Tilly's Still Has 20% Upside, Even After Recent Run-Up

| About: Tilly's, Inc. (TLYS)
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Summary

We initially became interested in TLYS following a dip in the stock after the company reported poor Black Friday sales.

Since then, the stock has run-up 20% due to Q3 revenues and earnings substantially beating analyst estimates.

Despite this run-up, we are still holding our position in the stock due to our $9.80 price target.

Back Story

A stock that has recently piqued our interest is teen specialty retailer Tilly's, Inc. (NYSE:TLYS), which has taken a toll in the past 3 months due to macroeconomic concerns in the specialty retail industry, specifically teen retail. The company is involved in merchandising hip skate and surf clothes to both boys and girls.

We actually initially became buyers of TLYS after the stock took a hit recently due to poor Black Friday results. The company reported that Black Friday sales this year decreased 11% compared to last year's Black Friday sales. Our decision to buy the stock following this dip came from analyzing the chart below (taken from Monday, December 1).

TLYS Chart

TLYS data by YCharts

At that time, we can see that the stock traded in line with its EMAs, but that the recent dip due to poor Black Friday sales was not reflected in the RSI index. And it shouldn't have been. Market sentiment surrounding this stock shouldn't be greatly afflicted by a poor Black Friday showing. Black Friday sales shouldn't affect TLYS too much, a store where moms do everyday shopping for their kids' clothing. Namely, we don't think TLYS' demographic is tailored too heavily to Black Friday shoppers.

At that time, we were happy owning the stock on the dip, given its cheap valuation (see below chart) and its bullish Insider sentiment (1.99 Insider Buy/Sell Ratio, with the most recent sale occurring in March at a price north of $12 per share).

TLYS PE Ratio (Forward) Chart

TLYS PE Ratio (Forward) data by YCharts

Since then, however, the landscape surrounding Tilly's has changed, as after-hours on Wednesday afternoon the company reported better than expected sales and earnings. TLYS reported a Q3 EPS of $0.18, marking a $0.07 beat on analyst estimates of $0.11. TLYS also reported revenues of $131.28 million (+6.1% y/y), a $6.1 million beat on analyst estimates.

The stock has had a very upbeat reaction to this news, as it is up 17.95% after-hours today.

Naturally, this requires us to do perform further analysis on TLYS.

Breaking Down Q3 Results

Net sales grew 6.10% y/y to $131.3 million in Q3. This sales growth was driven by excellent management follow through on TLYS 2014 growth initiatives, outlined at the beginning of this fiscal year:

  1. Increased Product Differentiation and Innovation
  2. Greater Emphasis on Digital Platform
  3. Evolving Real Estate Strategy

Addressing the first initiative, the company continued to make significant investments in dominant on trend products and categories in Q3. TLYS also started to feature GoPro, Stance, Sector 9, and Full Tilt Dream products in Q3, each of which posted good sales numbers in line with management expectations. In addition, TLYS rolled out exclusive products from LRG, Hurley, Volcom, Adidas (OTCQX:ADDYY), and Vans during Q3, which were a large driver in the 6.10% sales growth.

Addressing the second initiative, the company launched a new responsive design e-commerce platform for desktop and mobile in Q3. The company is very happy about the platform's smooth implementation and positive consumer reception. Further, Tilly's Hookup loyalty program (wherein products are selected for consumers based on prior purchases and interests) has grown to more than 1 million users.

Addressing the third initiative, TLYS opened 5 new stores, 2 of which are outlets, in Q3, bringing the new store count to 19 in FY 14. Further, the company closed 1 store, so by quarter end, TLYS owned and operated 207 stores throughout the US. The new stores are performing well and in-line with management expectations. Further, the success of new stores in new locations, including expansions into Atlanta and Memphis, serve to bolster the relevancy of the brand throughout the US.

As a result of following through with these initiatives, the company saw profit grow 7.1% y/y to $40.5 million. Comps, however, decreased 1.2% y/y due to decreased traffic [as seen in other mall retailers such as Michael Kors (NYSE:KORS) and Urban Outfitters]. Comps would've decreased further had a large portion of the decreased traffic not been offset by high transacting prices in Q3.

Product margins increased 30 basis points due to strong product offering and disciplined inventory management. This 30 basis point increase drove gross margin up to 30.9% in Q3.

Operating income was $8.6 million (operating margin of 6.54%) compared to $10.2 million (operating margin of 8.20%) a year ago, and net income came in around $5.1 million, nearly a 17% y/y decrease.

Turning towards the balance sheet, TLYS continues to grow cash while remaining debt-free. TLYS reported $61.3 million in cash and marketable securities, a 21.2% y/y increase, while cash used for capital expenditure fell in Q3 to $5.2 million, down from $12.2 million a year ago. Inventory totaled $62.2 million, a slight y/y increase.

Given these bullish quarter results, management expects Q4 EPS to fall in the range of $0.15 and $0.19 and SG&A expense to take a one-time hit in Q4, but gave little guidance elsewhere in Q4.

Financial Model

To craft our financial model for the company, we resourced historical data on how TLYS has done against analyst expectations this past fiscal year.

First, let's look at how TLYS reported earnings have compared to analyst estimates.

Fiscal Quarter Beat / Miss
Q1 FY14 In-Line
Q2 FY14 In-Line
Q3 FY14 +$0.07

Applying an exponential average to these beat / miss figures, we get:

[3($0.07) + 2($0.00) + 1($0.00)] / 6 = $0.21 / 6 = $0.035

Given the company's very bullish quarter and upside forthcoming in the holiday season, we have no reason not to believe this beat estimates trend should continue. Siding with a more conservative estimate, then, we forecast Q4 FY14 earnings to beat the consensus estimate $0.18 by $0.03 (rounding $0.035 down to nearest cent), thus finalizing our forecast for Q4 FY14 EPS at $0.21.

Second, let's look at how TLYS reported revenues have compared to analyst estimates, including our Q4 FY14 revenue estimate.

Fiscal Quarter Beat / Miss
Q1 FY14 -$2.12 m
Q2 FY14 +$0.85 m
Q3 FY14 +$6.1 m
Q4 FY14E +$2.9 m

Thus, we see that the sum total for a fiscal year is a beat by 7.73 million on revenue estimates. Again, given the company's very bullish quarter and upside forthcoming in the holiday season, expansion into new areas of the US, and the company's dominating e-commerce and omnichannel presence in the skate and surf world, we feel there is no substantial reason not to forecast revenues to continue to beat. Our forecast for FY15 revenue, therefore, is $551.5 million, a $7.73 million beat on current analyst estimates.

Holding COGS and SG&A relatively constant at 70% and 25% levels, respectively, we forecast a bottom-line in FY15 of $0.59, a nine cent beat on current estimates.

Consolidated Statements of Income (USD $)
In Thousands, except Per Share data, unless otherwise specified Q1 Q2 Q3 Q4 2013 Q1 Q2 Q3 Q4E 2014E 2015E
Net sales $109,119 $123,043 $123,779 $139,896 $495,837 $111,134 $123,060 $131,283 $148,290 $513,767 $551,500
% Change N/A N/A N/A N/A N/A 1.85% 0.01% 6.06% 6.00% 3.62% 7.34%
Cost of goods sold (includes buying, distribution, and occupancy costs) 77,313 85,155 85,587 95,487 343,542 79,807 88,405 90,735 98,369 357,316 386,050
% of Sales 70.85% 69.21% 69.15% 68.26% 69.29% 71.81% 71.84% 69.11% 66.34% 69.55% 70.00%
Gross profit 31,806 37,888 38,192 44,409 152,295 31,327 34,655 40,548 49,921 156,451 165,450
% of Sales 29.15% 30.79% 30.85% 31.74% 30.71% 28.19% 28.16% 30.89% 33.66% 30.45% 30.00%
% Change N/A N/A N/A N/A N/A -1.51% -8.53% 6.17% 12.41% 2.73% 5.75%
Selling, general and administrative expenses 27,889 30,689 28,042 35,938 122,558 30,250 32,326 31,971 40,038 134,585 137,875
% of Sales 25.56% 24.94% 22.65% 25.69% 24.72% 27.22% 26.27% 24.35% 27.00% 26.20% 25.00%
Operating income 3,917 7,199 10,150 8,471 29,737 1,077 2,329 8,577 9,882 21,865 27,575
% of Sales 3.59% 5.85% 8.20% 6.06% 6.00% 0.97% 1.89% 6.53% 6.66% 4.26% 5.00%
% Change N/A N/A N/A N/A N/A -72.50% -67.65% -15.50% 16.66% -26.47% 26.11%
Other income (expense), net 49 -47 116 -109 9 0 4 -22 0 -18 0
Income before income taxes 3,868 7,152 10,266 8,442 29,728 1,077 2,333 8,555 9,882 21,847 27,575
Income tax expense 1,560 2,885 4,121 3,025 11,591 486 1,067 3,442 4,002 8,997 11,168
% of Pre-Tax Income 40.33% 40.34% 40.14% 35.83% 38.99% 45.13% 45.74% 40.23% 40.50% 41.18% 40.50%
Net income $2,308 $4,267 $6,145 $5,417 $18,137 $591 $1,266 $5,113 $5,880 $12,850 $16,407
% of Sales 2.12% 3.47% 4.96% 3.87% 3.66% 0.53% 1.03% 3.89% 3.97% 2.50% 2.98%
% Change N/A N/A N/A N/A N/A -74.39% -70.33% -16.79% 8.55% -29.15% 27.68%
Basic earnings per share $0.08 $0.15 $0.22 $0.20 $0.65 $0.02 $0.05 $0.18 $0.21 $0.46 $0.59
Diluted earnings per share $0.08 $0.15 $0.22 $0.20 $0.65 $0.02 $0.05 $0.18 $0.21 $0.46 $0.59
Weighted average basic shares outstanding 27,692 27,727 27,884 27,884 27,822 27,983 28,014 28,024 28,000 28,000 28,000
Weighted average diluted shares outstanding 28,027 28,080 28,166 28,166 28,116 28,151 28,049 28,046 28,000 28,000 28,000

Applying our forecasted $0.59 EPS to the current 16.68x forward earnings multiple, we reach a 1-year price target for the stock of $9.80.

For that reason, we are still holding the stock, despite its nearly 20% after-hours run up.

Disclosure: The author is long TLYS.

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.