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Summary

  • Recent analyst upgrades reflect more confidence that the company is successfully executing its turnaround plans.
  • The latest same store sales (SSS) for the Teen Apparel Group showed the highest beat in the retail sector (1.6% v. expected 0.3%) indicating a positive change in teen-purchasing attitudes.
  • Significant short interest could provide fuel for a swift rally prior to and following the upcoming 2Q 2014 earnings release.

This article is a follow-up to several articles that I've written previously about the Wet Seal Inc. (NASDAQ:WTSL). For those not familiar with Wet Seal, the company is a national multi-channel retailer selling fashion apparel and accessory items through its stores and a growing e-commerce presence. The company operates through the following segments: Wet Seal and Arden B. As of May 3, 2014, the company operated a total of 532 stores in 47 states and Puerto Rico, including 478 Wet Seal stores and 54 Arden B stores. The Wet Seal is a junior apparel brand for girls who seek fashion apparel and accessories with a target customer age range of 13 to 23 years old. Until now, the Arden B has been a fashion brand for the contemporary woman. It targets customers aged 21 to 39 years old. However, the company is exiting its declining Arden B business and it's currently replacing those stores with Wet Seal and Wet Seal Plus merchandise. The transition will be completed in July 2014. The Wet Seal was founded in 1962 and is headquartered in Foothill Ranch, CA.

In recent months, shares in the company have undergone a major sell-off because of declining revenues and income caused in turn by poor winter weather, teenage unemployment, a slowdown in the discretionary income of young women. These cyclical trends have affected all of the players in this field. But because WTSL is very small compared to larger competitors such as Abercrombie & Fitch (NYSE:ANF), American Eagle (NYSE:AEO), Aeropostale (NYSE:ARO), Zumiez (NASDAQ:ZUMZ), Gap (NYSE:GPS) , etc., its strong cash position, concentrated focus, and steeper decline, it is a more compelling investment as it executes its plan to return to profitability. Not surprisingly, because of its size, WTSL declined more than its larger competitors after recent downgrades and a relentless short attack that followed.

WSTL's CEO, John Goodman, was one of the first ones to recognize the negative industry trends and to formulate aggressive steps to return to profitability. Mr. Goodman commented earlier this year: "There are macro issues that are facing the teen growth today, whether it's teen unemployment or other things that are out there," "We've got to put aside the macro for a second and ask, what can we do to get business for ourselves and what are the strategies we need to put in place to really turn the tide? The macro issues are out there, but how do we get our share of the business in a very difficult environment?"

The most significant improvement areas going forward are the replacement of the Arden B stores with Wet Seal and Wet Seal Plus stores, and the continued growth of the company's e-commerce and mobile business which posted a 1Q 2014 gain of more than 8% versus a 9% increase last year. What is even more encouraging is the fact that same store sales for June 2014 for the Teen Apparel Group grew 1.6% vs. a 0.3% forecast. This was the largest beat for the entire retail industry, and the first indication in several quarters that teens are starting to participate in the sector's recovery.

With this background, I would like to highlight changing analysts' sentiments towards the company in a positive way, and other positive catalysts that are certain to have a significant impact on results going forward. I must point out that Insider and institutional support have been strong throughout the recent downturn and pps collapse.

Recent analyst upgrades and positive CEO comments made on June 11, 2014

On June 30, 2014, analyst B. Riley upgraded Wet Seal from Sell to Neutral with a price target of $0.90. This is significant because it was the stunning analyst's 50c target following 1Q 2014 that certainly fueled the aggressive short attack on the stock causing a decline in pps to the current under-$1 territory. The 50c target seemed to ignore completely the 65c/share cash and no debt balance sheet, the progress that is being made in e-commerce, and the plans to exit the Arden B business to replace it in part with a potentially high-growth and higher margin Wet Seal Plus business.

On the opposite side of the spectrum was KeyBank's reiterating its Buy rating with a $4 target on May 28, 2014. Analyst Edward Yruma was the first one to notice positive signs. The analyst stated:

"While the 1Q proved to be another difficult quarter for The Wet Seal, Inc we believe the Company began to show signs of stabilization. Trends in the 1Q were difficult as evidenced by a -16.9% comp, but came in line with previous guidance, and there were some signs of improvement. We expect the teen retail environment to remain difficult, but believe The Wet Seal's new strategic initiatives should help improve results during 2014. We believe the Company presents significant upside opportunity for risk tolerant investors and reiterate our BUY rating and $4 price target."

More recently, on June 12, 2014, Piper Jaffray analyst Stephanie Wissink weighed in on WSTL after the company presented at the 34th Annual Piper Jaffray Consumer Conference the day before. Ms.Wissink commented, "The company's discussion highlighted product and channel evolution, both strategies to drive top-line improvement and operating margin expansion. The marketplace for a turnaround remains challenging, but management (CEO Goodman) was optimistic the worst is behind them. We anticipate comp sales rates will remain in flux, but should improve sequentially. The current pace of business suggests moderating declines. Exiting the Arden B business will aid in cash redirection toward the core Wet Seal and Wet Seal+ businesses; we are intrigued by the plus-sized concept roll-out, which will help to counterbalance pressure on the core juniors business." The firm maintained a Neutral rating and price target of $1.50.

Surprising Same Store Sales increase in June 2014 for the Teen Apparel Group

A positive macro trend was reported by Reuters on June 10, 2014 in an article entitled "JUNE SAME STORE SALES REVIEW -TEENS HIT THE MALLS JUST IN TIME FOR BACK-TO-SCHOOL."

The report stated, "The Teen Apparel group posted the biggest SSS beat, with a 1.6% SSS, above its 0.3% comp estimate. Zumiez has now posted three consecutive months of healthy comps. Teen spending is considered a proxy of discretionary spending, and the improvement in the group might suggest that consumers are starting to feel better about extending themselves."

Successful Wet Seal Plus Roll-out

Regarding the transition to Wet Seal Plus, Mr. Goodman stated in the 1Q 2014 earnings report, "We are on track with our transition work to exit the Arden B concept, including the conversion of 54 locations to Wet Seal and Wet Seal Plus merchandise, which is expected to be completed by late July. We're particularly excited about the 31 new Wet Seal Plus stores coming on line in high visibility locations, which will allow us to quickly establish a strong foothold in the rapidly growing junior plus market."

All indications are that the roll-out of the Wet Seal plus concept is proceeding successfully and as scheduled. This is potentially game-changing move by Wet Seal by focusing on the under-served teen plus-sized market, and the first one of its kind. The reception by plus teens of the new stores have been very enthusiastic and to a certain extent overwhelming.

You can read the following comments in response to the YouTube video covering the opening of a new Wet Seal Plus store in Vidalia, California:

  1. Dude I wish I had a Wet Seal Plus here in Arkansas!
  2. Me too! I looked online and supposedly the Hot Springs wet seal has plus sizes.
  3. I didn't realize this was a plus size store when I saw it a few days ago while shopping at Ulta! I'll have to go back. Thanks for the video!
  4. ahhh, what a dream! definitely going to have to go visit the one in LA when it opens!
  5. Awesome store !
  6. I want a store in Pennsylvania soo bad! I'd be there all the time

I've watched every Arden B YouTube video and I've never read a comment like "Dude I wish I had an Arden B store here in Arkansas!" The reason for the excitement is logical, there are hundreds of stores that offer Arden B like clothing to the 21 - 39 crowd throughout the US, but only Wet Seal is now focusing on the ignored teen plus crowd.

The company expects to complete the planned conversion of 54 Arden B locations to Wet Seal and Wet Seal Plus merchandise by the end of the second quarter. The conversion of 31 Arden B locations to Wet Seal Plus provides the company with a low risk opportunity to further test the concept and lay the groundwork for building Wet Seal's presence in the junior plus market. The stores will operate as Wet Seal Plus through the term of their respective leases, or longer if performance and lease renewal options warrant. The company estimates it will close 17 Arden B locations through lease expirations and the exercise of early termination provisions through the remainder of fiscal 2014. In FY14 the company expects to open 10 new Wet Seal stores, primarily in outlet centers and off-mall, and now estimates it will close 23 Wet Seal locations upon lease expiration.

The company is essentially replacing a dying Arden B brand with ever increasing SSS declines last approaching 20%, to a brand with potentially mass appeal and very little competition at this time. Being first also helps cementing brand appeal and name recognition as well as increasing customer loyalty in this market.

The company estimates that the Arden B division fully closed and transitioned will free up $1.3 million of annual costs going forward.

E-commerce/Mobile/Social Media Gains

Regarding the growing e-commerce contribution to revenues and net income, Ki Bin Kim, director of U.S. REIT equity research at SunTrust Robinson Humphrey, recently noted: "In our view, teens didn't suddenly stop shopping, they are simply spending a significant portion online at very well run online fashion retailers." As noted earlier, the company's e-commerce and mobile business which posted a 1Q 2014 gain of more than 8% versus a 9% increase last year. Company management is confident that they can increase the e-commerce contribution from 6% last year to about 10% this year. This is equivalent to an increase of over $20 million higher-margin yearly revenues!

Key contributors to the continued progress of this area of the business are the three of the newest Board members who have a wealth of experience in social, digital and e-commerce.

The retail industry has evolved drastically with a dramatic change in consumer buying habits. Consumers today are knowledgeable, more inquisitive and choosy. Moreover, today's customers have numerous shopping options at their disposal like in-store, online, mobiles, social media and so on, that influence their purchasing decision.

Short Interest As Fuel For PPS Uptick

Wells Fargo recently noted that 14 of the 62 retailers it covers have short interest equating to 15% or more of their shares outstanding. That is the highest number above that threshold since the recession ended. And short sellers are sticking to their guns. Any stock that crossed the 15% level over the past 12 months is still above 15%, the bank noted. This includes WTSL with 17.7 million shares short as of June 30, 2014, or over 20% of the shares outstanding.

As bad as the short attack has been thus far, short covering in anticipation of improving earnings results and guidance going forward could fuel a significant rally a quick pps recovery. As of June 30, 2014, shorts would need almost 10 days to cover.

Strong Insider and Institutional Support

Fidelity investments categorizes insider support at WTSL as "Positive" having purchased an average of 122,984 shares per year in the last two years. The following table was published by another SA contributor recently. The table does not reflect the 30,000 shares purchased by Director Adam Rothstein on June 26, 2014.

(click to enlarge)

Institutional support continues to be strong. The most recent filing for the period ending June 30, 2014 show that Blackrock Advisors LLC now own 3,859,122 or 4.57% of the company. It will be interesting to see if bargain-hungry groups like Sycamore Partners will file regarding a new position in WTSL. Sycamore Partners and other groups have acquired, or are in the process of acquiring, retailers in distress in a very active sector M&A environment due to low valuations and low interest rates.

WTSL - An Acquisition candidate?

There have been persistent rumors and statements in recent months that WTSL is a desirable acquisition candidate even when the stock price was at much higher prices. The macro sector improvements such as an uptick in SSS mentioned above, and the specific improvements being made by Wet Seal in the area of e-commerce, the successful transition from Arden B to Wet Seal Plus, its strong balance sheet and experienced management, makes WTSL and attractive acquisition candidate.

Conclusion

In my opinion, WTSL is one of the teen apparel players with the highest upside going forward because of its strong cash position, large P/S and P/B discounts, tangible plans for a sales turnaround, and strong management. The economic outlook for 2014 remains positive based on favorable economic data and an improved consumer and business outlook. The latest sales data of most retailers reveal that the industry has been picking up with better-than-expected comps reported for the fourth straight month. The latest key metrics data released last week reflect a positive sentiment. The improved results in June were mostly attributed to a rise in traffic resulting from the positive economic factors like a 0.2% decline in unemployment rate and 7.4% rise in consumer credit as well as heavy promotions and favorable weather.

With only about a month left until Q2 2014 is reported, the realization that WTSL is an extremely undervalued stock relative to its current price and progress being made in several fronts could trigger a significant uptick in stock price as shorts rush to cover their positions.

But there are also risks involved such as the June SSS progress shown not being sustainable, the company failing to execute its turnaround plans, losses potentially being higher than expected, an unsuccessful Wet Seal Plus roll-out, reduced mall traffic due to bad weather or any other reasons. Any investor looking to buy Wet Seal stock should read carefully the risks and uncertainties listed in the latest company 10-K and 10-Q filings with the SEC

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.

Source: The Wet Seal Inc.: Analysts Have Recently Upgraded The Stock To Reflect Successful Execution Of Turnaround Plans