While Express (EXPR) is trading for cheap, we don’t feel comfortable recommending a position in the company. We believe their business model is going to be fundamentally challenged in the quarters ahead as management tries to steer the ship out of troubled waters.

The two main concerns we see with Express is their heavy exposure to malls and a product assortment that seems out of touch with current trends. The pandemic has severely affected foot traffic at malls and could remain so until the people start feeling comfortable going into crowded places. We also believe their e-commerce channel is weak compared to other retailers, translating into incremental CAPEX to strengthen their omnichannel strategy in times where sales at their retail stores are expected to remain weak.

The pandemic has also accelerated the demand for athleisure and casual apparel as consumers shift their needs for work attire to comfort. The problem lies with Express building a brand image towards what management calls “wear-to-work”; fashionable dress shirts and blouses, suits, accessories, and clothing for other special events and nightlife. Found on their website, the company describes itself as:

Express is the style source for fashion-forward young women and men, for everything from first job interviews to weekend parties. We believe in living for the moment, dressing for the moment and having a strong individual style. – express.com

It is not hard to see why we believe there are fundamental challenges ahead for Express.

The most optimistic scenario would rely on a bit of luck with the pandemic behind us in a few quarters and everything returning to “normal.” The most probable scenario, however, is foot traffic at malls increasing at a slow pace while stores need to adapt to social distancing guidelines, and people slowly returning to their workplace. Social events would come back eventually, though their timing is less certain.

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With that said, we consider an investment in Express at a forward sales multiple of 0.03x pure speculation. Given that we see the business fundamentally challenged, we cannot recommend Express as a sensible investment and remain neutral.

The outlook is highly uncertain

Express is still feeling the effects of COVID. The company reported second quarter sales of $246M, down 48% on a year-over-year basis, beating expectations by $0.42M, while reporting non-GAAP EPS of minus $1.48, missing the consensus by $0.32. For a bit more context, sales in their first quarter were down 53%, compared to its prior-year period. This highlights a slight sequential improvement in Q2 but a business severely affected by the pandemic.

The impact on revenues was in part driven by having 30% of their stores closed for more than half of the quarter. That said, the majority of their retail stores have reopened their doors, with the exception of some in California, where there was a flare-up in the number of infections.

Foot traffic at the mall remains weak but the company is seeing slight month-to-month sequential improvement. For example, traffic and sales went from down 50% in May to down 15% by the third week in June. That said, the rising cases of infections in some states had an immediate impact on operations in the fourth week of June, which resulted in total comparable sales in July, including e-commerce to be down approximately 20%.

Due to having their stores closed for a significant number of days in Q1 and Q2, the company had to liquidate inventory buildup, causing merchandise margins to contract by 2,300 basis points. Gross margins for the second quarter were negative 18%.

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If there was one positive highlight during the quarter, it was the relative increase in demand from their e-commerce channel, which went from negative 35% in May to positive 25% in the back half of July, which lies somewhat at the mid-point from other mall-based retailers. For example, American Eagle’s (AEO) legacy brand AE posted online growth of 21%, while its Aerie brand posted online growth of 113%. Abercrombie & Fitch (ANF) had a 56% digital growth during their second quarter compared to its prior-year period.

However, we believe the company is trailing behind its peers in its omnichannel strategy. For example, the company recently announced the launch of their mobile app by mid-September and have recently completed their website revamp and the expansion of ship from store and BOPIS to almost all of their retail locations; the company is also relaunching their loyalty program. These value-added services are something other retailers have been offering for a while now.

What’s next for Express

The company expanded its liquidity to $425M, which we believe gives them enough to weather the storm. The $425M in liquidity comes from a combination of its credit facility ($165M), the cut of inventory receipts during Q2 ($100M), identified cost savings ($95M), rent abatements ($20M), lower CAPEX ($25M) and cash benefits from the CARES act ($20M).

Management is also optimistic about achieving its long-term target of mid single-digit operating margins as part of its EXPRESSway Forward strategy. However, that would depend entirely on how the pandemic evolves in the upcoming quarters.

However, we see a company with not much room to maneuver. For example, the company has set its brand image in a way that caters to the fashion market. As a result, management is doubling down on its denim line and introducing other fashion products such as knit suits. So even if the company clears out old inventory, it fills it with new fashionable products within the same categories.

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With customers seeking comfortable clothes as they spend more time at home, Express looks out of touch with the current trend. There could also be long-term headwinds if businesses adopt a “hybrid” workplace, in which employees split their time between working from home and going into the office/workplace, thus reducing demand for Express’s core product offerings.

The Bottom Line

The market is pricing Express like it is going out of business. At this point, we believe investing in the company is a purely speculative high-risk bet.

This is a situation in which management has zero control, as it depends on how the pandemic evolves in the upcoming quarters. We saw that increasing cases of infections have a direct impact on the company’s operations. Express’s marketing message and product assortment also seem out of sync with current conditions.

With the company’s business model facing its biggest challenge, we believe investors should look at other opportunities.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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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