In my last Commentary, I praisedPacific Sunwear
Sales and earnings growth
Pacific Sunwear's been on a tear when it comes to both sales and earnings growth. Third-quarter total sales shot up 23% to $281.2 million. Same-store sales jumped by 13.8%, and earnings increased a whopping 54% to $24.5 million.
The story's similar for its first nine months of the year. Over that period, PacSun's total sales grew 23% to nearly $714 million, and its same-store sales were up 13.7%. Net income for the same time frame is up 73% to $45.9 million.
During the past three years, PacSun's annual compound sales growth has been 24.7% and net income growth has been 12.1%. Over five years, the retailer's sales have grown 30.1%, and net income has grown 24.8%. Looking ahead, management's growth expectations for next year are for 20% earnings-per-share growth.
Same-store sales have averaged 8.3% for the last seven years. In 2002, it generated 9.7% comps. Given that, this year's standout numbers look even more commendable.
Margins
Now, we'll tackle PacSun's margins. Its gross margin in the most recent quarter (the third) reached 35.8%, up from 34.6%. Through the first three quarters of the year, PacSun's gross margins were 34.2%, ahead of the prior year's 32.5%. The company's stellar same-store sales results are giving it occupancy cost leverage, which then is driving the gross margin improvement.
PacSun's operating margins have been a focus for the company, as it has tried to get them back up to 1999 levels. After peaking at 12.9% that year, operating margins dipped to 10.8% in 2000 and tanked to 6.5% in 2001 before recovering to 9.6% in 2002.
The retailer's goal has been to produce operating margins of 12% in 2004, and it's nearly a year ahead of schedule on delivering that. Through the first nine months of the current fiscal year, operating margins ran 10.3%, much better than last year's 7.5%. PacSun's now targeting operating margins of 13% for 2004.
Net margins have also been showing improvement. They were 8.7% in the third quarter versus 7%, and 6.4% for the first three quarters combined, compared to 4.6%.
While gross margins are in line with industry averages, PacSun's operating and net margins are much better than apparel retailers as a group. The industry's average operating margin is 4.6% and its average net is 2.8%. That means PacSun is wringing efficiencies out of its business, and also benefiting from its string of great same-store sales successes.
Returns on equity and assets
PacSun also stands out when it comes to returns on equity and assets. The retailer's ROE is 19.3%, versus the industry's 10.7%. Its ROA is 14.3%, substantially above the 5.7% put up by the industry.
The same trend can be seen with its returns on equity and assets as with its margins: They are steadily improving after falling from peak 1999 levels. However, even at its worst, PacSun's ROE was still a very respectable 12% and its ROA a not-too-shabby 8.7%.
The balance sheet
Let's talk cash and debt and all that fun stuff now. At the close of the third quarter, PacSun was flush with green, sporting nearly $94 million in cash and short-term investments. That's up from just $36 million at the end of its fiscal year, and is a world apart from the negative cash balance from last year's Q3. (PacSun paid off $25 million in debt during that 2002 period.)
PacSun manages its inventories tightly, which is vital if a retailer's to remain healthy. They grew just 13% in the most recent quarter while total sales sprouted 23% and same-store sales increased by 13.8%.
After paying off most of its debt last year, the company has minimal borrowings now. At the end of the third quarter, PacSun's debt was just $1.32 million.
Cash flow, baby
We can't leave out every Fool's favorite focus: free cash flow. All the earnings growth in the world is meaningless if it doesn't translate into actual moolah for the company. Luckily, Pacific Sunwear isn't facing troubles here, either.
Through the first three quarters of the current year, its operating cash flow is $62.9 million, significantly higher than the prior year's $22.3 million. Free cash flow for the period is $32.2 million, compared to negative free cash flow for the same time frame in 2002. For all of 2002, PacSun produced $36.2 million in free cash flow, so clearly it will surpass that this year.
PacSun's free cash flow is less than its earnings because the company's funding its expansion through cash from operations. Some growing companies can't manage to generate any free cash flow, so the fact that PacSun can is a bonus.
Conclusion
Put all the pieces together, and PacSun looks like an efficient and well-managed organization. It's cash-rich and poised for more growth, with two concepts that stand out from other teen retailers such as American EagleOutfitters
I love Pacific Sunwear's story and its prospects for future success. The company wants to grow to 1,400 stores by the close of fiscal 2007. (The retailer operated 869 stores at the end of November.) The bulk of those will be its flagship stores, and about 400 will be d.e.m.o. locations.
I believe it will be a fascinating company to watch over the next several years, and will continue to be a destination for mall-hopping teens. Given that shares are trading at a forward P/E of 18, PacSun deserves consideration if you're looking to invest in a teen retailer with solid financials, a differentiated place in the market, and exciting prospects for more growth.
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LouAnn Lofton owns shares of Abercrombie & Fitch. The Motley Fool is investors writing for investors.
