Is Express' 20% Drop a Buying Opportunity?

Is Express' 20% Drop a Buying Opportunity?

As a value investor who is seeking opportunities to buy undervalued stocks, I am always interested in stocks which have recently dropped significantly. Recently, Express , the retail apparel chain with around 630 stores, plunged by more than 20% in one trading day after reporting a disappointing full-year outlook. Should investors consider this wild downward move an investment opportunity? Is Express a better buy than two of its peers including Guess? (NYSE: GES) and Gap (NYSE: GPS)? Let's take a closer look.

Growing third-quarter performance for Express but a disappointing outlook
In the third quarter, Express increased its sales by 7% to $503 million while its third-quarter diluted earnings per share grew 15% to $0.23. Comparable-store sales growth was quite decent at 5% as well. Despite this improved performance in the third quarter, Express lowered its guidance for the full fiscal year of 2013.

The company's management now expects full year EPS in the range of $1.46-$1.51, down from the previous estimate of $1.52-$1.60. Comparable-store sales growth is expected to be in the low-single digits and net income is expected to be in the range of $124-$128 million. According to chairman and CEO Michael Weiss, one of the reasons for the pessimistic full-year guidance was weak Thanksgiving-week sales, driven by the extremely competitive promotional retail environment.

Rapidly increasing inventory at Express is not a good sign
What investors should really notice is the increase in Express' inventory level. Sequentially, while Express grew its sales by 3.26% its inventory jumped by 41.8%. As inventory rises more than sales, this could indicate that Express is having a hard time selling its products.

Express has worse performance than both Guess? and Gap. In the third quarter, Gap's inventory rose by only 6.6% which was only a bit higher than its 3.7% sequential rise in sales. Guess? enjoyed the best performance in the third quarter as it saw its sales rising faster than its inventory. While its sales experienced 16.4% sequential growth, its inventory climbed only 6.5%.

Express is not so cheap
Although Express' share price has fallen off the cliff, it is still not so cheap compared to Gap and Guess?. At $20 per share, it trades for 6.6 times its EV/EBITDA, or enterprise value/earnings before interest, taxes, depreciation, and amortization. Gap has a similar valuation with a 6.76 EBITDA multiple. Guess? is the most expensive among the three although its EBITDA multiple of 7.1 is only a bit higher.

The higher comparable valuation for Guess? might be due to the fact that the company offers investors the highest dividend yield of this group, 2.30%, at a reasonable payout ratio of 42.60%. Gap also provides a decent dividend yield of 1.90% with a much lower payout ratio of 22%. Express does not offer its shareholders any dividend payments.

If Gap increased its payout ratio to Guess?'s level, its dividend yield would be quite high at 3.70%. However, Gap also bought back its shares as well. In the third quarter, the company repurchased 20 million shares, giving investors a cash distribution of $900 million. Gap is also expected to buy back an additional $1 billion worth of shares which will effectively give investors a 5.4% repurchase yield in the future.

My Foolish take
Personally, with the rapid rise in Express' inventory level I would expect its operating performance to be disappointing in the near future. Moreover, Express is not so cheap now when compared to both Gap and Guess?. Thus, I am not interested in Express currently. Among the three, Gap seems to be the most intriguing stock with a similar valuation to Express, a good dividend yield, and a commitment to return cash to shareholders over time via both dividend payments and share buybacks.

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Anh HOANG has no position in any stocks mentioned. The Motley Fool recommends Guess?. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published