Before long, the summer sun will be shining, and Pacific Sunwear's (NASDAQ:PSUN) business will be heating up. Following the release of its fourth-quarter results, however, things don't look so bright for the youth-geared activewear retailer. To get a better understanding of what's going down with the California-based enterprise, we will investigate the company's latest conference call to see what clues it may offer about itself as an investment opportunity.
On the latest results:
Bodhi: Bro, I'm going B-A-N-A-N-A-S over the company's latest performance. Revenues increased 11.9% to $424.9 million compared with the same period a year ago. On top of record sales, it achieved 16.7% growth in earnings per share to a record $0.63, matching analyst expectations.
Hank: Amigo, I'm beginning to think you are bananas. Pacific Sunwear's stock is down as much as 9% in recent trading -- clearly, the rest of the market doesn't share your enthusiasm. While it may have met Wall Street's expectations on the bottom line, it fell short of top-line estimates, where analysts were calling for $427.5 million in sales.
Jeremy: Coming up less than 1% shy of consensus estimates for revenues doesn't exactly compute with losing nearly a tenth of its market capitalization in recent trading. Instead, it appears investors are skittish over a potential negative trend developing in regard to revenues -- Pacific Sunwear's newly released February sales figures did little to alleviate concerns. The report showed that comparable-store sales for PacSun stores declined 4% versus the year ago period, and its net sales growth of 7% during the month is way off pace from the anticipated first-quarter revenue growth of 14% growth.
Hank: Even taking February out of the picture, PacSun's fourth-quarter comps of 2.2% are troublesome in light of the strong figures just released by American Eagle Outfitters (NASDAQ:AEOS), which posted a 7.8% increase in comps for the fourth period.
Bodhi: The market is simply having a brain freeze. CEO Seth Johnson said that he was "very pleased" with PacSun's latest results. He indicated that the performance is reflective of "tight management of merchandise margin and effective expense controls."
Jeremy: General and administrative expenses as a percentage of net revenues did improve for the fourth quarter to 19%, from 20.5% a year ago. But because of weaker comp sales, buying costs took a toll on gross margins by pushing the metric down more than 3 percentage points to 36.3%. While Johnson may be "pleased" with its expense management, the sales picture certainly doesn't thrill him, or me.
Hank: Yep, it's fixin' to get hog-tied if it can't figure out a way to sell more threads to the ladies. Johnson said that the company had some success with girls' sweaters and cut-and-sew tops, but these were offset by a "disappointing fourth-quarter business in fleece, tees, denim, and sneakers." He added that a lack of "sufficient newness in branded surf and skate tees" helped drag down sales among female consumers. The company purchased too few of the "more fashion-right" novelty styles and had an overassortment of other less appealing options. These problems have continued into February, and that probably helps explain the negative comps for the month.
On 2006:
Bodhi: Hang loose, Hank -- the company is addressing its apparel hang-ups. Johnson says, "We are very excited about the improvements we have made for our 2006 back-to-school girls' denim assortment. We will have improved fabrics, fits, and watches, as well as a significantly better denim marketing package." The company also plans to gain better traction among the female audience through upgrading its store design with "improved visual presentation, fixturing, and marketing." In the meantime, it's showing strength in sales of girls' shorts, skirts, capris, swimwear, and sandals.
Hank: My flip-flop-donning friend, I think it's going to be too little, too late. The new product mix doesn't hit stores till June 1. Until then, Johnson expects the "girls' denim business to continue to be tough." As a result, the company is anticipating earnings per share for the first quarter of 2006 to come in roughly flat versus year-ago comparisons.
Jeremy: It looks like PacSun is facing normal challenges that every apparel retailer must deal with -- keeping products appealing and relevant. Aeropostale (NYSE:ARO) and Gap (NYSE:GPS) are dealing with a similar challenge, particularly in light of the success Abercrombie & Fitch (NYSE:ANF) has enjoyed in capturing the look that teens are going for.
On the success of newly designed PacSun stores:
Bodhi: It was encouraging to hear Johnson say that the girls' apparel business is trending higher in the 14 newly redesigned units in comparison with the older models. He added that this demographic is the company's "single biggest opportunity for volume growth." It is planning on incorporating this new design into the roughly 40 stores slated for expansion in 2006 and to do a "minor retrofit" to some other units.
Jeremy: Speaking of volume growth, it was intriguing to hear Johnson's explanation of rising inventories, which were up 7.8% per square foot by the fourth quarter's end. In his view, the inventory level probably isn't high enough, and that is partially to blame for weaker February results. The expectation is for inventories to remain at this level throughout 2006 to necessarily "drive more volume and profit in the business."
Hank: Well, there you go, Bodhi, an optimist after your own heart. The company may indeed be below appropriate inventory levels in some product categories, but it's likely higher in others -- as described earlier by way of a poor product mix for its female audience. Considering it will be June until the new denim mix hits store floors, PacSun will be dealing with excess inventory that will have to be sold off at discounted prices, and that will have an impact on margins.
Foolish bottom line:
Jeremy: Management believes it maintains tight control on inventories. It does sound as though the early summer months will be the time when PacSun begins to put the pieces together as the new product mix goes out into increasingly more appealing store designs. While the company is going through a transition stage, the sky certainly isn't falling. For 2006, it is still projecting double-digit top- and bottom-line growth.
The market lost its appetite for the stock on Thursday, but interestingly, PacSun spent $2.8 million in 2005 buying its own shares at an average cost of $23.37. With an additional $49.9 million remaining in the repurchase program, you can bet the company will be putting it to use in the coming weeks. It's days like these, when the sentiment has cooled, that prospective investors should be taking a closer peek at PacSun -- before it heats back up again in the summer months.
Gap is a recommendation of the Fool's Stock Advisor and Inside Value newsletters. Try any of our investing newsletters out free for 30 days.
Fool contributor Jeremy MacNealy does not own shares of any companies mentioned.
