Express: The Long Thesis Looks Intact – Express, Inc. (NYSE:EXPR) No ratings yet.

Shares of Express (EXPR) have been incredibly volatile over the past few months, with shares dropping a whopping 38% since I became bullish on the name in the middle of May in spite of relatively limited news flow. Much of the fall has been a function of broader market weakness and increased anxiety related to the rise of trade hostilities between the United States and China.

In the interim, Express appointed Tim Baxter CEO, and he’s built out a new management team to lead the next stage of the Express lifecycle. Additionally, the company reported Q2 results that were slightly better than expected, and the balance sheet remains in pristine shape, though the company’s inventory remains slightly elevated. Let’s take a look at Q2 results, the new management team and strategy, which will explain why I remain bullish on the company.

Q2 Results: Not Strong, but In-line with Expectations

Q2 results weren’t great with comp sales down 6% on top of a 1% increase in Q2’18, moving the two-year stacked comp to -5%. Total sales declined 4% y/y to $473 million with gross margin down 160 basis points y/y to 26.8% with 60 basis points due to merchandise margin declining and 100 basis points of sales and occupancy deleverage. Both of these margin issues will be alleviated with improved merchandising, and I am not particularly concerned about the long-term trajectory of gross margin if Express materially improves its merchandise selection.

SG&A expenses increased 80 basis points y/y to 28.7% of sales, though actual expenses fell by $2 million. Management continues to message that additional cost reduction opportunities exist, and I think continued focus on bottoms-up cost analysis will allow the company to capture additional cost savings in spite of upward wage pressure.

Overall, the company lost about $9.8 million before taxes in Q2. More importantly, cash flow burn over the past six months has been relatively subdued, with negative free cash flow of just $10.4 million year-to-date, as Express’ high deprecation charges continue to mask cash earnings. Importantly, management reduced its capex guidance for FY19 to $35 to $38 million from $37 to $42 million that was forecasted earlier.

Express’ balance sheet also remains in wonderful condition. The company ended the quarter with $154 million in cash versus no long-term debt. While Express has long-term lease liabilities of nearly $1 billion, 60% of stores have a lease action date in the next three years, so that number will decline substantially in the next few years, while also providing Express the flexibility to exit leases without facing harsh financial penalties.

On top of a strong cash balance, Express continues to work to reduce its inventory position. Inventory was down roughly 1% y/y, and though not in great shape, inventory growth appears to be coming closer to matching sales growth.

Considering both P&L and balance sheet performance, Express looks to be mostly in adequate shape financially. While sales figures have been disappointing, Express’ ample liquidity provides time for the company to drive a turnaround.

Enter Tim Baxter and New Key Managers to Drive a New Strategy

Tim Baxter took the rains in the middle of June, so he is only about 60 days into his tenure as CEO. As I noted in my prior article, Baxter brings with him considerable experience from running Macy’s (M) e-commerce business and serving as a chief merchandising officer before leaving to become CEO of Delta Galil’s premium brands, which owned such brands as 7 for All Mankind and Splendid.

Baxter did a wonderful job on his inaugural earnings call, in my view. In short order, he walked through a few key management appointments as well as the four pillars that he believes will help revive Express.

From a talent perspective, Express added a new Chief Merchandising Officer as well as a new Chief Marketing Officer.

Malissa Akay takes over the role of Chief Merchandising Officer with considerable experience across the retail spectrum, serving in various merchandising roles at LVMH (MC) as well as reaching Chief Merchandising Officer at Ralph Lauren (RL) and mostly recently, Lane Bryant. Akay undoubtedly owns an impressive resume, and I will be interested to see how Express’ merchandising strategy evolves.

Sara Tervo will take the reigns as Chief Marketing Officer after spending a considerable time at L Brands ‘(LB) Victoria’s Secret and most recently serving as Chief Marketing Officer of tween retailer Justice. Tervo will certainly bring a different perspective to Express, and perhaps her experience with younger customers will inform a differentiated marketing strategy.

With a few key management changes on the books, Baxter started to focus on what he views as Express’ four key pillars for success. Product was the first area Baxter called out, noting that Express had a few key misses that hurt its positioning as a fashion authority. I thought Baxter’s insight into misses in Women’s Tops and a lack of fashion diversity as key issues. I completely agree, and I think the Express look, particularly in Women’s, is in dire need of a refresh.

Secondly, Baxter called out brand as a key pillar going forward. I believe the Express brand recognition remains robust, though without question, I agree with Baxter that the company needs to improve its storytelling.

The third pillar of Baxter’s strategy involves customer. Express needs to do a better job of converting its well-known brand into brand loyalty, and it looks like the company is focused on changing the way it interacts with customers. I expect continued investment into digital and a better mapping of the customer experience to be key drivers going forward.

Lastly, Baxter noted that execution is important. In my view, this goes without saying. Any company can have a great plan, but plans are worthless if employees don’t act upon them. We will see if Express is able to drive accountability that helps drive results. Execution shows up in the P&L, and ultimately, it will be Baxter’s most important scorecard.

Overall, I think Baxter demonstrated an excellent understanding of Express’ issues, which mostly come down to stale merchandise and a need to improve marketing. If Express executes on these pillars, I believe we could be in the early innings of a turnaround.

Why I’m Still Bullish

Overall, I think the situation has marginally improved for Express. There is a new management team in place, the company expects to post positive free cash flow in FY19, and the balance sheet remains in solid condition. Shares continue to look undervalued, and I think the company could be worth $7-12 per share. Only time will tell, but at the current moment, Express’ price reflects a perpetual mid-single digit comp decline, while I believe shares the company will be able to return to flat-to-low single digit comp growth within the next two years.

Disclosure: I am/we are long EXPR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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