Women’s apparel and accessories retailer Chico’s FAS (NYSE:CHS) fell short of analysts' expectations in Q2 FY2023, with revenue down 2.43% year on year to $545.1 million. Chico's made a GAAP profit of $59.3 million, improving from its profit of $42 million in the same quarter last year.
Chico's (CHS) Q2 FY2023 Highlights:
- Revenue: $545.1 million vs analyst estimates of $554.9 million (1.76% miss)
- Revenue Guidance for Q3 2023 is $515 million at the midpoint, below analyst estimates of $524.6 million
- The company dropped its revenue guidance for the full year from $2.19 billion to $2.16 billion at the midpoint, a 1.37% decrease
- Free Cash Flow of $19.8 million, down 71.2% from the same quarter last year
- Gross Margin (GAAP): 39.8%, down from 41.4% in the same quarter last year
- Same-Store Sales were down 3% year on year (miss vs. expectations of down 0.3% year on year)
With a style that ranges from casual to dressy, Chico’s FAS (NYSE:CHS) is a women’s apparel and accessories retailer that operates multiple brands.
The company operates under the Chico's, White House Black Market, and Soma brands, each of which exclusively sells that brand in its stores. Chico's offers everything from casual distressed jeans to sophisticated resort wear. White House Black Market offers an elevated aesthetic, including workwear and special occasion dresses, mostly in black and white hues. Soma offers comfortable yet stylish lingerie, sleepwear, and loungewear.
The core Chico’s customer across its brands is a woman aged 35 or over who values a retailer who can offer a broad spectrum of age-appropriate yet fashionable clothing. Each brand is mid-tier in its pricing, meaning that it’s perfect for the middle-income shopper. Sales and promotions further entice this shopper, who likes a good deal.
Chico's stores are typically around 4,000 square feet and located in malls and shopping centers alongside other mid-tier and mass retailers. In most stores, clothing is arranged by type and color, with tables and racks featuring coordinated outfits and accessories. There are often displays featuring new arrivals or seasonal collections. In addition to the physical store footprint, Chico's has an e-commerce platform, which was launched relatively early in 1999.
Apparel sales are not driven so much by personal need but by seasons, trends, and innovation, and over the last few decades, the category has shifted meaningfully online. Retailers that once only had brick-and-mortar stores are responding with omnichannel presences. The online shopping experience continues to improve and retail foot traffic in places like shopping malls continues to stall, so the evolution of clothing sellers marches on.
Retail competitors offering mid-tier women’s apparel and accessories include department stores such as Macy’s (NYSE:M) and Kohl’s (NYSE:KSS) as well as off-price concepts such as TJX (NYSE:TJX) and Ross Stores (NASDAQ:ROST).Sales Growth
Chico's is a small retailer, which sometimes brings disadvantages compared to larger competitors that benefit from economies of scale.
As you can see below, the company's annualized revenue growth rate over the last four years (we compare to 2019 to normalize for COVID-19 impacts) was flat, or 0.86% as its store count dropped, signaling that growth was driven by more sales at existing, established stores.
This quarter, Chico's reported a rather uninspiring 2.43% year-on-year revenue decline, missing analysts' expectations. The company is guiding for a 0.64% year-on-year revenue decline next quarter to $515 million, a reversal from the 14.3% year-on-year increase it recorded in the same quarter last year. Looking ahead, the analysts covering the company expect sales to grow 2.67% over the next 12 months.
Number of Stores
When a retailer like Chico's is shuttering stores, it usually means that brick-and-mortar demand is less than supply, and the company is responding by closing underperforming locations and possibly shifting sales online. As of the most recently reported quarter, Chico's operated 1,258 total retail locations, in line with its store count a year ago.
Taking a step back, the company has generally closed its stores over the last two years, averaging a 1.34% annual decline in its physical footprint. A smaller store base means that the company must rely on higher foot traffic and sales per customer at its remaining stores as well as e-commerce sales to fuel revenue growth.
Same-Store Sales
Same-store sales growth is a key performance indicator used to measure organic growth and demand for retailers.
Chico's demand has been spectacular for a consumer retail business over the last eight quarters. On average, the company has increased its same-store sales by an impressive 22.9% year on year. Given its declining store count over the same period, this performance could stem from higher e-commerce sales or increased foot traffic at existing stores, which is sometimes a side effect of reducing the total number of stores.
In the latest quarter, Chico's same-store sales fell 3% year on year. This decline was a reversal from the 19.5% year-on-year increase it posted 12 months ago. A one quarter hiccup isn't material for the long-term prospects of a business, but we'll keep a close eye on the company.
Gross Margin & Pricing Power
We prefer higher gross margins because they not only make it easier to generate more operating profits but also generally indicate product differentiation, negotiating leverage, and pricing power.
As you can see below, Chico's has averaged a healthy 39.2% gross margin over the last two years. This means the company makes $0.39 for every $1 in revenue before accounting for its operating expenses. 
Chico's produced a 39.8% gross profit margin in Q2, marking a 1.6 percentage point decrease from 41.4% in the same quarter last year. One quarter of margin contraction shouldn't worry investors as a retailers' gross margins can often change due to factors such as product discounting and dynamic input costs (think distribution and freight expenses to move goods).
Operating Margin
Operating margin is a key profitability metric for retailers because it accounts for all expenses that keep the lights on, including wages, rent, advertising, and other administrative costs.
This quarter, Chico's generated an operating profit margin of 8.54%, down 1.9 percentage points year on year. We can infer that Chico's was less efficient with its expenses or had lower leverage on its fixed costs because its operating margin decreased more than its gross margin.
From an operational perspective, Chico's was profitable but held back because of its expense base over the last two years. The company has produced an average operating margin of 6.76%, mediocre for a consumer retail business. However, Chico's margin has remained more or less the same, highlighting the consistency of its business.EPS
These days, some companies issue new shares like there's no tomorrow. That's why we like to track earnings per share (EPS) because it accounts for shareholder dilution and share buybacks.
In Q2, Chico's reported EPS at $0.49, up from $0.34 in the same quarter a year ago.
Between FY2020 and FY2023, Chico's adjusted diluted EPS flipped from negative to positive. These results show that the company is headed in the right direction as profitability is vital for success in the challenged consumer retail sector.
Cash Is King
Although earnings are undoubtedly valuable for assessing company performance, we believe cash is king because you can't use accounting profits to pay the bills.
Chico's free cash flow came in at $19.8 million in Q2, down 71.2% year on year. This result represents a 3.63% margin, 8.6 percentage points lower than its free cash flow margin in the same period last year.
Over the last two years, Chico's has shown decent cash profitability, giving it adequate opportunity to invest organically into its business, pay down debt, or return capital to shareholders. The company's free cash flow margin has averaged 3.93%, slightly better than the broader consumer retail sector. Furthermore, its margin has been flat, showing that the company's cash flows are relatively stable.
Return on Invested Capital (ROIC)
Chico's subpar returns on capital may signal a need for future capital raising or borrowing to fund growth. Its five-year average return on invested capital (ROIC) is 3.94%, somewhat low compared to the best retail companies that consistently pump out 25%+ returns.
We argue ROIC is one of the most important indicators of quality because it tells us how much return (profit) a company makes on the money it invests into its business, shedding light on its prospects and its management team's decision-making prowess. ROIC is also a helpful tool to benchmark performance versus peers, and just like how we focus on long-term investment returns, we care more about a company's long-term ROIC because short-term market volatility can distort results.
Key Takeaways from Chico's Q2 Results
Sporting a market capitalization of $632.1 million, Chico's is among smaller companies, but its more than $150.7 million in cash on hand and positive free cash flow over the last 12 months puts it in an attractive position to invest in growth.
Overall, this was a mediocre quarter for Chico's. The company missed Wall Street analysts' expectations for same-store sales and revenue. However, adjusted EPS beat slightly. The major negative was that the company reduced its full year revenue and EPS guidance. Next quarter's revenue and EPS guidance are also below expectations. The stock is up 2.54% after reporting and currently trades at $5.25 per share, perhaps reflecting low expectations going into the earnings report.
Is Now The Time?
When considering an investment in Chico's, investors should take into account its valuation and business qualities as well as what happened in the latest quarter. We cheer for everyone who's improving the lives of others but in the case of Chico's, we'll be cheering from the sidelines. Its revenue growth has been uninspiring, but at least that growth rate is expected to increase in the short term. And while its wonderful same-store sales growth has been among the best in the consumer retail sector, the downside is that its relatively low ROIC suggests suboptimal profitability prospects and its decline in physical locations suggests that its demand is shrinking.
While it's trading at a reasonable price and we've no doubt one can find things to like about Chico's, at the moment, we think there might be better opportunities in the market.
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