To bebe (NASDAQ:BEBE) or not to bebe. That's the question for today, if you can forgive me for debasing Shakespeare so.
The once-hot lower-case retailer has suffered from bad merchandising decisions, declining same-store sales, increased competition, and ever-weakening results for three years now. Granted, it's hardly been an oasis of joy for many other retailers during the same period, but bebe in particular has gone from hot to not in record time. What went wrong, and is bebe's turnaround imminent?
The low-down on bebe
First, a little background: The retailer's been around since 1976, and went public in June 1998. Its founder, Manny Mashouf, is also bebe's CEO and president, in addition to controlling about 81% of the company.
bebe's a tiny company and sells tiny clothes -- literally. It operates 178 stores in 30 states, the District of Columbia, and Canada, and maintains an online store at www.bebe.com. Its revenues for 2002 were $316 million, and its market cap is around $425 million.
Itty bitty, teeny weeny
As for its tiny clothes, this is perhaps what bebe's best known for. There's no real delicate way for me to describe bebe's clothes with the adjectives that immediately jump to mind, so let me just say this: bebe is all about exposure. Skin is always in at bebe.
And the clothes aren't cheap, either. All those tiny scraps of fabric barely covering a bottom here and a top there are pricey. bebe shoppers pay for the privilege of going just about nekkid in bebe's clothes.
Lest you think I have a bebe vendetta, I'll 'fess up to several bebe articles of clothing, hanging there like so many handkerchiefs, in my closet. I'm not one to pick on bebe's or its customers' lack of coverage, since I've also found myself barely covered in bebe more than once.
Those tiny clothes, though, necessarily dictate that bebe isn't targeting the vast majority of American women. It embraces this, pointing out that its customers are "body-conscious" 18-35-year-old women, who are also "hip," "sophisticated," and appreciate bebe's "signature hint of sensuality."
In other words, the average American women, at a size 14, best shop elsewhere. bebe's sizes only go up to a 10 anyway, so the temptation's eliminated before it exists. The retailer's free to target whatever customers it wants, of course, but it should be acknowledged that bebe's growth as a company will always be limited by, ahem, size.
bebe's sweet suits
bebe benefited in the late 1990s from the wildly successful television series Ally McBeal. Calista Flockhart, in the title role of kooky lawyer Ally, wore suits with skirts so short it was nearly criminal. The fad caught on, and bebe, which was already doing good business in fashionable suits, saw its thigh-baring offerings fly off the racks. Workplaces from Topeka to Newark were transformed.
The good times for bebe didn't last, though. The biggest risk with specialty retailers -- fashion risk -- nailed bebe. After the popularity of obscenely short suits waned, bebe fiddled around with fad after fad before ultimately deciding to move much of its merchandise to a more casual look. The lower-priced offerings ate into margins and also confused customers.
The company is now trying to shift back to more suiting in its stores, but it's proving to be a long and painful road for the business. Shareholders have suffered, too, as shares are still well off their 1999 high of nearly $50, and recently traded at around $17.
The financials
Just how long and painful has bebe's trip been? Well, let's start with margins. After peaking in 1999, gross margins and net margins have gone down every year since.
Gross Margin Net Margin1998 51.13% 11.87%1999 52.60% 13.91%2000 50.43% 12.16%2001 48.01% 9.56%2002 45.00% 8.37%
Then there's the little issue of same-store sales. Before eking out an April improvement of 1.2%, they were down for 19 consecutive months. March and February saw fat comps declines of 10.5% and 15.2%, respectively, pointing to a company still struggling mightily to bring customers back.
Also troubling is the fact that total sales have recently dropped below year-earlier levels. It released third-quarter results in April that were as ugly as last summer's peasant blouse trend. The two earnings warnings prior to announcement certainly didn't help, either.
Sales for the quarter ended March 31 fell to $68.77 million from $70.61 million, its bottom line saved only by interest income. The company posted an operating loss of $325,000, with net income as skimpy as its clothes, at $142,000, or $0.01 a share. It earned $3.77 million, or $0.15 a share, in the prior period. Ouch.
For the first nine months of its fiscal year, bebe netted $16.03 million vs. $22.52 million in the same year-earlier time frame. The retailer won't make up the difference in its fourth quarter, which means it will mark its third straight year of lower earnings. It earned $29.41 million in 2000, $27.81 million in 2001, and $26.48 million in 2002.
Inventory problems
bebe's inventory situation has been perplexing, and hasn't inspired much confidence. Over the last several quarters, it controlled its inventory pretty tightly -- too tightly, perhaps, resulting in lost sales. Sourcing issues and the movement of a production plant have combined with fashion miscues to mess with inventory management. Still, though, at least it hasn't had scads of stuff sitting around.
Until now. In the third quarter, its inventory levels shot up 29%. The retailer's Foolish Flow Ratio, which had been steadily improving for four quarters in a row, ballooned to 1.42.
It's like the company can't win -- it's either too conservative, resulting in lost sales of really popular items, or when it takes a chance on stocking more inventory, it chooses the wrong merchandise and gets burned. Regardless, inventory management is key for a company like bebe, and as such it's disconcerting to watch the company get it wrong again and again.
Competition galore
bebe is also facing much more competition today than a few years ago. Wet Seal's (NASDAQ:WTSLA) Arden B., the fantastically cheap and fashionable Swedish import chain H&M, BCBG Max Azria, Charlotte Russe (NASDAQ:CHIC), and Polo Ralph Lauren's (NYSE:RL) Club Monaco are just a few of the many names challenging it.
bebe needs to convince customers that it's the place to shop and must differentiate its brand and its clothes. As of now, the company's failing to do this effectively.
The pluses
bebe does have a few things going for it, though. It has no long-term debt to weigh it down, and is consistently free cash flow positive. In 2000, it produced $12.13 million. In 2001, it turned out $15.75 million, and 2002 saw free cash flow of $27.98 million (in part because of the aforementioned tight inventory levels.)
It won't generate anywhere near that this year, but it has still produced $15.18 million through the first nine months of the fiscal year. It's smartly slowed its capital expenditures, and will spend between $14 million and $16 million on them this fiscal year. It spent nearly $22 million on capital expenditures in fiscal 2002. The company knows it needs to fix what's wrong in its existing stores before shelling out to add many more to the fold.
In conclusion...
How close bebe is to figuring out the magic formula behind the fix is still unknown, though. I'd like to imagine bebe with just a tiny snag in its skirt, one that can be quickly and easily mended. However, as you've just seen, it is addressing problems that go back a couple of years. We're looking at a serious slash in the fabric here, and it's going to take some time and ingenuity to sew it up properly.
There's no solid evidence that things are turning around right now for bebe. The third-quarter results only confirm that the company still has a lot of work to do. Before we can definitively say that bebe's back on top, we'll need to see some more consistency from it. Until then, I'll just keep watching, holding my breath, and scrunching myself into its minuscule clothes.
LouAnn Lofton doesn't own shares in any of the companies mentioned, though she just visited her first H&M this past weekend and fell in love with it. The Motley Fool is investors writing for investors .
