My second investment

After reading FRAN‘s quarterly and annual reports (please see my previous post) in early October, I made a few calculations in Excel to help me value the company:

5 year average

In the table above, we can see several Pros:

  1. Sales grew every year at about 13% per year;
  2. Equity also grew at 13% since 2012, and could have grown faster if the company was not spending most of the cash it generates to buy its own stock. Equity decreased slightly in 2016 due to increased share repurchases;
  3. Shares outstanding have decreased from 44.81m in 2012 to 38.55m in 2016 (and currently stand at 36.47m, as per the latest quarterly report), with the company repurchasing an average of 3.7% of its own shares every year since 2012;
  4. Operating cashflow increased every year since 2013 at about 13%;
  5. Capital expenditures remained stable at about $24m per year from 2012 to 2016;
  6. Because of the two points above, free cash flow doubled since 2013, increasing 25% per year on average since, but only at 10.8% per year if we include 2012 in the calculation.

The main Cons are:

  1. Net income decreased heavily from 2012 to 2014, from $47.06m to $32.11m (taking a 28% hit from 2013 to 2014), but growing to $42m in 2016 (a 14.37% yearly growth rate from 2014 to 2016);
  2. Operating cashflow will be impacted this year due to the Hurricane Harvey effect, investment in new and existing boutiques, and the implementation of a new POS and CRM system. I can’t know the exact figure, but I’m estimating that it will decrease about $20m due to these challenges, standing at around $50.5m at year end 2017;
  3. The company says that capital expenditures will be $28m-$33m this year, way above the average $24m for the last five years. For my 2017 capex estimate, I’m using the average of the first two figures, at $30.5m;
  4. If the two paragraphs above turn out to be correct, this means that 2017 free cashflow will be about $20m, a 60% decrease compared to 2016 (and probably why the share price has been hammered this year).

2017 will be a period of abnormally low earnings, so I don’t want to base my valuation solely on this year’s earnings. During 2016, FRAN’s share price traded between $10.11 and $21.19, according to Google Finance. 2016 earnings per share was $1.09, giving me PE multiples between 9.3 and 19.4 during last year.

To value FRAN on a long term basis, I would prefer using a PE multiple of 13x, which I consider conservative and appropriate, since it matches the growth in sales and equity for the last five years. Applying this multiple to the five year average net income of $40.8m gives me a valuation of about $530m, more than double the current market capitalisation.

According to the latest quarterly report, there were 36.47m shares outstanding. Dividing $530m by 36.47m gives me a value of about $14.50 per share (which will probably get higher by the end of next year, since the company keeps repurchasing its shares).

Seeing all this, I decided to invest.

TD Order

At the time I was valuing FRAN, the shares were trading at $7.50, which was a discount of about 48% to my valuation of $14.50 per share. I chose to commit about a quarter of the funds available in my ISA, and bought 100 shares at $7.50 on October 6 (I know it was almost a month ago, but life gets in the way), investing $750. At the exchange rate that day, that meant paying £583.56 for the shares, plus £12.50 in commission (2.14% of the investment value!), for a total investment of £596.06.

Since October 6 the share price has decreased to $6.47, and FRAN now has a market capitalisation of about $237.67m, giving me a $119.07 loss (my book cost is $766.07 and the current market value is $647), which is a 15.54% decrease from when I first invested in the company. Whoever buys now has a potential upside of about 125%.

I’m hoping the shares go down to $5 before they start to recover. At that price I’ll commit another quarter of my ISA and buy 150 more shares.

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