The Wet Seal Inc.: Significant After-Earnings Sell-Off Makes It A Compelling Value Play

| About: The Wet (WTSL)


Significant sell-off was fueled by downgrades following 4Q 2013 financial results. Most post-earnings price targets are greater than $2/share. However, a 50c/share target might have aggravated the sell-off.

The company has set forth an aggressive growth plan with emphasis on high-margin e-commerce, social media, mobile, and real estate initiatives to overcome current sector challenges faster than larger competitors.

Successful execution of the new growth plan discussed in detail in the 4Q 2013 conference call will enable WTSL to exit weather-challenged 1Q 2014 with a more bullish outlook.

The Wet Seal Inc. (NASDAQ:WTSL) lost 13% to close at $1.55 after reporting 4Q and FY 2013 earnings on Thursday, March 20, 2014. The stock lost an additional 40% to close at $1.11 on Tuesday, March 25, 2014. The sell-off occurred after several brokerage houses adjusted their price target on the stock following earnings. The majority of the new price targets are above $2/share, except for a 50c/share target assigned by B. Riley, which rated the stock a "sell." The only other "sell" rating came from UBS AG, which cut their price target on shares of Wet Seal to $2.10 in a research note on Monday.

Besides the B. Riley and UBS AG "sell" ratings, three analysts have given a "hold" recommendation, two have assigned a "buy" recommendation, and one has issued a "strong buy" recommendation on the company. Analysts at Brean Capital cut their price target on shares of Wet Seal from $3.00 to $2.00 in a research note on Friday. They now have a "buy" rating on the stock.

On Thursday, March 20, WTSL reported fourth-quarter fiscal 2013 adjusted loss of 23 cents per share, which was narrower than the consensus estimate of a loss of 24 cents. However, it was wider than a loss of 6 cents incurred in the year-ago quarter. WTSL reported $530.1 million for fiscal 2013, compared to net sales of $580.4 million in fiscal 2012.

What appeared to disappoint analysts was a weak 1Q 2014 forecast, primarily caused by reduced mall traffic due to severe weather during most of the quarter. For the first quarter of 2014, WTSL expects to report net loss in the 16 to 19 cents per share range. The other downgrade reason cited in some of the research notes was the new $27 million convertible financing also announced on March 20, 2014.

The company ended the quarter with $46 million of cash and cash equivalents and short-term investments, no debt, and a $35 million revolving credit facility. The $27 million convertible notes will be convertible into shares of the company's Class A common stock at a price of $1.84 per share. In connection with the sale of the convertible notes, the company will issue warrants to purchase 8.8 million shares of common stock. The warrants will be exercisable at $2.12 per share. After the $27 million financing warrants and converts are exercised, the company will have about 70c/share cash exiting 1Q 2014, based on a 108 million fully diluted share count.

The improved balance sheet will help accelerate growth of all the company's business lines, and its e-commerce, social media, and mobile operations in particular. Improved weather conditions and new programs being proactively implemented by the company are expected to improve performance significantly beginning in the 2nd quarter of 2014. Since 1Q 2014 will be reported in only 6 more weeks, investors will not have to wait long to hear from the company about a more bullish rest-of-the-year and beyond.

Wet Seal is not alone, but it's better prepared to deal with an exceedingly fickle teen crowd than larger competitors and "teen-retail" sector leaders American Eagle Outfitters (NYSE:AEO), Abercrombie & Fitch (NYSE:ANF), and Aeropostale (NYSE:ARO). Teens don't think that products from the "Big Three A" are cool anymore. Wet Seal has a major advantage over these competitors to deal with current market trends, because it has adopted and mastered the "fast fashion" retail operating philosophy several years ago. Fast-fashion retailers like Wet Seal, Zara, H&M, and Forever 21 have much shorter lead times than traditional teen retailers. Always changing products entices teens each time they are in the mall and online. But Wet Seal (nor any other retailer) does not have control over harsh weather conditions and mall traffic. To counter this, Wet Seal has moved quickly to close several non-performing traditional-mall stores, and has opened (and plans to open more in 2014) several stores in higher-traffic outlet malls.

Regarding the company's strategic plan to deal with current "teen retail" market challenges, Wet Seal's CEO, John D. Goodman stated on March 20, 2014:

"We are embarking on a strategic plan designed to restore comparable store sales growth, improve merchandise margins and strengthen our market position."

"We have a prudent capital spending plan for 2014 and will be deploying resources toward the significant opportunities we see to grow our e-commerce business, transform our real estate portfolio and expand our presence in the plus-size market. This new capital provides us with the financial flexibility to more effectively execute our strategies."

Clinton Group, one of the largest shareholders, and frequently rumored to want to take the company private, commended management for their proactive approach to address mall-traffic, weather-related, and other macro challenges affecting the industry.

Regarding the growing and high-margin e-commerce revenue component, CEO John D. Goodman had this to say in the conference call:

"We think by the end of the year, we should be at 10% of our business being e-commerce (up significantly from the current 6%). So there's no reason to think we can't get there, and then clearly, if you think about it from a productivity and profitability standpoint, it's double what the stores' profitability is. So, for us, the quicker we get there, the more profitable we look."

Other fast-growth and high-margin areas the company is aggressively pursuing are social media and mobile. Mr. Goodman stated this about these key growth areas:

"Social media is beginning to take on epic proportions and we are seeing Wet Seal's presence grow dramatically on sites like Twitter, Instagram and Wanelo. We're leveraging the visibility from our alliance with Crush by ABC Family and doing more product integrations and social media promotions. And AwesomenessTV continues to be a home run for us, offering a tremendous amount of engagement with our core customer. We will also be doing more frequent promotions and store events that tie-in to our partnerships with musical artists."

"Turning to mobile, we are utilizing the internal capabilities we now have announced to rebuild our subscription base, offer more frequent text and e-mail promotions and engage the customer with a more direct called action, both in-store and online. Lastly, we are investing greater resources in digital marketing initiatives, including SEO DOAs and blogger partnerships. We will be investing wisely, shifting our spending as needed to ensure we are properly funding critical marketing tactics that will help us drive traffic and engage the customer."

To help drive the e-commerce, social media, and mobile initiatives, the company recently announced the appointment of three new board members with significant experience and leadership in these areas.

The entire growth plan, including the company's real estate and plus-size strategies, is discussed in detail in pages 1-5 of the earnings call transcript.

I echo the Clinton Group's bullishness about the proactive and swift multi-pronged action the company management is executing to return to profitability sooner rather than later. Larger retailers like the "Big Three A" cannot move this fast due to their size and complexity. Other forward-thinking investors also believe that WSTL is a great value, particularly at the current bargain stock price.

Wet Seal has seen prices this low only two other times in its entire history. And in both cases, the bounce has been quick and powerful. I fully expect WSTL to be trading north of $2/share in a quarter or two, and significantly higher next year. WTSL is currently trading 80% lower than sector averages, assuming a total share count of 108 million shares after full conversion of the new $27 million financing. I believe the sell-off has been excessive, and this makes WTSL an attractive investment opportunity under $1.5/share.

I mentioned the buyout and going-private scenarios in my initial article on Wet Seal. I've provided ample references to prove that this is a very possible scenario, particularly since many suitors have been interested in taking over Wet Seal in the last two years. Now that the stock is near its all-time lows, it will be interesting to see how these scenarios could unfold.

In conclusion, in my opinion, WTSL is a steal at these prices. I also believe that 1Q 2014 will prove to be an inflection point, which will be followed by significant growth as the e-commerce, social media, mobile, and other growth engines are unleashed. However, since no investment in the stock market is free of risks, investors should review all the risks and uncertainties as detailed in the company filings with the SEC.

Disclosure: I am long WTSL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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