Tilly's Hits the Wall Running

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Without painting in overly-broad brushstrokes, I think it's fair to say that all teenagers are fickle. Part of that isn't their fault -- they quickly stop being teenagers and become young adults, while kids become the new teenagers. What will eventually appeal to teens in 2016 depends on what today's nine-year-olds turn into. So it's no wonder that companies like Tilly's (NYSE: TLYS  ) have a hard time keeping on top of the teen retail pack. Not only is Tilly's chasing fashion instead of dictating it, it's chasing teen fashion. The company's third-quarter results highlighted how difficult that can be.

Top line miss, bottom line bunt
For a stock that dropped 17% in one day, the earnings report wasn't all that bad. Analysts were expecting the company to post $0.30 of earnings per share, and the company put up $0.33 instead. Both the forecast and the reality are a far cry from the $0.59 it managed last year, but the company has been investing in growth. What started the pullback was that analysts were also looking for $129 million in revenue; Tilly's managed only $125 million.

Still, it seems like a harsh reaction to a 3% miss on analyst's forecasted revenue. What pushed investors over the edge was the company's growth rate and forecast. Comparable sales -- revenue from stores that were open last year -- grew only 1.9%. That's rough. On top of that, management said that it expects fourth quarter comparable sales to be similar in growth -- between 1% and 3%.

Investors were hoping for more of what they saw in the second quarter, when comparable sales grew 5%. That's a much better growth rate in an uncertain economic environment. The figures that Tilly's put up this quarter are more aligned with the weaker macroeconomic climate, which no one is dying to be a part of.

The lining isn't even silver
Some companies have the common courtesy to at least get cheap when things go south. Guess? (NYSE: GES  ) has had a wildly disappointing year; but, if investors now believe in the company, they can get in at a P/E below 10. That's actually cheap -- though whether it's a good value is up for debate.

Unfortunately, even with the bad news and the big drop, Tilly's still isn't cheap. It's not expensive, by any means, but there's no compelling reason to buy based solely on the cost. With a P/E near 20, Tilly's is just above average in the fashion world. True Religion (Nasdaq: TRLG  ) , which is in much worse shape, has a P/E of 14. Gap (NYSE: GPS  ) , which is making all of the right moves, is trading at 17. In that light, Tilly's just doesn't make sense.

The bottom line
Right now, Tilly's is doing one of two things. Either it's showing a lack of confidence in its ability to manage the market and appeal to consumers, or it's being less than honest about its internal forecast. Either way, it doesn't make for a strong buying opportunity. With its low growth and ultra-thin competitive moat, the only reason I can see to buy into Tilly's is the hope of a complete about-face in the future.

In order for Tilly's to be more than just "the store kids go to right now," it needs to carve out a niche that other companies aren't already managing. That's a tall order in the teen fashion market, but it's not impossible. Gap has done it twice -- first in the 1990s, and then again over the last year -- by appealing to teens who want to lead their groups and be fashion forward. Instead of simply producing what's hot, Tilly's can focus more on carrying what will be hot. Then it becomes a destination in its own right, and a good company for investors to own.

Until I see that sort of change, I'll stick with industry leaders like the three companies in the Motley Fool's free special report on Companies Ready to Rule Retail. Unless there's a turnaround in sight, then I can't think of any reason to speculate with my investments. The three stocks in this special report are strong, industry leaders that investors can feel good about owning. Check all the details out for yourself in the report.

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