Monday, June 7, 1999
Wet Seal Inc.
Price (6/4/99): $28 1/4
HOW DID IT DOUBLE?
Selling apparel and accessories to young women can be quite a challenge. Thanks to smart merchandising and fast inventory turns, Wet Seal (Nasdaq: WTSLA) has become the queen of teen retailers. Still, it remains a slippery stock that periodically dives back into the water, creating major opportunities for investors looking for washout values.
For the first part of last year, this retailer's same-store sales were so-so -- down 3.2% in Q1 and up 4.3% in Q2. Growing fears of recession late last summer sank Wet Seal along with other specialty retailers. Then, on September 15, the stock plunged 30% to below $14 per share after warning that weak back-to-school sales would cause earnings to fall well short of the $0.48 per share estimate.
Third quarter earnings actually came in at $0.41 per share, well above the $0.35 worst-case figure management had feared. Same-store sales even rose, albeit by an anemic 0.1%. The stock began recovering with the market. Fourth quarter results proved terrific, with sales up 23% to $146 million on a 6% increase in same-store sales. Earnings per share (EPS) shot ahead 51% to $0.95.
As sales and market psychology turned, Wet Seal was bid up. The stock hit a recent May high of $47. Investors were heartened by the strong fourth quarter and saw easy comp-store comparisons ahead. Also, the company acquired leases and store fixtures for 19 Mothers Work (Nasdaq: MWRK) locations on December 1 while finalizing the acquisition of leases and fixtures for 80 Britches of Georgetown stores on February 1. Wet Seal planned to use this real estate to do a national rollout of its new Arden B. chain in basically one quarter.
That rollout went smoothly and helped pump sales up 17% to $123 million. EPS of $0.34 beat the $0.31 analyst consensus estimates. However, same-store sales increased just 2.9%, less than the 4% that analysts were expecting. That raised fears that the company's second quarter has started off on the wrong foot. Priced for good news, the stock has recently given back most of its 1999 gains.
Wet Seal is a specialty retailer of apparel and accessories catering mostly to fashion-oriented teenage girls (juniors) and young women. It operates 538 stores in 42 states. Its 248 Contempo Casuals stores and 197 Wet Seal locations serve juniors, while its rapidly expanding chain of 76 Arden B. stores attracts young contemporary women (ages 20 to 45) looking for both casual and dressy apparel. It also has 17 unisex Limbo Lounge locations.
The company opened an extraordinary 85 new stores during the first quarter, with about 80 opened in the last six weeks of the period. Of the new stores, 51 were Arden B. locations. Though Wet Seal tested this concept in its other chains during 1997 and 1998, the first Arden B. didn't open until last November. Wet Seal plans to open 108 total stores this year, including 78 in former Britches locations.
By midyear, the company will launch a website to promote its Blue Asphalt private label brand (www.BlueAsphalt.com) and reintroduce a related catalog for back-to-school wear. Capital expenditures will run about $53 million this year due to the real estate acquisitions and rapid rollout of Arden B. stores.
Wet Seal defines its comp-store sales figures rather restrictively as stores "that were open throughout the full fiscal year and throughout the full prior fiscal year." I read that to mean that Arden B.'s results won't figure significantly into the comp-store sales figure until fiscal year 2001.
Wet Seal competes with other specialty apparel retailers such at The Limited (NYSE: LTD), Gap, Inc. (NYSE: GPS), Delia's (Nasdaq: DLIA), Gadzooks (Nasdaq: GADZ), Pacific Sunwear (Nasdaq: PSUN), and bebe (Nasdaq: BEBE).
Insiders own 29% of the stock, including all of the supervoting class B shares.
Income Statement 12-month sales: $503.4 million 12-month income: $26.87 million 12-month EPS: $2.00 Profit Margin: 5.3% Market Cap: $362 million Balance Sheet* Cash: $31.6 million Current Assets: $87.0 million Current Liabilities $65.1 million Long-term Debt/Rent: $8.7 million (*As of January 30, 1999. As of May 1, cash was $60.8 million) Ratios Price-to-earnings: 14.1 Price-to-sales: 0.7HOW COULD YOU HAVE FOUND THIS DOUBLE?
During last fall's stock market meltdown, shares of apparel retailers were getting skinned -- Wet Seal especially. So after the Q3 profit warning, the board announced plans to buy back up to 20% of the Class A shares. That was a super-smart move given that the shares traded down to $13 5/8. After all, the company had cash and investments to back nearly half the firm's market capitalization.
By the end of September, Wet Seal had repurchased 1.33 million shares (12.4% of the Class A stock) at an average per-share price of $14.82. Stock buyback announcements call attention to potential values. Actual buybacks underscore the point. Of course, our own "Fool Plate Special" detected a potential value at the time, too.
WHERE TO FROM HERE?
The first rule of investing in fashion-oriented apparel retailers is to make sure the balance sheet is solid. Wet Seal's definitely is. Even after the store expansion and substantial stock buyback, the company reports cash and investments of $60.8 million ($4.75 per share).
Moreover, inventories for the quarter rose 17.8%, which is more than sales, but considerably less than the 25% increase in retail square footage. Backing out the catalog inventories from last year, inventories are actually up 3% on a comp-store basis, in line with same-store sales growth. That's good.
While Q1 EPS benefited from the share buyback, the company lost some interest income versus last year as a result. The tax rate also increased to 40.0% from 38.5%. So operating income actually increased 42.2%, or even better than EPS. Gross margins improved to 29.18% from 28.59%, while selling, general and administrative (SG&A) expenses fell to 23.91% of sales from 24.24% last year.
However, there are a lot of cross currents in here. For example, last year's SG&A included catalog expenses not incurred this year since the catalog is being revamped. On the other hand, Wet Seal has already started its $3 million FY99 ad campaign, so SG&A expenses minus the catalog actually rose by 90 basis points in the first quarter. Meanwhile, the company is spending on training to get its new Arden B. personnel up to speed.
The current consensus earnings estimate for FY99 (ending next January) is $2.38 per share. So the stock trades at about 12 times this year's earnings projection, which itself assumes nearly 25% growth. That's just a little ahead of the 21% long-term growth analysts are projecting. Yet, if you back out the cash, the P/E drops to about 10. The price-to-sales ratio is also low for a company delivering 5.3% net margins. In addition, the trailing return on equity is an appealing 22.1%. So, based on the financials, the stock looks like a value.
What interests me about Wet Seal, though, is my own Peter Lynchean experience. I recently accompanied a friend into an Atlanta area Arden B. located next to a bebe. Arden B.'s styles and prices compared favorably to bebe's. Better yet, the clothes actually fit my relatively svelte thirty-something friend. She had a hard time squeezing into bebe's "body-conscious" threads. The Arden B. sales help was exceptional, too. A random stroll into a new store turned into a major shopping outing.
My experience jibes with CEO Kathy Bronstein's comments that Arden B.'s merchandise has been well received and that the real work to be done is on the marketing side. This is great news for Wet Seal since some analysts think Arden B. could do $350 in sales per square foot, or 30% above the average Wet Seal store. Also, operating margins at Arden B. could run in the 15% to 20% range, or at least double the margins at Wet Seal stores.
Arden B. looks like a winner, and one that won't be captured by the firm's same-store sales metric for some time. Moreover, I like the fact that Wet Seal's executive team rolled out this chain so rapidly and deftly. Between that and the huge stock buyback, management has proven its smarts.
However, Wet Seal is highly dependent on female shoppers, which gives management less flexibility in adjusting store displays to fashion trends than a more unisex retailer has. Given Wet Seal's small same-store sales gain in the first quarter and the recent interest rate scare, the stock could come under more pressure as investors discount slower consumer spending and worry about the second quarter results. So while the stock looks like a solid long-term value today, it might get cheaper.
-- Louis Corrigan (TMFSeymor@aol.com)
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