Sunday, November 26, 2006

Chico's FAS (CHS) Analysis

We have looked at CHS before. CHS is a specialty clothes retailer - specializing in womens clothes.

Chico’s FAS, Inc. operates as a retailer of private label, casual-to-dressy clothing, intimates, complementary accessories, and other nonclothing gift items. The company offers its products under the Chico’s, White HouseBlack Market (WHBM), Soma by Chico’s, and Fitigues brand names. The Chico’s brand includes clothing focused on women who are 35 years old and over.

At that time - we found a risk for P/E contraction.

From a strict earnings point of view, the earnings per share are expected to increase by 25% year over year. However, the P/E of the stock is close to 40 - so there is definitely some mismatch here. For the first thirty nine weeks of 2005, the earnings grew by ~38% compared to 2004 and sales by 31%. The share dilution increased by 1.1% year over year. The analysts are expecting 1.34 per share in 2007 where as the expected earnings this year is 1.07 a share. The growth rate is 25% for the next year. Although the stock risk dilution is minimal, there is the risk of P/E contraction which in turn poses a risk to the stock price.

Since then, the stock has had a P/E contraction. A word from Ben Graham from intelligent investor may be mentioned in this context.

"The philosophy of investment in growth stocks parallels in part and in part contravenes the margin of safety principle. The growth-stock buyer relies on an expected earning power that is greater than the average shown in the past. Thus he may be said to substitute these expected earnings for the past record in calculating his margin of safety. In investment theory there is no reason why carefully estimated future earnings should be a less reliable guide than the bare record of the past; in fact, security analysis is coming more and more to prefer a competently executed evaluation of the future. Thus the growth-stock approach may supply as dependable a margin of safety as is found in the ordinary investment - provided the calculation of the future in conservatively made, and provided it shows a satisfactory margin in relation to the price paid"

The company is managed well - with ROE of 28.8% and ROA of 22.91%. The EPS has increased an average of 25% in the past five years. However, it is likely that the EPS growth will be far lower in the next five or ten years. Consequently the P/E has compressed to a more reasonable 20 from a more lofty 40.

The cash flow from operations have increased year over year for the past several years. However, the free cash flow has declined this year because of the increasing capital expenditure. The analysts estimate for growth next year is about 17% compared to this year but the median estimate of the stock price is around $25. If the earnings grow by the estimated amount and the stock price stays put, it should present a good buying opportunity with a good margin of safety.

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