There's a school of investing that says just go ahead and buy good companies, hang on forever, and everything will work out. You'll see a lot of that in these pages, as a matter of fact.
I say "Bogus."
Cheapskates like me say, "Good companies are fine, but I'll take only what's on sale, thanks."
That, in a nutshell, has been the problem at Pacific Sunwear (NASDAQ:PSUN), whose shares I owned not so long ago, but sold in the $20s when it became clear that they were overvalued. Since then, on ever-weakening sales, stubs have dropped into the mid-teens.
They took a major tumble yesterday when July's same-store sales report showed a 10.6% decline, roughly ten times the minor drop the Street expected, and an overall sales drop of 5%. As we've seen frequently these days, hip-hop wanna-be d.e.m.o. led the decline with a 13.4% screamer. That instigated a guidance downgrade to the $0.15 per-share range, about 25% shy of what Mr. Market wanted to see, and that meant bad things for PacSun shares. I'm no Nostradamus, but it was pretty easy to see this coming.
Don't get me wrong. I think PacSun is a decent company, I really do. Sure, it's on the receiving end of some trash talk. It's not as hip as Abercrombie & Fitch's (NYSE:ANF) Hollister division, and the Volcom (NASDAQ:VLCM) crowd -- which is fickle and maybe looking for the next Volcom -- might consider PacSun a nerdlinger pretender next to the likes of Zumiez (NASDAQ:ZUMZ).
But returns like these don't come by accident:
|
FY |
FY |
FY |
FY |
FY | |
|---|---|---|---|---|---|
|
Return on Equity |
12% |
18% |
21.9% |
24.1% |
25.1% |
|
Return on Capital |
11.3% |
17.4% |
21.7% |
23.9% |
24.5% |
Unfortunately, they may not come forever, either. As Pacific Sunwear has continued to expand, sales have slackened, leaving less cash earnings for investors. Free cash flow peaked in 2004, at $111 million, and has been on the wane ever since.
That's why I don't consider PacSun a good bargain, even today, trading at an enterprise value of about 0.75 times sales. Assuming 10% annual cash flow growth from a fairly generous baseline estimate, I peg the fair value of these shares about $16 each these days.
Let's be honest, we're not looking at an American Eagle Outfitters (NASDAQ:AEOS) or a Guess? (NYSE:GES) here, companies that have been belting it out of the park quarter after quarter. We're looking at something a lot more like Gap (NYSE:GPS).
And this isn't the 90s, when being compared to Gap might have been a compliment. With PacSun's sales and earnings moving in the wrong direction from that rosy valuation scenario, this investor has a pretty big problem with that "fair" price. Unless PacSun shares give you a $13 opportunity in the near future, there are better bargains out there in retail, folks. Find them, or flee the field.
Pacific Sunwear, Gap, and American Eagle Outfitters are Motley Fool Stock Advisor recommendations. Gap is also an Inside Value pick. Volcom and Zumiez are Hidden Gems recommendations. To see the logic behind the calls, a free trial of any premium service is just a click away.
Seth Jayson watches retail like a hawk, but that's not always a good thing. At the time of publication, he had shares of Guess? and American Eagle but no positions in any other firm mentioned. View his stock holdings and Fool profile here. Fool rules are here.
