Express, Inc. (NYSE:EXPR) Memo

Important  Company  Financial  Data  

 Thesis  /  Key  Points  

Ø Inability  to  sufficiently  attract  target  demographic  o Target  customers  are  much  more  likely  to  shop  at  competing  stores.  In  a  survey  completed  by  84  people,  only  30.95%  of  

respondents  would  consider  Express  for  professional  apparel   (behind  H&M,  Forever  21,  and  Zara).  The  survey  also  found  that   only   13.25%   of   respondents   would   consider   Express   for   casual/going   out   apparel   (behind   six   other   stores:   H&M,  Forever  21,  Urban  Outfitters,  Zara,  Asos,  and  J.  Crew).  At  face  value,  these  results  could  be  considered  deceiving  because  the   results  do  not   truly   reflect  Express’s  declared   target  market   (respondents   ranged   from  age  18-­‐49).   In  EXPR’s  10K   for  FY2012  they  state:  “We  are  part  of  the  specialty  apparel  market  focusing  on  20  to  30  year  old  women  and  men.  We  believe  the   specialty  apparel  market   is  a   significant  piece  of   the   total  apparel  market   for   this  demographic  and   that   the  Express  brand  appeals  to  a  particularly  attractive  subset  of  this  group,  who  we  believe  spend  a  higher  percentage  of  their  budget  on  fashion  compared  to  the  broader  population.”  After  taking  these  conditions  into  account,  of  the  respondents  aged  21-­‐29  who   spent   21-­‐50%   (37%   of   total   participants)   only   22.48%   visit   Express   for   professional   apparel   (behind  H&M,   Zara,  Forever   21,   J.   Crew,   and   Banana   Republic).   Taking   those   same   conditions   into   account,   only   10%   of   respondents   visit  express  for  casual/going  out  clothes  (behind  nine  stores:  H&M,  Forever  21,  Urban  Outfitters,  Zara,  Asos,  Topshop,  Guess,  and  J.  Crew).    

o Inventory   composition   does   not   exploit   competitive   advantage.  Although   the   survey   shows   a   general   apathy   towards  EXPR  for  casual/going  out  clothes,  it  does  show  that  EXPR  has  a  slight  competitive  advantage  among  shoppers  looking  for  professional  clothing.  However,  EXPR’s  inventory  does  not  take  advantage  of  these  consumer  preferences.  In  a  survey  of  15  stores   around   the   country,   I   asked   employees   what   proportion   of   their   inventory   was   dedicated   towards   professional  apparel   vs.   causal/going   out   apparel.   After   surveying   15   stores,   the   average   inventory   composition   for   women’s  merchandise   was   36.7%   for   professional   clothing   vs.   64.3%   for   casual/going   out   clothing.   The   average   inventory  composition  for  men’s  merchandise  showed  a  slightly  better  focus  on  professional  apparel:  45.7%  for  professional  clothing  vs.  54.3%  for  casual/going  out  clothing.  This  is  very  problematic  because  it  exposes  EXPR  to  unnecessary  fashion  risk  within  the   causal/going   out   space.   EXPR   has   positioned   them   at   a   disadvantage   as   lower-­‐cost   fast-­‐fashion   brands   like   H&M,  Forever  21,  and  Zara  offer  consumers  fashion  sensitive  merchandise  at  a  greater  value.    

o Traffic   is  driven   from  promotions  not   inventory.  “We  have  sales  all   the   time.  Usually  we’ll  have  a  big  one  at   the  end  of  each  quarter,  but  we  still  have  ongoing  promotions  throughout  each  season.  Like  right  now,  in  terms  of  menswear,  we  have  buy   one   t-­‐shirt   get   the   other   one   for   $9.99,   shorts   40%  off,   and   a   bunch  of   other   discounted  merchandise   on   both   the  men’s   and   women’s   sides.   Which   is   pretty   typical,   I   can’t   really   remember   a   time   when   there   wasn’t   some   sort   of  promotion   going  on.”  Manager   at   Express,   Charlottesville,  Virginia.     This   is   inline  with  what  was   reported  during   the  Q4  earnings   call:   “merchandise   margin   declined   170   basis   points,   reflecting   the   promotional   competitiveness   in   the  marketplace  during  the  quarter.”  

Ø Inability  to  compete  with  the  fast-­‐fashion  model  and  online  competitors  o Longer   lead   times  manifest   into   dated   inventory.   The   fast-­‐fashion  model   was   first   pioneered   by   the   Spanish   company  

Inditex  (parent  of  Zara)  as  a  way  to  quickly  respond  to  market  demands,  and  has  since  been  adopted  by  other  companies  like  Forever  21  and  H&M.  Inditex  policy  states  that  “production  shall  be  adapted  to  customer  demand…production  will  be  able   to   focus  on   trend  changes  happening   inside  each  season.”  This   is  achieved  by  placing  company  designers   in   fashion  hubs   (think  Milan   and   New   York)   where   they   attend   runway   shows   and   tailor   their   designs   to  match   emerging   trends.  Inditex   then   utilizes   a   vertically   integrated   supply   chain   by   sending   designs   to   be   manufactured   at   company-­‐owned  production  facilities  in  places  like  “China,  India,  Morocco,  Turkey,  Germany,  Italy…where  these  subsidiaries  dye,  print,  mark,  and  cut  fabrics  following  patterns  set  by  designers.  Once  cut  and  processed,  fabric  is  contracted  out,  mostly  to  a  network  of  over   four   hundred   sewing   cooperatives   and   independent   workshops,   especially   in   rural   areas   around   La   Coruna,   the  commercial  capital  of  Galicia,  and  Northern  Portugal.  After  sewing,  products  are  sent  back  to  Inditex  subsidiaries  for  quality  

Name:  Kunal  Arora   Phone:  757.235.1111   College/School:  CLAS   Year:  3rd  

Price  (04/21):  $17.19  Market  Cap:  $1.47B  52wk  Range:  $10.47-­‐24.47  Beta:  1.32  P/E:  10.7  P/S:  0.7  P/Tangible  BV:  8.5  EPS  growth:  -­‐3.61%  Short  Ratio:  3.9  Short  Interest:  5.42%    

Express, Inc. (NYSE:EXPR) Memo control,  finishing,  and  packaging.”  This  at  odds  with  traditional  fashion  firms  like  EXPR  who  “combine  design  and  sales  but  outsource   manufacturing,   often   to   low-­‐wage   subcontractors   in   East   Asia   and   elsewhere.   Searching   for   cheap   labor,  companies   use   networks   of   subcontractors   that   may   embroider,   and   sew   fabric   each   in   a   different   country.”   Express’s  horizontal   supply   chain  means   their   “seasonal   design   process   begins   approximately   45  weeks   (lead   time)   in   advance   of  store  delivery  (2013  10K),”  which  forces  them  to  manufacture  “nearly  80  percent”  of  their   inventory  by  the  start  of  each  season.  Whereas  fast-­‐fashion  companies  can  leverage  their  vertically  integration  and  shorter  lead  times  (as  short  as  15  days  in  Zara’s  case)  to  only  commit  “50  to  60  percent  of  their  lines  by  the  start  of  the  season,  meaning  that  up  to  50  percent  of  their  clothes  are  designed  and  manufactured  smack   in  the  middle  of   the  season.” Thus,   fast-­‐fashion  companies  can   limit  fashion   risk  by   taking  advantage  of  new  trends,  while  EXPR   is   left  with  dated   inventory   that  can  only  be  moved   through  promotional  means.    

o International  expansion  likely  to  disappoint.  International  expansion  is  one  of  EXPR’s  focal  points  in  their  four-­‐pillar  growth  strategy.   Currently,   expansion   is   being   targeted   in   the   Middle   East   and   Latin   America,   but   these   are   markets   that   are  already   dominated   by   fast-­‐fashion   competitors   like   H&M   and   Zara.   Given   EXPR’s   inability   to   attract   customers   in   their  current  markets,  it’s  unlikely  that  they  will  thrive  in  markets  where  fast-­‐fashion  companies  already  have  a  stronger  foothold  than  they  do  in  the  US.  

o E-­‐Commerce  is  a  current  bright  spot,  but  growth  is  unsustainable.  EXPR’s  e-­‐commerce  growth  has  covered  much  of  EXPR’s  strategic   missteps   in   their   brick-­‐and-­‐motor   locations:   “The   flat   comparable   sales   resulted   from   decreases   in   both  transactions  and  average  dollar  sales,  was  offset  by  growth  in  e-­‐commerce  sales.  We  attribute  the  decrease  in  transactions  to  lower  traffic  in  our  stores  and  a  lesser  acceptance  of  product  in  certain  women's  categories  during  the  second  and  third  quarters  (10K  2013).”  In  2012,  sales  increased  32%  over  2011,  representing  13%  of  net  sales.  However,  the  majority  of  this  growth   has   been   driven   by   increased   investment   in   the   e-­‐commerce   platform   and   a   significant   amount   of   catch-­‐up  compared  to  their  peers.  Once  the  novelty  wears  off,  the  e-­‐commerce  division  will  suffer  from  the  same  pressures  of  dated  inventory  and  fast-­‐fashion  competition  that  their  brick-­‐and-­‐motor  stores  have  already  encountered.  

Ø Financials  confirm  these  underlying  trends  (refer  to  exhibits)  o Slow  FCF/square  foot  growth  and  decreasing  same-­‐store  comps  o Lowest  margins  among  peer  group  

Misperception  Ø “Express   represents  one  of   the   few  names  with  a   low  bar   to  beat.”  Simeon  Siegel,  Analyst,   J.P.  Morgan.  Currently,  analyst  

lump  EXPR  within  the  specialty  retail   industry  against  companies  like  The  Limited,  The  Gap,  Abercrombie  &  Fitch,  Zumiez,  etc.  This  is  a  fundamental  mistake,  although  EXPR  follows  a  similar  “retail-­‐to-­‐market”  strategy,  there  target  market  (fashion-­‐forward  20-­‐30  year  olds)  put  them  in  direct  competition  with  fast-­‐fashion  companies.  So,  although  the  bar  may  be  low,  it  should  be  even  lower  if  EXPR  is  pitted  against  the  likes  of  H&M,  Forever  21,  and  Zara.  

Ø “Forever  21  and  H&M  are  cheaper  than  Express,  but  the  clothes  at  Express  are  cheaper  than  Zara.”  Survey  Respondent.  Refer  to  exhibits.    

VAR.  Refer  to  exhibits.  How  It  Plays  Out  

Ø Declining  same-­‐store  comps  are  indicative  of  EXPR’s  structural  decline.  This  trend  will  continue  as  customer  appeal  for  EXPR’s  “value  proposition”  continues  to  lose  out  to  fast-­‐fashion  brands,  especially  as  they  expand  into  the  US  market  (Zara).  

Ø Continued  discounting  and  promotions  to  move   inventory  will  eventually  signal   the  market.  As  EXPR  ups  their  promotional  schemes,  market  participants  will  begin  to  take  EXPR’s  inability  to  understand  fashion  trends  much  more  seriously.    

Ø E-­‐commerce  division  will  lose  steam  and  fail  to  hold  up  topline  growth.  Once  the  novelty  of  EXPR’s  online  platform  wears  off  and  e-­‐commerce  catch  up  transitions  into  a  more  mature  division,  growth  will  slow  and  failure  at  the  brick-­‐and-­‐motor  level  will  be  more  evident.    

Risks  /  What  Signs  Would  Indicate  We  Are  Wrong?  Ø If  management  recognizes  their  inability  to  manage  fashion  risk  and  begin  to  act  accordingly:  by  shortening  lead  times.  Ø If  the  new  outlet  concept  actually  holds  up  topline  growth,  so  far  its  just  in  the  concept  stage.  

Signposts  /  Follow-­‐Up  Ø Gross  Margins  Ø E-­‐commerce  sales  Ø Promotions  and  discounting  Ø Lead  times  Ø Net  income  is  expected  to  be  in  the  range  of  $29.5  million  

to   $32.5  million,   or   $0.34   to   $0.38   per   diluted   share   for  Q1.  

       

Company  Description  EXPR  is  a  specialty  apparel  and  accessory  retailer  offering  both  women's  and  men's  merchandise.  The  Company  operates  in  brick  and  mortar  retail  stores  and  the  express.com  e-­‐commerce  Website.  The  Company  offers  its  customers  an  assortment  of  fashionable  apparel  and  accessories  to  address  fashion  needs  across  multiple  aspects  of  their  lifestyles,  including  work,  casual,  jeanswear,  and  going-­‐out  occasions.  During  the  fiscal  year  ended  January  28,  2012  (fiscal  2011),  the  Company  opened  its  stores  in  Canada.  As  of  January  28,  2012,  it  operated  609  stores  in  47  states  across  the  United  States,  as  well  as  in  the  District  of  Columbia,  Puerto  Rico,  and  two  provinces  in  Canada.  These  include  576  dual-­‐gender  stores,  20  women's  stores,  and  13  men's  stores.  

Express, Inc. (NYSE:EXPR) Memo  This  survey  was  conducted  through  SurveyMonkey.com  and  was  completed  by  84  respondents  from  the  greater  Richmond  area,  greater  New  York  area,  greater  Atlanta  area,  Hampton  Roads,  Dallas,  Austin,  and  Charlottesville.      http://www.surveymonkey.com/s/DLY2WFF    

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Express, Inc. (NYSE:EXPR) Memo

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Express, Inc. (NYSE:EXPR) Memo  

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 *This  includes  e-­‐commerce  sales;  the  only  data  for  SSS  excluding  e-­‐commerce  is  for  Q4  2010  (7%),  Q4  2011  (3%),  Q4  2012  (-­‐3%)      

Black  Blazer  at  Zara  for  $159 Black  Blazer  at  Express  for  $228;  both  blazers  are  a  polyester  and  wool  blend.  

Express, Inc. (NYSE:EXPR) Memo  

                 

Express, Inc. (NYSE:EXPR) Memo Ideas  for  the  Club    Portfolio:  I  believe  we  can  begin  to  outperform  the  market  if  we  amend  the  way  we  think  about  our  portfolio.  

1. Strategy.  Just  looking  at  the  portfolio,  it  is  hard  to  discern  what  strategy  we  are  pursing.  Since  the  central  strategy  of  MII  is  focused  on  using  VAR  to  gain  an  informational  edge  on  the  market,  I  think  we  should  focus  on  stocks  where  gaining  such  an  edge  is  possible.  I  don’t  think  that  we  are  in  a  position  to  gain  helpful  VAR  on  an  Apple  or  a  Google  that  isn’t  already  being  reflected  in  the  price  of  their  stocks.  To  use  VAR  to  our  advantage  we  should  focus  on  smaller  cap  stocks  with  informational  inefficiencies.    

2. Composition.  MII  shouldn’t  construct  portfolios  with  second-­‐tier  ideas.  We  should  consider  pushing  our  long  positions  towards  the  10%  level  if  we  have  particularly  strong  conviction.  There  is  no  need  to  hold  a  2-­‐3%  position  if  we  truly  believe  we  have  an  edge  over  the  market.    

3. Risk  Control.  We  should  consider  pair  trading  to  mitigate  industry/market  risk.      Organizational  Structure  

1. Industry  Groups.  Associate  groups  should  be  created  around  industries.  Associates  can  have  the  choice  to  work  with  a  new  industry  group  each  semester.  This  will  not  only  give  members  exposure  to  working  with  different  industries,  but  also  MII  as  a  whole  will  benefit  from  associates  who  understand  the  industry  as  a  whole  and  it’s  implication  on  specific  firms.  Associate  groups  should  meet  weekly.  

2. Company  Experts.  We  should  consider  anyone  who  pitches  a  stock  as  that  company’s  expert  and  decisions  to  buy  or  sell  should  be  run  by  that  expert  before  any  action  is  made.  We  should  also  consider  their  recommendations  in  a  timely  manner  so  we  can  catch  movements  associated  with  identified  catalyst.    

3. Transparency.  Minutes  should  be  distributed  among  the  organization  from  both  the  associate  and  manager  meetings.