A Brief Summary of the Businesses The purpose of this term paper is to discuss the similarities and differences between Talbots Inc. (“Talbots”) and Chico’s FAS Inc. (“Chico’s”). This paper will detail the nature of each company’s respective business, past financial performance, and expected future outlook. The paper is divided into two sections. The first section will discuss each company’s history, business structure, and future plans independently from each other. The second section will discuss several important financial ratios and provide a detailed analysis comparing the two companies.
By the end of this analysis, the reader will have a better understanding of these two retailers and the industry in which they operate. Chico’s is a specialty retailer of private label women’s merchandise, with fashion looks ranging from casual to dressy. The company also sells intimates, accessories and other non-clothing items. Chico’s began its operations in 1983 with its target market being women over 35 years old and of moderate to high level income households. The company designs the vast majority of its products in-house or through its independent vendors.
Chico’s has made small acquisitions of product lines and/or companies, including the White House / Black Market (“WHBM”) brand and Soma’s, as well as acquiring most of the assets of Fitigues which operated 784 retail stores in 47 states, the District of Columbia, the U. S. Virgin Islands and Puerto Rico. Over the past several years, Chico’s has continued to open new stores. Chico’s business strategy is focused on its private-label merchandise and the accessories it sells at a great, bargain value.
As of March 17, 2006, Chico’s operated 31 Chico’s brand outlet stores, eight WHBM brand outlet stores and one Fitigues brand outlet store. Currently, the distribution for all brands (except the Fitigues brand) is handled through Chico’s distribution center in Winder, Georgia. As of January 28, 2006, Chico’s had roughly 11,000 employees. In fiscal year 2005 (“FY 2005 “), Chico’s continued to see strong growth in its financial performance. Chico’s reported its ninth consecutive year of double-digit comparable same store sales increases, as well as record revenues, net income and its highest ever operating margin. They also elieve that the increase in comparable Company store net sales in the current fiscal year resulted from the continuing effort to focus Chico’s product development, merchandise planning and allocation, buying, technical design, and marketing departments on Chico’s’ target customers. In FY 2005, net income rose 37. 4% from $141 million to $194 million. Net sales increased for the FY 2005 by 31. 7%, to $1. 4 billion and operating income rose 33% to $298 million. The main drivers in the increase of net sales were catalogue orders and Internet orders for FY 2005, which increased by $9. 3 million, or 34. 7%, compared to FY 2004.
It is believed that this increase was primarily due to the increased circulation of catalogue mailings and additional television spots in FY 2005 compared to FY 2004. Comparable store sales for Chico’s owned stores increased 14. 3% year over year, primarily due to increased transactions compared to FY 2004. Chico’s believes that comparable store sales growth is critical in achieving its ability to manage their stores efficiently and continue future increases in financial performance. In other words, by increasing the transactions per store, while minimizing markdowns, and other miscellaneous costs, the same store sales will increase.
Besides their operating liabilities, Chico’s is virtually debt-free, while having cash and marketable securities of over $400 million. In FY 2005, Chico’s generated $268 million of cash flow from operations compared with $224 million in FY 2004, an increase of 20%. Strong cash flow is paramount to Chico’s’ future success. By efficiently managing its cash flows, Chico’s will help support its general operating needs and capital expenditure requirements while simultaneously increasing shareholder value (i. e. , increasing the present value of future cash flows).
In FY 2005, Chico’s brand strategy was re-focused by refining the business operations, and broadening the customer base. In FY 2005, Chico’s opened a total of 106 new stores, 57 Chico’s stores, 44 WHBM store, and five Soma’s stores. In addition to its new store openings, 36 stores increased their square footage, thus allowing them to have more merchandise readily available to the customer. Based on its current business strategy, Chico’s will continue improving their existing stores by increasing the square footage as additional selling space is needed.
In addition, the Chico’s loyalty club (also known as “Passport”) reached 1. 7 million “permanent” members with spending in excess of $500 by the end of FY 2005. As Chico’s moves into FY 2006, their goal remains unchanged: “to continue to create and grow strong branded concepts that target compelling niche markets and ultimately deliver predictable, sustainable growth to out shareholders . ” In FY 2006, Chico’s plans to open between 140 and 165 net new stores (as of January 2007, there are currently 920 total stores).
Talbots is a national specialty retailer and cataloguer of women’s, children’s and men’s classic apparel, accessories and shoes. Talbots operates stores in the United States, Canada and the United Kingdom. They offer many varieties of clothes, ranging from sportswear to casual wear and shoes. They also brand their own merchandise in misses and women’s petite sizes. Talbots merchandising strategy focuses on achieving a classic look, emphasizing different styles and quality. Talbots’ stores and catalogues offer the option to mix and match clothing with accessories, enabling the customer to complete their wardrobe.
Talbots has two reportable segments, including the retail segment and direct marketing segment (i. e. , the internet and catalogue sales). Each segment requires a different marketing and management strategy. The retail segments (based on television and printed advertisements) revenue is driven primarily by the in-store sales of women, children and men’s clothing and accessories. The direct marketing segments (based on online advertising and mailings) revenue is driven primarily by its approximately 25 catalogue mailings per year and online, via the website.
Talbots currently circulates 48 million catalogues per year. As of January 28, 2006, Talbots employed 11,600 people and operated a total of 1,082 stores (as compared to 1,049 stores in FY 2004). Based on Talbots filing of the 10-K, net sales in FY 2005 were $1,808,606 compared to $1,697,843 in FY 2004, an increase of 6. 5%. Operating income was $152,148 in FY 2005, compared to $142,115 in FY 2004, an increase of 7. 1%. Cash flow from operations was 12% of sales, or $211,438 for FY 2005, compared to $155,223 for FY 2004. Total revenues for the year rose 7% to approximately $1. billion. Comparable store sales also grew at a modest 2. 6%. Comparable store sales were positive in each of the first seven months of FY 2005, driven by a healthy sales performance across the U. S.. However, the catastrophes of Hurricane Katrina and Rita, led to a decrease in comparable store sales in September 2005 as Talbots had significant operations in the south (roughly 50 stores, from Louisiana to Alabama, up to Arkansas and Kentucky). Due to the natural disasters, Talbots needed to markdown its merchandise in order to clear out unsold inventory.
Another reason for the small comparable same store sales, year over year, was also due to the fact of more of the same styles, thus, resulting in fewer options to choose from for the customer, again resulting in markdowns. The final reason for the lower sales was due to Talbots releasing fall clothing in September, based on customer patterns, but the customers were not ready to buy such clothing at that time period. In other words, for this time period, Talbots did not have a good sense of product differentiation, as many of these styles weren’t “unique” or “unusual” to the general population.
Customers were not enthusiastic about the semi-annual sale either, and much of the summer inventory was also left unsold. Because of this, inventory was up 3. 4% in FY 2005 as compared to FY 2004. Talbots direct marketing business also increased at 9% to $265 million, driven by an impressive 28% increase in internet sales. Online sales accounted for roughly 42% of the total direct marketing sales, up from 36% in FY 2004. Besides record profits for the third consecutive year, Talbots set a record for Internet and catalogue order fulfilments.
Based on the company’s studies, 50% of customers who visit Talbots online are considered “window-shoppers,” who would then make their purchases at their local stores. Likewise, 67% of those who receive catalogues would also shop in the store within two weeks. Talbots has a credit “charge” card, except theirs does not go through a third party, as they have their own department who process orders and fulfil sales (also known as the Talbots Charge Card), to roughly 600,000 customers. The nature of the business tends to create two different distinct selling seasons; spring and fall.
During the spring season, direct marketing sales are stronger in the first quarter, while retail store sales become stronger in the second quarter. During the fall and winter seasons, both the retail stores and direct marketing have strong fourth quarters, as Christmas holiday season is the primary cause. The Company’s fourth quarter sales for the last two years were 26. 9% for FY 2005 and 27. 7% for FY 2004, of total sales for the year. The Company’s merchandising strategy focuses on liquidating seasonal inventory at the end of each selling season which historically happens at the end of the second and fourth quarters.
These markdowns usually lead to an increase in sales; however, since these are markdowns, this negatively impacts the company’s bottom line. Understanding the Businesses, based on Ratios and Financial Statements I will now start discussing the financials of both companies, based on the form 10-K filed with the SEC. A comparison of both companies will be performed from the perspective of financial ratios as well as benchmarking against the industry average for several of the ratios. The first ratio that I will discuss is the price earnings ratio, also known as the P/E ratio, as well as “price multiple” or “earnings multiple. The P/E ratio is calculated by the market price of the security in relation to the earnings per share of the security. The historic P/E ratio for Chico’s as of January 28th, 2006 was 39. 8, while the P/E ratio for Talbots during the same time was 16. 5. In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E, but this isn’t always the case. For Chico’s, an investor is willing to pay $39. 8 for $1 of current earnings while Talbots’ investors are willing to pay $16. 5 for $1 of current earnings.
I will now touch upon another very important ratio, the quality of inventory turnover analysis. As we are dealing and focusing on retail businesses, understanding this ratio is paramount to the industry, as this is the heart of the business. The inventory turnover is calculated by taking the cost of goods sold divided by the average inventory for the year. This ratio measures the efficiency of a company’s inventory management and should be compared against industry averages. A low turnover implies poor sales and therefore, excess inventory. A high ratio implies either strong sales or ineffective buying.
For FY 2005, Chico’s inventory turnover was 6. 5, while Talbots was 4. 8. Based on these numbers, we can see that Chico’s inventory moves more quickly through the production process to the ultimate sale to the customer, thus reducing storage and miscellaneous costs. Since 2001, inventory turnover has increased each year for Chico’s, while Talbots inventory turnover has decreased during the past year. Much of this has to do with the hurricanes during September, as well as incorrectly forecasting customer’s patterns of when they would buy products, thus resulting in price markdowns.
To note, the industry average inventory turnover is 4. 56. Gross profit margin (“GPM”) is also a very important measure for retailers. The GPM shows the relationship between sales revenue and cost of sales and indicates the portion each dollar of sales that contributes to the company’s profit. GPM is calculated as revenue minus cost of goods sold divided by revenue. Chico’s GPM was 61% in FY 2005, 61. 4% in FY 2004 and 60. 5% in FY 2003. The GPM for Talbots during the past three years was 36. 2% in FY 2005, 35. 6% in FY 2004 and 38. 3% in FY 2003.
Gross profit margin serves as the source for paying additional expenses and future savings. As with most retailers, they [i. e. the industry] are very fickle with fashion (i. e. wrong guess in style and design could ruin an entire season). This typically results in price markdowns. In this particular case, I feel that Talbots’ fluctuation between FY 2003 to FY 2005 could be based on the fact that they had bad styling and designs for the line of clothing and accessories, and the customers were not pleased. Another ratio I will discuss is the net profit margin (“NPM”) .
It is calculated as net income divided by net sales. Based on FY 2005 results, the NPM for Chico’s was 13. 8% while the NPM for Talbots was 5. 15%. What NPM truly shows is management’s effectiveness at controlling revenues and expenses to generate greater shareholder returns. Basically, it measures the portion of sales a company actually keeps in earnings. Since 2003, Chico’s NPM has steadily increased, while Talbots’ NPM has steadily decreased. The NPM since 2003 for Chico’s was 13. 24% in FY 2004 and 13. 04% in FY 2003. The NPM for Talbots over the same time span was 5. 2% in FY 2004 and 6. 44% in FY 2003. This may also be attributable to Talbots’ inefficiency to sell and market their products. I will now touch upon another very important ratio, the quality of income ratio (“QIR”). The QIR is calculated as cash flow from operating activities divided by net income. The QIR measures the portion of income that was generated in cash. With all things being equal, a higher QIR indicates greater ability to finance operating and other cash needs from operating cash flows. Any ratio [QIR] that is greater than 1:1 is considered “quality income. Based on FY 2005, Chico’s QIR was 1. 38:1, while Talbots was 2. 27:1. Based on the assumption that anything greater than 1:1 is “quality income,” both Chico’s and Talbots have quality income. The next two ratios are considered liquidity ratios . The first ratio that I will talk about is the working capital turnover. Working capital turnover is used as a means of comparing the depletion of working capital to the generation of sales over a given time period (i. e. money used to fund operations and the sales generated from these operations).
This provides some useful information as to how effectively a company is utilizing its working capital to generate sales. It is calculated by dividing sales by working capital . Based on FY 2005 results, the working capital turnover for Chico’s was 3. 38, while the working capital turnover for Talbots was 4. 81. In a general sense, the higher the working capital turnover, the better, because it means that the company is generating a lot of sales compared to the money it uses to fund the sales. The current ratio is also a term used frequently when discussing a company’s liquidity.
The current ratio measures a company’s ability to pay short-term obligations utilizing current assets. It is calculated by dividing current assets by current liabilities. It is also known as “liquidity ratio,” “cash asset ratio,” and “cash ratio. ” The higher the current ratio, the more capable the company is of paying its current obligations. The current ratio for Chico’s is 4. 39:1 and Talbots’ is 2. 54:1. Based on these ratios, it can be assumed that both companies do not have any issues paying off their obligations. Free cash flow (“FCF”) is an integral part of every company.
It is a measure of financial performance calculated as operating cash flow less capital expenditures and dividends. In other words, FCF represents the cash that a company is able to generate after expending the money required to maintain or expand its asset base. FCF is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it is difficult to develop new products, make acquisitions, pay dividends or reduce debt. Based on the calculations, the FCF for Chico’s is 120,771 and the FCF for Talbots is 113,420.
Debt to equity is yet another important term used when discussing companies. It is a measure of a company’s financial leverage calculated by dividing its total liabilities by stockholders’ equity (also can be calculated by long-term debt divided by stockholders’ equity). It indicates the portion of equity and debt the company is using to finance its assets. Chico’s debt to equity is 0. 24 (24%) while Talbots’ is 0. 83 (83%). In this case, both Chico’s as well as Talbots’ assets are primarily financed through equity.
In the same category as debt to equity, return on equity (“ROE”) is also a useful tool in measuring a corporation’s profitability. It reveals how much profit a company generates with the money shareholders have invested. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry. ROE is viewed as one of the most important financial ratios. ROE is equal to a fiscal year’s net income (after preferred stock dividends but before common stock dividends) divided by total equity (excluding preferred shares), expressed as a percentage.
Based on FY 2005 calculations, the ROE for Chico’s was 28. 4% and the ROE for Talbots was 15. 3%. Based on these calculations, it shows that Chico’s is more efficient at generating profits for every dollar of net assets, and to that extent, shows how well it uses investment dollars to generate earnings growth. Gross profit percentage (“GPP”) is another measurement used to analyze companies. It measures how much of every sales dollar is considered “gross profit. ” All things being equal, a high gross profit results in higher net income. For FY 2005, Chico’s GPP was 61%, while Talbots was 36. 2%.
Historically, the GPP for Chico’s was a bit higher than 61% (61. 4% in FY 2004 and 61. 3% in FY 2003). The decrease of 40 basis points over the last year resulted primarily from a decrease in merchandise margins from their outlet stores, as well as their investments into WHBM and Soma’s. Year over year, Talbots GPP increased from 35. 6% in FY 2004 to 36. 2% in FY 2005. The final ratio I will talk about is the total asset turnover (“TAT”). The TAT can be defined as sales (or operating) revenues divided by average total assets. In other words, the amount of sales generated for every dollar’s worth of assets.
Asset turnover measures a firm’s efficiency at using its assets in generating sales or revenue – the higher the number the better. It also indicates pricing strategy: companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover. Based on FY 2005 results, the TAT for Chico’s as well as Talbots was 1. 64. Regarding the common sized income statement, I will now express the ending fiscal year figures since for Chico’s as well as Talbots. CHICO’S To note, all percentages above represent their respective dollar amounts over net sales, with net sales being 100%.
For instance, the gross profit (net sales minus cost of goods sold) was $857,042. $857,042 divided by $1,404,575 is 61%. TALBOTS The same situation is expressed here. Net sales for the year were $1,808,606 (expressed in thousands). Hence, if cost of sales was 63. 8%, then the actual dollar amount was equivalent to $1,153,890. Thus the gross profit (not expressed above) is $654,872 (roughly 36. 2%). Every percentage is divided by the net sales to achieve the desired result (within reason). In conclusion, there is a lot to be said about these two companies and where they are going.
They are both highly motivated to produce the highest quality merchandise and they scale their merchandise to the mid-income families, more towards the women 35 and over. While one company was gaining ground versus their peers, the other was having an average year, but the negativity was centered on the hurricanes and bad judgement of when styles were in and when to have their sales. Much can be said about these companies, and where they are heading. Both CEO’s seem very upbeat and optimistic about the “market” as well as their expansion.
Both companies feel that their future success relies on the many different factors, and that uncertainties will occur. These potential risks and uncertainties include the financial strength of retailing in particular and the economy in general, the extent of financial difficulties that may be experienced by customers, the quality of merchandise received from vendors, the extent and nature of competition in the markets in which the companies operate, and the extent of the market demand and overall level of spending for women’s private label clothing and related accessories, to name a few.
Hopefully, after reading this analysis and comparison of Chico’s and Talbots, you were able to understand a bit more about the nature of their businesses and management strategies.
