “We still see a challenging outlook with the repositioning of Rampage yet to take hold, weaker performance at Charlotte Russe, and more difficult comparisons in FQ2:05 (March) and FQ3:05 (June). Given these issues we remain on the sidelines with our Hold rating.”
NEGATIVE RATINGS
Deutsche Bank – Report date: January 20, 2005 – Sell ($7) The analyst has maintained their Sell rating because they noted that weak business trends are offset by the fact that earnings estimates have already cone down significantly.
Wachovia – Report Date: January 20, 2005 – Underperform ($6-$7) “Management now has issues to fix at both of its concepts. We were expecting Rampage to remain difficult, but now Charlotte Russe is running negative comps – first time since January 2004. The slowdown at Charlotte Russe is attributed to some major merchandise misses for holiday, which management believes can be fixed by spring.”
NOT RATED
SG Cowen – Report date: January 21, 2005 – “We are maintaining our cautious view regarding the CHIC business as a result of the persistence of challenging business trends driven by merchandise misses at the core Charlotte Russe division, and ongoing difficulties surrounding the repositioning of Rampage.”