Description
Feb. 6, 2003 (This idea was submitted as my application to join VIC, so it is written in several parts as I continued to update my write-up after my initial submission and as I answered some questions posed by VIC.)
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The Wet Seal, Inc. is a retailer of fashionable and contemporary apparel
through its stores in the US under the names of: Wet Seal, Contempo Casuals,
Limbo Lounge, and Arden B.
WTLSA today pre-announced their outlook for the 4th Qtr as being a loss of
$0.15 to $0.20 (including a write-down of $0.15 to $0.20 for inventory and
other reserves) and their January comparable store sales being down 25.1%
and fourth qtr comp sales down 18%. Their net sales for the fiscal year
ended Feb.1, 2003 increased to $608.6 million from $601.9 million from the
prior year. They also fired their CEO. First Call was estimating a profit
of $0.01 for the qtr, so the stock is down over 13% on the news after being
down lower earlier in the day.
At these price levels the company is CHEAP. First of all they have no debt. Second, most services including Bloomberg, mis-report their cash and investment balances due to them investing in some longer term cash investments (bonds with longer than 1 yr maturities). For example, Bloomberg lists their cash and investments at the end of their 3 qtr at $52.4 million, whereas in reality (and as announced by the company in
their 3 qtr report) if you include their long term investments their cash
and investments balance at the end of the 3 qtr was actually $93.4 million.
In their release today they stated that their 4 qtr cash and investment
balances would be "slightly higher" than the end of 3 qtr balance. So
assuming they end the 4 qtr with $95 million in cash and investments
($3.26/share), if you back that out of their equity market cap of $213.1
million you get a net enterprise value of $118.1 million or $4.05/share. So the company is trading at:
EV/Sales = 0.19
EV/EPS = between 23.8 and 33.75 on a trailing basis depending on their final numbers for 4qtr
(est. today at between $0.12 and $0.17), and 9 times the average estimate of $0.45 for the current year ending 01/2004.
Their 9 mth (through 11/02) EBITDA was $29.436 million so assuming a
breakeven EBITDA in the 4 qtr (they have around $5.402 million/qtr in D&A,
so even a $0.15 loss (or $4.37 million) in 4 qtr should generate added
EBITDA):
EV/EBITDA = 4
UPDATE - March 5, 2003
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The stock has come down with the market the past few days and is now trading at $6.31. I believe this is an incredible opportunity to buy the shares. Although February will likely turn out to have very bad comp numbers for WTSLA as for most retailers due to the weather conditions, I believe most, if not all, of this is priced into the stock. From a technical basis there is a support level in the $6.25-6.35 range (made back in 2000), although if the markets continue to weaken and it breaks that, the next support levels are at $5.75-5.90 and then $4.90-5.00 . Given that the company has around $3.26/share in cash and investments, I would recommend adding to positions at each of those levels if it reaches them.
UPDATE - March 11, 2003
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1. When one looks at WTSLA's historical profitability you can see that over the last five years operating margins have ranged from 3.75% to 7.96% with an average of 6.3%. This past year which has clearly been the worst for the company for many years from a profitability standpoint should still come in (after all one-time write-offs, including the severance payment for the CEO) around 1% operating margin when they report on March 20. I expect this to improve to the 3-4% (with potential upside to around 6% if the economy improves) range this year. It looks like they will have burned about $6 million in cash this year, so even after a horrible year in which they completely missed the fashion trend and fired their CEO (which probably will cost them about $3.5 million in severance), the burn rate is relatively low and I believe they will more than make up for that this year. I believe the stock is worth around $15 on an average year, $20 on a good year, and about $10 on a bad year. The average retail stock is currently trading at an EV/Sales=0.54 (this after a generally bad year for retail), which translates into a $15.33 stock price for WTSLA.
2. I expect a new CEO to make the operations more efficient. While they may be inclined to create some one-time charges when they first join in order to "clean house" and to give themselves a lower base to build their success on, I believe any such changes would be viewed positively by the market. As to the rest of the management team, I believe their success over the years speaks for itself, with their main weakness being in managing the Street's expectations in order to avoid the large swings in the stock price. However, I believe a new CEO may solve that "problem" which may also eliminate the stock as a great investment opportunity each year when Wall Street overreacts. I would be disappointed to see that happen as this stock has been very lucrative for me both on the long and short side for many years.
3. Rather than repeat it here, I will try to upload the Oct.2002 JPMorgan analyst report on WTSLA. It offers a lot of detail on store breakdowns, growth expectations, inventory turns and the like. While I would not trust/count on analyst recommendations on when to buy or sell WTSLA, I do use their work and analysis as background while forming my own judgment, and felt this detailed report would also be helpful to you all.
Catalyst
Feb.6, 2003
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There are several potential near term catalysts to correct the price of the
stock. The first is the analyst reports that will come out today and
tomorrow based on today's news. As I write this SunTrust Robinson Humphrey
has just come out and raised WTSLA to an Overweight.
The next catalyst is the 4 qtr and full year results and conference call to
be released on March 20.
And the longer term underlying catalyst is that the company's results will
improve this year as they start comparing against a very difficult last year
in which both the economy reduced their comp sales and the fashion trends
weren't as strong as the prior year in which WTSLA had a banner year. Also,
if you look at a long term chart of WTSLA you will see that it repeats a
pattern of large stock rallies as they beat their numbers in the first few
quarters follow by all the analyst raising their guidance too much, and the
stock price getting over-valued. The company then misses the new numbers
(or doesn't beat them by enough), the stock price drops and gets undervalued
and then the cycle repeats.