Chico's Good News Is Actually Full of Holes

Here's what worries me. Chico's has lost its place in the forefront of its customers' minds. As I wrote a few months ago, the company has lost market share to Federated(FD Quote) Macy's, Nordstrom (JWN Quote) and Kohl's (KSS Quote).

The company's admission that May's comps will be down in the mid-single digits is further evidence that Chico's brands and merchandise no longer resonate with customers the way they used to.

So when Chico's ramps its marketing spending, perhaps it can stabilize the business or even garner some small upside. But if the marketing doesn't drive customers to Chico's cash registers, operating margin will continue to deteriorate, leading to an earnings miss.

On the earnings call, management said gross margin is expected to slip in the second and third quarter. My concern is that with slow sales in May, we could see more markdowns that would further erode gross margin.

Gross margin was the one bright spot in the quarter. If analysts don't have that to hang their hat on, we could see the already bearish analyst community cut their estimates.

Still Too Pricey

Right now, analysts expect earnings of $1.06 a share for the fiscal year ending in January, according to Thomson Financial. However, factoring in operating margins that I expect will come in below expectations, I optimistically project Chico's will earn $1 a share for the full year.

On a forward price-to-earnings basis, the stock trades at a 15% premium to the sector average. Using my $1-a-share earnings estimate, I believe the stock should trade down to $21 to be more in line with its peers.

At this point, I don't see a reason to assign Chico's a premium until it proves that it can once again be the top brand in its space.

And if things get even worse at Chico's because of execution or external events such as weather or macroeconomic issues, that $1 EPS estimate might become way out of reach.