Bebe: A Turnaround In Progress, And A Rally Set To Continue

| About: bebe stores, (BEBE)
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Since we first profiled bebe stores (NASDAQ:BEBE) on January 29, recommending that investors open positions in shares of the retailer, shares of bebe have risen by over 37% through the close of trading on June 19, trouncing the S&P 500's 8.97% gain over the same time period. With a new management team and strategy, bebe is poised to continue not only its turnaround but its rally as well. Unless otherwise noted, financial statistics and management commentary cited in this article will come from one of three places: bebe's Q3 2013 earnings release, its Q3 2013 earnings conference call or its latest 10-Q filing.

Q3 Review: A Turnaround Underneath the Surface

In retail, turnarounds do not happen overnight, nor do they happen in a single quarter, or even a single fiscal year. The challenge for retailers is to have the capital, brand reputation and management team to complete a turnaround, all while continuing to communicate effectively with their customer base. And bebe has the necessary resources across all channels. The retailer continues to have a clean balance sheet, with $181.544 million in cash and investments, and no debt. Although bebe is burning cash ($10.043 million in its latest quarter), the company's financial position remains solid. Assuming current burn rates hold, bebe will have more than enough cash to return to sustained profitability, currently estimated to occur in fiscal 2015. Losses are set to narrow in fiscal 2014 to a loss of 21 cents per share, down from an estimated 31 cents in fiscal 2013. The company has also revamped its management team, hiring Steve Birkhold as its new CEO in January, something we covered in detail in our previous article on bebe, as well as revamping other managerial positions. And in May, the company hired Keith Keegan as its new head of marketing. Keegan has previously worked at several leading retailers, including American Eagle Outfitters (NYSE:AEO), Abercrombie & Fitch (NYSE:ANF), as well as Limited and Express (NYSE:EXPR). Crucially, bebe is continuing to be engaged with its customer base, with CEO Steve Birkhold noting on the company's earnings call that,

"All of these changes are enabling us to create a new organization that is much more action oriented and will allow us to stay focused on our core and react quickly to the business trend. While we continue to anticipate some level of needed mark downs to our current assortments on the floor, I'm encouraged by the momentum we are starting to see across many categories. The new merchandise that we have been developing is more trend wise and we are encouraged by the strong reaction we have received from our customers in dresses, body-conscious silhouettes casual and impressive bottoms, the new BEBE SPORT logo and opening price points across all categories. Last with marketing, we are very excited about the work that we've done since I've joined in January. We have gone through in-house customer surveys and external research partnered with an outside agency to assist us with our re-branding and messaging. The underlying strategy is very simple. We have gone back to our roots. Our emphasis is to set the trend, not just follow the trend. We will continue to focus on our core customer, who is very focused on contemporary faction, proud to be sexy and noticed, expect quality and value in the products that she purchases."

Bebe's results for Q3 2013 may seem to suggest that the company's turnaround is failing. Sales fell 6.72%, and the company's gross margin fell to 29.7%, down from 38.7% a year ago. SG&A expenses also rose by 10.58% to $52.191 million, due in large part to costs related to bebe's restructuring, including store closures, severance costs, as well as costs tied to rebranding bebe. CFO Liyuan Woo noted on bebe's earnings call that the company was highly promotional during the quarter in an attempt to flush out its legacy inventory in advance of new product offerings set to debut later this year. The company expects same store sales to decline in the high single digits in Q4 2013, which ends at the end of June, and does not cover the crucial holiday season, by which point in time bebe will likely have a wide slate of new product offerings. Part of bebe's guidance for the quarter encapsulates contractual obligations to purchase what it calls "legacy" products from its manufacturers, with CFO Liyuan Woo stating that these products will likely work their way through bebe's channels by the end of Q1 2014, ending in September. On the surface, bebe's Q3 results offer little tangible evidence of a turnaround. But, underneath the surface, the situation is much different.

The company's 2b stores, structured as everyday lifestyle-focused stores, saw positive same store sales this quarter, and bebe is maintaining focus on investing in its marketing and sales platforms, not only in e-commerce, but also in traditional formats as well. CEO Steve Birkhold noted that the company's April mailers drew positive responses from its customers, and that its e-commerce channels saw pockets of strength, particularly in "on-trend" product categories. Analysts also pressed bebe's management team about its gross margins on the call, for this has been an area of obvious weakness for the company. CEO Steve Birkhold noted that gross margin rates for what he termed "incoming products," which consists of bebe's non-legacy items, have been "very stable." The gross margin issues stem almost completely from the company's promotional activities tied to its legacy inventory, and Birkhold stated that, "we continue to drive through what I would call inventory problems in a very, very strong way. So we're not looking for major, major changes (to gross margins) although we are seeing some improvements."

Analysts also looked for indications of bebe's longer-term plans, with questions raised about the company's potential plans to put more emphasis on wholesale. CEO Steve Birkhold effectively tabled such a discussion, something we view as a positive, by saying the company's focus is firmly set on its own stores and e-commerce platforms, and that wholesale plans will have to wait. Retail turnarounds are complex matters, and we view it as a positive that bebe is led by a CEO who knows the company's limits. At this point in its corporate lifecycle, bebe needs to maintain focus on its most crucial areas: merchandise, management and marketing.

We have discussed the first two areas, and would like to now turn to the third. Bebe has stated on its Q3 earnings call that it has hired a new creative agency in order to create a new slate of advertising campaigns that would be viable for some time, as opposed to "one-off" events that fail to hold the attention of bebe's core customers, or attract the attention of new customers. CEO Steve Birkhold declined to reveal many details regarding the company's upcoming marketing campaign on bebe's Q3 earnings call, but did note that it will include all of bebe's key brands, such as 2b and bebe Sport, which according to Birkhold is seeing signs of success, including market share gains.

We do not believe that bebe's Q3 results should be viewed as a final judgment on the company's turnaround potential. CEO Steve Birkhold and his new management team are executing across a number of fronts, and already, there are signs of progress on multiple fronts. Bebe is working to put its legacy inventory issues behind it, and its new offerings should be in place for the 2013 holiday season. The company plans to outline its full long-term strategic vision to the board of directors in September, with an investor and analyst day set to occur after this board meeting. In our view, investors should, at a minimum, maintain their positions through bebe's investor and analyst day, for we believe that the company will provide meaningful insight into its turnaround plans and strategy, insights that should prove profitable for bebe's investors.

Capital Structure Review

As we noted above, bebe ended its latest quarter with $181.544 million in cash and investments, and no debt. And although bebe is currently burning cash, there are levers for the company to preserve or raise cash should such a necessity occur. Notably, bebe instituted a $30 million buyback program in November 2012, and through May 8, 2013, the company has spent $21 million on repurchasing approximately 5.5 million shares (bebe's outstanding share count has fallen by 4.73% in the last quarter alone to 78,935,446 shares). The company could elect not to spend the remaining $9 million of its buyback program, and could also suspend its dividend, a move we believe would not be seen as a material negative by investors. Bebe's current $0.025 quarterly dividend results in a yield of 1.76% at current prices. And while such a yield is not necessarily low, we doubt that many of bebe's existing investors hold its shares for its dividend. The dividend cost bebe $6.242 million in its latest quarter, and we believe that this cash could be put to better use by investing it in the company's business. Per its latest 10-Q, bebe has access to a $10 million line of credit through May 14, 2014, should the need for further cash arise. Furthermore, although the company leases all of its stores, it does hold millions of dollars worth of land and buildings. Per its latest 10-K (bebe does not break down the details of its property and equipment in its quarterly filings), the company holds $29.457 million of land and buildings (the bulk of the company's property and equipment consists of leasehold improvements, property that we believe could be lent against should the need to do so arise.

A review of bebe's capital structure would be incomplete without mentioning founder and chairman Manny Mashouf, who remains bebe's non-executive chairman, as well as its largest investor. Manny Mashouf has not sold shares of bebe since our last article, electing to maintain his 47,172,857 share stake, which has expanded to 59.76% of bebe's outstanding shares (up from 55.89% in January), thanks to the company's buyback program. We believe that should bebe's capital needs intensify Mashouf will come to the company's aid, for should bebe falter, he has the most to lose. Mashouf's stake provides for a meaningful backstop for shares of bebe. Although the company has nearly 79 million outstanding shares, its float is less than 29 million shares, which has caused short interest in bebe to rise to over 15% of its float. Should bebe continue to buy back stock, and execute on its turnaround, there is potential for a short squeeze to take place.

Conclusions

Even with a rally of more than 36% since January, we believe that shares of bebe have further to climb. Under the leadership of Steve Birkhold and his new management team, bebe has begun to show signs of turning itself around, and we believe that in the quarters to come, there will be more tangible signs that bebe can once again reach sustainable profitability. In our view, bebe has the necessary resources to execute on its turnaround, both from a strategic and financial perspective, and that investors who add to or initiate positions in bebe will be rewarded for their conviction.

Disclosure: I am long BEBE, AEO, ANF. 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.