Description

Gadzooks is a mall-based specialty retailer catering to the teen market. The company is coming off of a couple of difficult years during which they struggled with their merchandise offerings. After putting a new merchandising team in placed in early '99, the company has shown a steady improvement in comps, margins & earnings. The turnaround has been driven by a return to national brands such as DKNY but more importantly an offering of hot "teen brands" such as Ecko, Hurley, Mecca & Billabong which have shown great performance. Private label, which is new for back-to-school, is off to a good start & offers potential for gross margin expansion going forward.

The new team has clearly put the company on the right track & I believe that things will continue to improve for the back half of this year & over the next couple of years. EPS outlook for this year ~$1.25 but the real opportunities lie in the next couple of years when the company should be able to return to historical operating margins in the 8-9% range (currently ~6%). This translates to earnings well over $2.00 on the current store base of ~345 stores. GADZ could easily open another 200+ stores in both existing markets & particularly on the West Coast which is well-suited for their concept & where they currently have almost no presence. GADZ is debt-free with over $1.00 in cash & will generate ~$8m ($.90/sh) in free cash this year. I believe the stock could be a double from current levels based on a 15x multiple (below growth rate & industry average) on (conservative) EPS of $2.00 in the next year or two.

Catalyst

Growth in same store sales, new merchandising strategy, earnings growth