Francesca’s Holdings Corp (FRAN), Vera Bradley, Inc. (VRA) and rue21, inc. (RUE): 3 Small Cap Plays on Rising Retail Sales

A recent report from the U.S. Department of Commerce showed an unexpected jump in retail sales for April, which rose 0.5% year-on-year after an anemic 0.1% gain in March. Excluding gas and auto sales, retail sales rose 0.6%. Economists had originally projected a 0.3% decline in April.

Strong sales of building materials, clothing, sporting goods and electronics boosted retail sales, which account for 30% of total consumer spending in the country. Lower gas prices, which slid an average of 14 cents per gallon in April, also gave consumers more discretionary income. Meanwhile, job growth has held steady over the past three months, allaying concerns that the U.S. economy is slowing down.

Amid all of these positive headlines, one figure stood out – sales of clothing stores recorded their highest year-on-year increase since last February.

Therefore, it may be a good time to consider investing in some smaller, higher growth retail apparel stocks, such as Francesca’s Holdings Corp (NASDAQ:FRAN), Vera Bradley, Inc. (NASDAQ:VRA) and rue21, inc. (NASDAQ:RUE). These three companies have posted strong double-digit top and bottom line growth in a time when larger retailers, such as Abercrombie & Fitch Co. (NYSE:ANF) and Aeropostale, Inc. (NYSE:ARO), have struggled. If U.S. retail sales continue to improve, these three small cap stocks could easily rally and outgrow their bigger peers.

For the ladies: Francesca’s Holdings

Francesca’s Holdings Corp (NASDAQ:FRAN) is the parent company of Francesca’s Collections, a national chain of women’s retail boutiques that sell clothes, shoes and accessories at low to mid-range prices on par with H&M and Forever 21. Francesca’s Holdings Corp (NASDAQ:FRAN) is focused on smaller format stores between 1,200 to 1,400 square feet, which the company believes gives it more flexibility at a wider variety of venues. The company is one of the fastest growing small cap retail apparel brands, opening 77 boutiques in fiscal 2012 and finishing the year with 360 boutiques. It is also one of the most ambitious companies, with a stated long-term goal of opening 900 boutiques across the country.

During its fourth quarter, Francesca’s Holdings Corp (NASDAQ:FRAN) same-store sales rose 16.7%, up from 14.7% growth a year earlier. Total net sales rose 40.6% to $86.7 million, with $19.5 million contributed by non-comparable boutique sales from its 77 new locations. Direct to consumer sales, which include the increasingly important e-commerce channel, rose 65% over the prior year quarter, yet only contributed to 1.9% of the company’s total sales.

In other words, while other brick-and-mortar apparel companies have had to repeatedly emphasize their e-commerce growth over slumping brick-and-mortar sales, Francesca’s Holdings Corp (NASDAQ:FRAN) brick-and-mortar locations are reporting healthy, robust growth. Francesca’s Holdings Corp (NASDAQ:FRAN) has stated that it plans to relaunch its direct to consumer channels, including its website, during the first quarter of 2013, which should spur even stronger e-commerce growth.

Not only is Francesca’s Holdings Corp (NASDAQ:FRAN) top line growth impressive, it is also extremely profitable. It reported fourth quarter earnings of $0.33 per share, or $14.9 million, up from the $0.19 per share, or $8.4 million, it reported a year earlier.

For the teens: rue21

Meanwhile, rue21, inc. (NASDAQ:RUE) has been a hot name in teen fashion. The retailer, which sells tank tops, graphic tees, and accessories at affordable prices, operates approximately 1,000 stores across the United States, with an average store size between 5,000 to 6,000 square feet. The store was formerly known as Pennsylvania Fashions, which filed for bankruptcy in 2002. After it emerged from bankruptcy in May 2003 as rue21, inc. (NASDAQ:RUE), it began expanding aggressively from its small footprint of 170 stores. In fiscal 2012, rue21, inc. (NASDAQ:RUE) opened 125 new locations, and has a long-term goal of opening 1,700 locations.

During its fourth quarter, rue21, inc. (NASDAQ:RUE)’s revenue rose 22.4% to $269.05 million, while earnings per share rose 25.0% to $0.65. Same-store sales rose 0.7%, during a tough holiday season when many teen apparel retailers posted horrifying declines. By comparison, Aeropostale, which targets the same demographic, reported an 8.0% plunge in same-store sales.

While rue21, inc. (NASDAQ:RUE)’s numbers are firm enough to justify an investment at current levels, the real story behind this company is the LBO (leveraged buyout) buzz surrounding the company. Private equity firms have been on a shopping spree, picking up 38 apparel and shoe retailers last year.

Since rue21, inc. (NASDAQ:RUE) has no debt and is forecast to triple its free cash flow to $49 million this year, it has been listed along with Aeropostale and Abercrombie & Fitch as one of the three most attractive LBO targets among U.S. specialty apparel retailers, according to Jefferies Group analyst Randal Konik. According to Konik, if a buyer purchases rue21 with an acquisition premium of 30% and a minimum equity contribution of 25%, rue21 could generate an internal rate of return between 29% to 31%.

Yet that’s not to say that investors should own rue21 merely to expect a buyout, since the company still is fundamentally sound enough to continue growing on its own.

For the Moms: Vera Bradley

Last but not least, Vera Bradley, Inc. (NASDAQ:VRA), which I consider an undervalued growth stock, is my favorite pick in the handbags and accessories market. The company, which is mainly known for its iconic patterned bags, lacks the higher profile of its rivals Coach, Inc. (NYSE:COH), Michael Kors Holdings Ltd (NYSE:KORS), and Fifth & Pacific Companies Inc (NYSE:FNP) (Juicy Couture, Kate Spade), but nonetheless doubled its annual revenue between 2008 and 2012 from $239 million to $541 million. Net earnings during that period nearly tripled from $24 million to $69 million.

Last quarter, Vera Bradley, Inc. (NASDAQ:VRA) reported a 21% increase in revenue to $162.6 million, while earnings climbed 25% to $0.62 per share, or $25.1 million. Same-store sales slid 0.4%, but e-commerce sales rose 23%.

Yet the main reason I like Vera Bradley, Inc. (NASDAQ:VRA) is its new Baby line, which caused a surge in expenses last quarter but adds designer diaper bags, clothes, blankets, changing pads and tops to its product line. This line targets an untapped female demographic, of busy mothers who still enjoy a touch of affordable luxury in their lives.

Shareholders will know on May 27 if Vera’s efforts to reach moms has paid off, but I believe that strong retail numbers and improving consumer sentiment will yield positive results.

The Foolish Bottom Line

In closing, let’s stack up these three small cap stocks to gauge their fundamentals.

Source: Yahoo Finance, May 14

In my opinion, all three stocks represent solid investments on three different levels – Francesca’s is a great growth stock, while Vera Bradley, Inc. (NASDAQ:VRA) is a fundamentally cheap value stock. rue21 is somewhere in between, but is an attractive LBO candidate that can still hold its own against bigger competitors.

Therefore, all three companies should continue growing as U.S. retail numbers continue to improve.

The article 3 Small Cap Plays on Rising Retail Sales originally appeared on Fool.com and is written by Leo Sun.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.