Thursday, December 31, 1998

bebe stores
(Nasdaq: BEBE)
Phone: 415-715-3900
Website: http://www.bebe.com
Price (12/30/98): $34 3/4


bebe got a lot of attention a few years back for putting Heather Locklear of Melrose Place in those sexy suits. But let's face it, bitchy old Amanda is not likely to take you mainstream.

Enter Ally McBeal, eh, Calista Flockhart, and a host of other stars, from Party of Five's Jennifer Love Hewitt to MTV's sublime Serena Altschul. Voila, bebe is everywhere!

Or so it seems. bebe's near monopoly on bus-stop signage in Atlanta is certainly eye-catching. Featuring what the company calls "playfully sensual and evocative imagery," this relatively low-budget branding campaign seems to have been highly effective.

With a focused selection of trendy "body-conscious" apparel for urban women, including cashmere camisoles and fleece hipster pants, bebe now appeals to more than just the wear-to-work market. And the company's earnings reflect that appeal, sending the stock to a highly fashionable triple from September's low of $10.

For the fiscal first quarter ended September 30, sales strutted 33.3% higher to $41.6 million on a luscious 27% increase in same-store sales. That was especially stunning given that it came atop a 54% comp store gain in the year-ago period. Net income stepped ahead 40% as EPS rose 31% to $0.21. A quarter like that after a terrific FY98, and investors have just gone gaga for bebe.


Founded in San Francisco in 1976, bebe (properly pronounced Bee-Bee) designs and sells contemporary women's apparel and accessories under the bebe and bebe Moda brands. Its target customers are 18- to 35-year-old women, mostly hip urban types looking for some sensuality in their suits, tops, pants, skirts, and dresses.

The company operates 91 specialty retail stores located in 22 states, with a heavy presence in California. Most are located in regional shopping malls, though 7 are outlet stores.

bebe added 7 stores last year and plans to open 15 more in both FY99 and FY00, mainly in existing markets. New stores become profitable at an operating level within the first quarter of business. bebe is also plotting international expansion, mainly through licensing deals.

While the average store today offers a clean, upscale boutique experience with its 2,700 square feet, bebe's new prototype is 3,000 to 5,000 square feet in order to handle the broader product line and higher sales volume. This past fall, the company also opened what looks like a pretty decent online store.

The company's merchandise is made in the U.S., allowing it to take a product from the design stage to the store in just 10 weeks. That's a much faster turnaround than is possible with overseas manufacturing.

bebe competes with more expensive brands such as BCBG, Laundry by Shelli Segal, and Donna Karan's (NYSE: DK) DKNY. It also competes against less fashion-forward retailers such as Ann Taylor (NYSE: ANN) and Gap's (NYSE: GPS) Banana Republic.

Chair/CEO Manny Mashouf owns 88% of the shares.


Income Statement
12-month sales: $157.1 million
12-month income: $19.0 million
12-month EPS: $0.78
Profit Margin: 12.1%
Market Cap: $882.3 million

Balance Sheet
Cash: $42.6 million
Current Assets: $60.0 million
Current Liabilities: $19.3 million
Long-term Debt: $2.5 million

Price-to-earnings: 44.6
Price-to-sales: 5.6


Despite all the Internet hoopla, IPOs generally underperform the market in the five years after going public. However, bebe presents a compelling story, especially for a retailer.

Revenues increased from $71.6 million in FY96 to $95.1 million in FY97 on the way to $146.8 million in FY98. Such heady growth came not just from 13 additional stores but from massive comp store sales gains of 18% in FY97 and 41.3% in FY98. Net sales per average store increased from $1,065 in FY96 to $1,719 in FY98. Sales per square foot soared from $481 in FY97 to $649 last year.

With such momentum and leverage at work, the 54% jump in sales for FY98 pushed EPS up 204% to $0.73 a share. The June Q4 results helped, as EPS of $0.20 crushed the underwriters' Q4 earnings estimate of $0.11. Yet, bebe was a good story even at the IPO.

With the world markets in turmoil and fears of a looming U.S. recession, the real concern was the macro picture. Once Greenspan's hints of interest rate cuts alleviated some of the panic, bebe should have looked cheap. Plus, Fool readers could have read about bebe back in August in our StockTalk interview with company CFO Blair Lambert.


Back in September 1995, Women's Wear Daily said CEO Mashouf was predicting sales would rise from $65 million in FY95 to $120 million in FY96. As it turns out, that wasn't even close. Hopefully Mashouf has gotten a better grip on reality since then.

To be fair, bebe had expected to have 90 stores open by the end of FY96. Instead, the company slowed its expansion to beef up its management team and fill out its product line. The expanded merchandise mix has shifted from an excessive reliance on professional clothes to more lifestyle-oriented apparel that moves easily from the office to the evening. The company also added a "logo" line of activewear for younger "aspirational" customers who want the bebe status at a lower price.

More recently, the company also introduced its own line of intimate apparel, a natural given bebe's sexy image. This past fall, it signed a licensing deal with Genender International to make a watch collection and another deal, with Titan Industries, to make bebe footwear. Both lines will be sold in bebe's stores and in upscale department stores. Other licensing deals are likely.

Gross margins hit 51.1% in FY98 versus 43.2% the year before. The trend continued in Q1 with gross margins up to 52.3% from 50.1%. That suggests initial markups have been high and inventory-clearing markdowns low. In other words, the brand and the merchandise mix are working beautifully to keep profits heading higher.

Though the company has warned that these gross margins are unsustainable, bebe still offers a story that's attracting interest. Hambrecht & Quist initiated coverage December 23 with a "buy" rating and a $37 a share price target based on 20% or better long-term revenue and earnings growth.

Part of H&Q's report highlights bebe's emphasis on testing new designs before committing to produce them. bebe's apparel is more demand-driven than that of a Donna Karan, which aims to set the fashion. Domestic sourcing plus point-of-purchase sales tracking allows bebe to take this more nimble approach, which keeps the merchandise fresh while avoiding some massive markdowns due to a glut of inventory.

Analysts are calling for earnings of $0.85 per share for FY99 ending in June and $0.96 the following year. So the stock trades at around 36 times forward estimates, well above the 11% growth rate implied by these numbers.

That's rich, but the company clearly has momentum and plenty of room for expansion. Especially given the thin float, it wouldn't be surprising to see the stock head higher. But at such a high P/E multiple, one quarter's disappointment, renewed fears of recession, or even a filing by Mashouf to sell some stock might cause at least temporary trouble.

-- Louis Corrigan

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