After Backpedaling Sharply, Can Quiksilver Inc. Find Its Footing?

Mr. Market wasn't too pleased with the worsening financial outlook at teen retailer Quiksilver and dropped its share price sharply after the company's latest financial update. Is it time to buy in?

Jul 20, 2014 at 10:00AM

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Source: Quiksilver

Teen-focused retailer Quiksilver (NYSE:ZQK) has been attempting to improve its financial performance through an ongoing restructuring plan that has seen the company offload some of its non-core units, highlighted by the recent sale of its Mervin snowboard manufacturing business. Unfortunately, Quiksilver has been stymied in its turnaround efforts by an anecdotally weak selling environment in the teen retail sector, a trend that has also hit the fortunes of competitors like Tilly's (NYSE:TLYS).

A case in point was the company's latest financial update, which included declines in revenue and adjusted operating income, and naturally led to a steep subsequent sell-off in its share price. However, after losing roughly half of its market value over the past twelve months, is Quiksilver a good buy?

What's the value?
Quiksilver is one of the major players in the teen retail sector with a wholesale distribution network in over 100 countries, the favorable result of the near-universal popularity of its trio of action-sports brands, Quiksilver, Roxy, and DC. The company also has a major presence in the retail channel where it operates more than 600 stores around the globe, mostly in international markets. Quiksilver's significant scale of operations, though, has done little for its profitability lately, as its operating margin has declined over the past few years.

In its latest fiscal year, it was more of the same for Quiksilver, highlighted by a 6.8% top-line decline that was a function of across-the-board sales weakness. More importantly, the company's need to engage in highly promotional activities to drive marginal sales put a dent in its adjusted operating margin and produced a double-digit drop in operating income relative to the prior-year period. Not surprisingly, Quiksilver's cash flow generation remained at a sub-optimal level during the period, so it could not fund the capital expenditures necessary for the company to deliver on its turnaround plan.

Looking into the crystal ball
Despite management's initial optimism for better results in fiscal 2014, the overall trajectory for Quiksilver has remained negative, evidenced by single-digit year-to-date declines in both revenue and adjusted operating income. While the company's gross margin improved during the period from the prior-year period, thanks to slightly positive comparable-store sales growth in its retail channel, heavy overhead expenditures continued to hurt Quiksilver. The net result for Quiksilver was a continuation of low adjusted operating profitability. Worse, management pushed out the date for fully delivering on its turnaround plan to fiscal 2017, a move that clearly didn't sit too well with Mr. Market.

It's tough all over
Of course, Quiksilver is hardly alone in its current business malaise, as its competitors are almost universally exhibiting similar profit pressures. Fellow action sports-oriented retailer Tilly's reported a similarly disappointing financial performance in its latest fiscal year, highlighted by its first negative comparable-store sales result since fiscal 2009. With its gross margin shrinking by a sizable amount as well, this added up to a decline in operating profit for the company, putting into question whether management could or should continue expanding its store base at such a fast clip.

Even category standout Urban Outfitters (NASDAQ:URBN) has been revealing some chinks in its armor lately, primarily due to a weak comparable-store sales performance at its Urban Outfitters unit. While the company was able to generate an impressive double-digit increase in operating profit during its latest fiscal year, courtesy of the strong sales growth of its Free People brand, Urban Outfitters' overall performance in its most recent fiscal quarter would indicate that a repeat of double-digit profit growth in the current fiscal year is a pretty low-probability event.

The bottom line
Quiksilver is certainly cheaper than it was at the start of 2014, as it has lost more than half of its market value. Given the dissipation of management's optimism surrounding the company's near-term financial performance, though, there seems to be valid justification for the price action. Quiksilver is an interesting long-term bet due to the popularity of its brands among its target demographic, but investors who are looking for a quick rebound should probably look elsewhere.

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Robert Hanley owns shares of Quiksilver and Urban Outfitters. The Motley Fool recommends Urban Outfitters. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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