The Pullback In Pacific Sunwear Presents An Opportunity Heading Into The High Season

Jun.24.14 | About: Pacific Sunwear (PSUN)

Summary

Guidance for the 2nd Quarter was slightly lower than analyst expectations, causing a pullback in PAC.

The company operates in a highly cyclical industry, and is heading into the high season, with improving YoY results.

The company still looks weak compared to peers, but is working to increase profitability by closing under-performing stores.

Pacific Sunwear of California Inc. (NASDAQ:PSUN) saw a major pullback after releasing the 1Q14 results, based mainly on the guidance for the next quarter. In spite of challenges the company faces in the sector, I believe the pullback was too far and presents an opportunity to get in and take advantage of the cyclic nature of the business. There are still some cautions with the business, and its valuation compared to peers, but if the market continues to improve, the stock could see a pop.

Overview

Pacific Sunwear of California, Inc. operates in the action sports and fashion segment, based on the influences of the California lifestyle. It sells branded and proprietary apparel, accessories, and footwear for teens and young adults out of mall-based stores under the brand names of Pacific Sunwear and PacSun.

The company is currently trading at $2.30 with 69 million shares outstanding and a market cap of $160 million.

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(Source: Yahoo finance)

Cyclic results

During the recent earnings release, the company issued the following guidance:

The Company's guidance range for the second quarter of fiscal 2014 contemplates a non-GAAP loss per diluted share from continuing operations of between $(0.08) and $(0.02), compared to $0.02 in the second quarter of fiscal 2013.

The forecasted second quarter non-GAAP loss from continuing operations per diluted share guidance range is based on the following assumptions:

  • Comparable store sales from -5% to flat;
  • Revenue from $200 million to $210 million;
  • Gross margin rate, including buying, distribution and occupancy, of 26% to 29%;
  • SG&A expenses in the range of $56 million to $58 million; and
  • Applicable non-GAAP adjustments are tax effected using a normalized annual income tax rate.

In comparison, the company had a decent 1st quarter.

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(Source: chart compiled from NASDAQ.com data)

Revenues were up year over year and EPS beat the two previous 1Q results.

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(Source: chart compiled from NASDAQ.com data)

The downturn came due to the specific guidance for 2nd quarter, $200-210 million, below industry analyst's expectation of $211 million. In addition, the company also expects -5% to flat sales, a decrease from the 3% gain in 1st quarter. One of the primary reasons for the decreased estimate was due to the decreased performance in the swim and non-apparel side. During the conference call, Gary Schoenfeld (President and CEO) stated the following:

Our Women's business came in below plan at a minus 5 comp, largely due to soft performance in two areas, swim and non-apparel. Excluding these categories the rest of our Women's business was up driven by continued strength in Brandy Melville and Kendall & Kylie as well as key categories of tops and shorts.

The 1st quarter has historically been the worst quarter for the company. 2nd and 3rd quarters have progressively been stronger as the summer kicks off and back to school sales bring in shoppers.

While it will be difficult to precisely predict how the summer retail season will look, the trends are looking good. While there was a slight pull back from the Monthly Sales in the Clothing and Clothing Accessories category compiled by the Census Department, the overall trend has been positive over the past two years.

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(Source: census.gov)

Industry Comparison - the Downside

When compared to the rest of the industry, PSUN does not look as favorable. It looks expensive compared to its peers based on the Price to Book, Price to Free Cash Flow, and ROE.

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(Source: data compiled from Yahoo Finance)

In order to combat the poor performance, the company has been closing stores that have been underperforming:

We ended the quarter with a total of 618 core and outlet stores versus 638 a year ago. During this quarter we opened one store and closed another. We plan to open four stores during the remainder of fiscal '14 and close approximately 10 to 20 stores with the majority of closures occurring in Q4 2014.

The closing of the underperforming stores will help the company to increase their profit margins and profitability per employee. The last quarter the company reported revenues of $77,456 per employee, not bad when the average worker probably earns closer to $10 an hour, but again, near the low end of the spectrum:

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(Source: data compiled from ihub)

Conclusion

I believe PSUN is a good speculative play for a few reasons:

  • Cyclical industry: The company operates in an industry that moves in cycles. Right now, the company just passed through what is historically the worst quarter, and is in the beginning of the high revenue quarters.
  • 2Q14 Guidance: The company issued guidance that was lower that analyst estimates. The current trend in the retail space is positive. If the company can capture a fair share of the positive trend, then it may beat its lower guidance.
  • Recent pullback: Right now the company is just off its 52 week low in spite of a record 1st quarter. While it may drift a little lower, I believe it will build up resistance in the $2 range, and be a good place to initiate a position.

I wouldn't bet money on the company that I couldn't afford to lose, but the pullback does look attractive for the short term cyclic nature of the company.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in PSUN over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.