Description

I think going long Body Central is compelling risk/reward at current levels.  A reasonable level of turnaround should lead to a mid-teens price and potentially a double from current levels. 

Body Central was founded in 1972 and is a specialty retailer offering fashion based apparel and accessories at value prices.   Body Central operates stores under the Body Central and Body Shop banners.  There is also a direct business (catalog and e-commerce). 

Body Central focuses on “body conscious” customers – not the self conscious kind rather the ones that flaunt it.  They market the core customer as the late teen to early 30s but my understanding is it skews towards the lower end of that range.  They are fast cycle – 8-14 week merchandise changes.  They sell across 4 key categories -club, casual, dressy and active and there is a significant accessories component (~25% of sales).   E-commerce is 12% of sales.

BODY currently has 258 stores while they added around 30 stores in 2010, 2011 and 2012 ~14% square footage growth.  An average store is 4,000 sf with annualized sales of $1.1MM, a 4 wall EBITDA margin of 20% and an average out of pocket investment of $145K (with inventory) so 8 month paybacks/ROI of 150%.  Mgmt believes it can double the store base. 

The company competes with Rue, Charlotte Russe, Wet Seal, Forever 21, Strawberry, Deb and Maurice’s (some of which have also had some issues). 

In mid-August, the CEO “retired” unexpectedly from his post for the past three years.  In recent conversations, Mgmt was pretty adamant the CEO departure wasn’t a signal about current trends worsening (but its hard to know for sure).  There had been rumblings that the CEO and head merchant didn’t get along and the merchant is frankly more important to a company like this.  The CFO has been elevated to interim CEO while the search is underway but there is some added risk here potentially.

Valuation is attractive:

The stock has gone from a high of $30.93 in early May to a low of $7.71 in early August before settling in the low $9s after a series of disappointing guide downs due to weak comp trends from merchandise mistakes.  This has led to a stock trading at extremely compelling valuation multiples.  Off 2012, BODY is trading at 3.6x EBITDA (and 2.8x next year assuming little improvement) and PEs of 11.1x ’12 and 9.9x ‘13 (adjusted for the significant net cash balance, the PE is 7.3x ’12 and 5.7x ‘13).  EBITDAR multiples are 5.8x ’12 and 5.4x ’13 while the TEV/Revenue multiple is 0.31x ’12 and 0.25x ’13.  Comps are trading at higher multiples and BODY has historically traded at materially higher multiples (~2x).  I’m not arguing for a return to historical multiple levels (but if execution materially improves, its not an unlikely scenario).  Charlotte Russe was taken private by Advent in 2009 at roughly 6.6x LTM EBITDA/5.3x forward. 

The significant net cash balance (35% of the market cap by year end) enables the company the time to get the merchandise right. 

Merchandise mistakes happen – its fixable:

BODY has a decent track record of positive comps.  As most fast fashion retailers do, they screw up on trends from time to time.  BODY screwed up but given its fast fashion nature, the new fall merchandise came in during late July and August and allows for a hit of the restart button.  Its possible it takes awhile for the mgmt team to right the ship again but given the track record here, it seems reasonable to assume they will.  The feedback we’ve heard on the new merchandise has been much better than their summer offering.  The head merchant and the rest of the merchandising team that was delivering double-digit comp performance over the past couple of years remains in place.  Mgmt is strengthening some of its testing programs and adding some layers of talent to the existing team.  They have a test and grow strategy whereby they try limited runs of a pattern and if it takes off they blow it out to all the stores – obviously they made some mistakes around this recently but are adjusting/enhancing their testing strategy.  

Mgmt guidance seems conservative:

Mgmt got burned by having to guide down Q2 twice in a short period of time and then completing the hat trick of guide downs with its Q2 results.  This latest guidance sounded extremely conservative in follow up conversations with mgmt as the rest of the year assumes negative 12-14% comps.   They said on their 8/2/12 call that the new merchandise was comping down mid-teens so they basically extended that out for the rest of the year. 

New merchandise looks to be performing better:

Despite guiding to substantially weak comp trends recently and on the new merchandise line the reality is that July isn’t that important of a month for the fall set (in terms of $/acceptance).  Several stores didn’t even have the merchandise yet, some stores only received small amounts of it, some only received it late in the month and given how hot July was – not a lot of customers were looking/focused on the fall goods at that time.  Further, considering the merchandise miss, there were a significant number of clearance racks offering decent discounts on summer goods.  Retail in general was pretty strong in August so I think its reasonable to assume the situation improved.  Further, based on our diligence, the number of clearance racks in each BODY store is down materially from the checks we made in July.  Qualitative color we’ve heard on the fall merchandise is also positive.  Though challenging to know for sure, I imagine its still choppy week to week, I do think the trend is better than expected.

Mgmt recently buying some stock:

Several members of the mgmt team and Board have recently purchased a small amount of shares.

New store growth/payback is impressive:

BODY only has 258 stores.  There is the potential for a store base that’s double the size.  The payback on a new store is extremely compelling – typically a 150% ROI.  Even after its missteps the past quarter or so, mgmt remains very committed to its store growth plans.

Mid-Teen EBIT Margin potential

Mgmt believes that with store growth and a return to positive comps, EBIT margins can get to the mid –teens in the next three years.  I don’t even have the company getting to the 10.6% rate they achieved in 2011 in any of the next 3 years and I still see material upside. 

Potential Private Equity interest:

Private equity made a lot of money on BODY in the past and is likely still interested.  There were rumors of other private equity firms trying to buy the company at the time of the IPO.  The IPO price was $13 in October of 2010. 

Given the recent departure of the CEO, the valuation and the store growth potential, it would be an opportune time for PE to step back in.  An LBO is compelling at significantly higher share prices. Interestingly, the PE owners saw similar merchandise issues at the time of their initial investment and they were eventually fixed.   

Sentiment is poor:

Given the guidance reductions and mgmt changes, sell-side analysts are in wait and see mode.  There are six analysts that cover the stock and each one has a Hold rating.  If merchandise performance can improve, there is a substantial re-rating that should occur.    

Growth investors could return

When comps turned south in the Q2 time period, all the growth investors ran for the hills.  If mgmt can get its comps back on track, given the store growth plans here, I think there is a decent chance they will return as quickly as they left. 

Catalyst

-          Mgmt is on the road this week with most of the mgmt team in NY and Boston

-          Improvement in comp trends

-          Takeout

-          Sell Side analyst love returns

-          Growth investors return