Will A Larger Chico's Look As Sharp?

At first I thought, only I would find this weird. Why is Chico's, one of today's hottest retailers of women's apparel, advertising before dawn on CNBC? That's the time and place for ads from insurers, brokers, and those (think Boeing (BA )) with nasty PR problems. Chico's and its lissome models just don't fit. Yet as the spots kept popping up recently, my curiosity about Chico's FAS (CHS ) (its full corporate name) got the best of me.

Soon, I found myself at a Chico's in Vero Beach, Fla., looking through the "casual-to-dressy" clothes -- a $98 black jacket with orange and pink floral trim, for example, and a tableful of $39 linen-and-silk sweaters. Much about Chico's is distinctive, from its original designs to the fact that most of the clothes come in just four roomy sizes (0, 1, 2, and 3, covering the usual range of women's sizes 4 to 16). Its TV ads, which along with the rest of their ads are produced in-house, stand out too. The ones I saw featured models slowly showing off the clothes to a sedate, down-tempo trumpet solo. "We have more control" this way, Charlie Kleman, Chico's chief financial officer, said. "Ad agencies wouldn't have a clue about what we're up to."

WHATEVER CHICO'S HAS been up to within its Fort Myers (Fla.) headquarters, it's clicking. Sales soared 45% in fiscal 2003, and this year they're headed up 30% or so, to $1 billion. The stock recently touched $47.60, a 184% gain in one year's time. Just the same, skeptics have to wonder: As well as Chico's has done for investors, how much better can Chico's shareholders have it?

To see what I mean, first examine the source of so much of its recent growth. Last September, Chico's paid $93 million for another chain of women's boutiques, White House/Black Market, or WHBM, which specializes in, you guessed it, white and black apparel. The deal came just as WHBM was ready to go public. It vaulted Chico's to a total of 536 stores, from 417. But the average WHBM store sees a 20% profit margin, well below the 32% at an average Chico's.

Next, note that the company a year ago figured North America could hold up to 650 Chico's stores. Now, based on showings of units in such spots as Boise, Idaho, and Billings, Mont., Kleman says Chico's is aiming higher, for up to 800 locations. Yet outposts in secondary or tertiary markets will have to work overtime to yield as much profit as units in such lusher locales as Short Hills, N.J., or Palo Alto, Calif. Similarly, before it agreed to be bought by Chico's, WHBM dreamed of running up to 400 stores; Chico's now thinks the market can absorb 500-plus WHBMs.

Even if Chico's keeps its profit margin while expanding broadly, as it gets bigger, the rate of profit growth will likely slow. Most investors, who at $45 a share are pricing Chico's at 31 times this year's expected profit, betray little worry. But not all. Chico's largest shareholder, Fidelity Investments' parent FMR, has been selling. A year ago, FMR held nearly 5.9 million shares, or 6.9% of Chico's. In February it said it cut that by a fifth, to less than 4.7 million shares.

A Fidelity spokesman declined to explain. But noticeable selling by such a sharp operator as FMR brings me back to those Chico's ads on CNBC. I wondered: Did Chico's run them as much to bolster the stock as to sell skirts? "Absolutely, positively not," Kleman told me. The ads, he said, ran on CNBC almost by fluke -- bonus time in a bigger national ad buy. "It was just so cheap there was no reason not to." Perhaps. Yet it's also worth noting that I was not alone in scratching my head. Jefferies (JEF ) analyst Robin Murchison, who recently downgraded the stock to a hold, also queried Chico's about the ads. They seemed so oddly placed, she said. When I suggested the target audience might not be just women looking for a new jacket but investors, too, she paused and then said: "That's probably closer to the truth."

By Robert Barker

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