CAPScall of the Week: Tilly's

For years, satirical late-night TV host Stephen Colbert has been running a series on his show called "Better Know a District," which highlights one of the 435 U.S. congressional districts and its representative. While I am no Stephen Colbert, I am brutally inquisitive when it comes to the 5,000-plus listed companies on the U.S. stock exchanges.

That's why I've made it a weekly tradition to examine one seldom-followed company within The Motley Fool CAPS database and make a CAPScall of outperform or underperform on that company.

For this week's round of "Better Know a Stock," I'm going to take a closer look at Tilly's (NYSE: TLYS  ) .

What Tilly's does
Despite having a name that might inspire images of a cookie shop or a Midwestern thrift store, Tilly's is a West Coast-inspired apparel and accessories store. Focused on skateboarding and other action sports, art, and various new fashions, Tilly's seeks to carry the newest styles from brand-name apparel producers in its network of 168 stores and through its website.

In Tilly's most recent quarter, released in March, it delivered a net sales increase of 14.5% to $140.8 million but saw same-store sales decrease by 0.9%. Direct-to-consumer sales also jumped 20% compared to the previous year. Looking toward 2013, management forecast same-store sales growth in the low single digits given continued economic uncertainty.

The competition
Having plenty of name brands within Tilly's stores helps curbs some of the competitive aspects known to drive consumers from store to store looking for brands they'll remain loyal to. With a lineup of brand names such as Nike, Volcom, New Era, Adidas, and Billabong, to name a few, Tilly's really has something to offer any active individual.

Of course, that still doesn't stop Tilly's from facing quite a bit of competition. It has sort of moved into the role that used to be filled by Pacific Sunwear (NASDAQ: PSUN  ) , which has been unable to deliver an annual profit since 2007 and has seen sales contract for five straight years. Pacific Sunwear is certainly in dire straits, turning to store closures to cut expenses as it continues its attempt to figure out what its previous loyal customers want to wear.

Urban Outfitters (NASDAQ: URBN  ) and Zumiez (NASDAQ: ZUMZ  ) aren't having nearly the same problems. While both have experienced sales slowness -- which I'd describe as being more related to tax refund delays and higher taxes than a reflection of weaker fashion trends -- they've both done a remarkable job of controlling inventory levels and reaching a younger consumer. Urban Outfitters speaks to this with its 9% rise in same-store sales reported in its first-quarter results last night. Zumiez, similarly, reported strong April results, with net sales up 12.1% as it continues its rapid expansion and satiates a growing demand for action sports clothing.

The call
After carefully reviewing the prospects for Tilly's, I've decided to make a CAPScall of outperform on the company.

Although competition among younger consumers is tough right now, I feel they're the future growth opportunity in the retail sector. Tilly's offers a practically unparalleled number of brand names for younger consumers to choose from, which should help transform these shoppers from brand-loyal customers to store-loyal consumers.

Another factor to consider with younger shoppers is that they'll be relied on more in today's society to pick up the slack from a household income perspective. As higher taxes weigh on family income, and the potential for cutbacks hit the retail sector with the coming full implementation of Obamacare, I'd anticipate the sub-21 crowd to hit the labor force earlier than in recent years. While this does mean extra money for the family, it also provides these teens and young adults with disposable cash that we haven't seen in more than five years. I'd anticipate Tilly's will see a big boost in its bottom line once the younger generation is coerced into the workforce.

Finally, the valuation here is very reasonable. Tilly's ended its most recent quarter with $53 million in cash on hand (almost $2 per share) and should be able to expand its bricks-and-mortar locations using existing cash and operating cash flow rather than utilizing debt. That's an important comfort measure that'll keep Tilly's shareholders at ease.

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of the last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.


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