Don't be fooled by the jump in Chico's ( CHS) stock Thursday. The retailer's latest quarter was another disappointment.

This onetime best-of-breed women's clothing seller has seen its days as a Wall Street darling come to a crashing halt. The company warned last summer that its growth was slowing sharply, and the stock has fallen nearly 50% from its high in February 2006.

Shares, however, recently were up $1.64, or 6.4%, to $27.26 after the company exceeded first-quarter earnings estimates. Still, the report did little to convince me that the situation is improving at the Chico's.

While the profit may have topped low expectations, same-store sales dropped and are slipping again in May. Operating margin shrank as well -- and I expect further declines.

Chico's is yesterday's news. As far as your portfolio is concerned, it shouldn't be today's or tomorrow's stock.

Where Are the Customers?

Chico's should be congratulated for maintaining its gross margin in the first quarter despite a 1.6% decline in same-store sales. Operating margin, however, fell for the sixth consecutive quarter when measured year over year.

The higher operating expenses in the first quarter were primarily due to the costs of running and staffing larger stores. But the income statement benefited from a smaller-than-expected expenditure on marketing, and those dollars will be pushed out to later in the year.

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) Macy's, Nordstrom ( JWN) and Kohl's ( KSS).

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.

In keeping with TSC's editorial policy, Lichtenfeld doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.

Marc Lichtenfeld was previously an analyst at Avalon Research Group and The Weiss Group and a trader at Carlin Equities. He holds NASD 86, 87, 7 and 63 licenses. His prior journalism experience includes being a reporter/anchor for On24 in San Francisco and a managing editor of InvestorsObserver, a personal finance Web site. He is a graduate of the State University of New York at Albany. He appreciates your feedback; click here to send him an email.

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