Is The Sun Setting Or Rising At PacSun?

| About: Pacific Sunwear (PSUN)

Pacific Sunwear of California (NASDAQ:PSUN) is a youth-oriented retailer that sells brand name and private label California and action-sports themed apparel. Competitors selling similar apparel include Zumiez (NASDAQ:ZUMZ) and Tilly's (NYSE:TLYS). While Zumiez and Tilly's reported profits in their most recent earnings releases, PacSun has not reported positive earnings for any fiscal year since 2007.

There have been numerous articles written recently suggesting PacSun's days are numbered. As some of these article seem narrow in focus, I will offer some counterpoints that investors may wish to explore further. The two main concerns I will look at are suggestions that PacSun is on the brink of bankruptcy, and concerns that it cannot compete with Zumiez and Tilly's.

Concern No. 1: Some say that PacSun is on "the brink of bankruptcy" or will disappear from the mall.

In its most recent 10-Q, filed on June 6, 2012, for the quarter ended April 28, 2012, the company stated:

Based on current forecasts and plans for the year, the company believes that cash flows from operating activities, working capital, borrowing availability under the New Credit Facility, and cash on hand resulting from the closing of the Term Loan and the two mortgage transactions discussed below will be sufficient to meet its operating and capital expenditure needs for the next 12 months.

Same-Store Sales

The company went on to state that the preceding assumption was based on a scenario in which the company does not experience same-store sales declines comparable to its same-store sales declines in 2009 and 2010. According to the company's 10-K filed on March 31, 2011, same-store sales declined 20% in 2009 and 8% in 2010.

Is there any reason to expect this kind of decline in same-store sales in the near future? At the end of last year, PacSun announced it would be closing approximately 200 of its underperforming stores by the end of fiscal 2012. The company further stated at the time that the stores to be closed had average sales per store over the prior 12 months of $600,000 vs. average sales of $1.1 million for the remaining stores. PacSun closed 87 stores in Q4 2011. The company's net store count declined by four stores from the end of fiscal 2011 to May 17, 2012, to a total of 729 stores.

Furthermore, in PacSun's most recent earnings release for the first quarter ended April 28, 2012, the company reported a same-store sales increase of 1% and guided same-store sales for the second quarter of negative 1% to positive 4%. Based on this sales guidance, the company guided a non-GAAP net loss from continuing operations of between $0.11 and $0.16 per share for its second quarter.

Whatever conclusions investors may draw after reviewing management's commentary and financial statements, it may be worth looking at PacSun's insider activity following the issuance of the second-quarter guidance. Specifically, from the end of May 2012 to the beginning of July 2012, PacSun insiders, including CEO Gary Schoenfeld, have been notably buying stock in the company. Despite these insider buys, according to Nasdaq, there were about 6.4 million shares short of the company on July 31, 2012, which has declined from almost 8.8 million shares on June 15, 2012.

Affiliate of Golden Gate Capital Loan

While some of the articles I have seen have raised questions of PacSun's solvency, I have not seen many articles commenting on the specific details of its $60 million dollar loan.

The company's 10-K, filed on April 4, 2012, described a five-year, $60 million senior secure term loan funded by an affiliate of Golden Gate Capital. Page F-14 of the 10-K specified: "Annual cash interest for fiscal 2012 is expected to be approximately $3 million." Furthermore, the "principal balance and any unpaid interest related to the Term Loan is due on Dec. 7, 2016. The company is not subject to any financial covenant restrictions under the Term Loan."

So while some articles may question PacSun's solvency, investors may want to consider the company's comments on same-store sales and that metric's relation to cash flows. In addition, investors may want to consider the due date of the term loan, and whether they believe the company can afford to pay $3 million in interest on the loan in fiscal 2012.

Concern No. 2: Some say that PacSun is unable to compete with Zumiez or Tilly's.

While PacSun's competitors have fared better in recent years, that is no guarantee that the future will resemble the past. Investors can conduct channel checks at various stores and talk to target customers to attempt to subjectively determine which retailers may be "cool."

I believe that social media, while far from scientific, can provide potential clues as to which brands are increasing or decreasing in popularity. A recent comScore study commissioned by Facebook (NASDAQ:FB) indicates that when an individual posts a status update mentioning a retail brand, that individual and his or her Facebook friends who see the update are more likely to buy a product from that brand's store.

In May, I compared Facebook "likes" of PacSun, Zumiez, and Tilly's. Since then, all three companies' "likes" have increased by approximately 13%. PacSun has the most "likes" of the three, recently passing the 2 million "like" mark. The chart below, comparing Facebook stats at the time of writing this article, would seem to indicate that if the "likes" are authentic -- PacSun is not as unpopular as some investors may believe. The source of this information on Facebook can be viewed by clicking on PacSun's Facebook page, Zumiez' Facebook page, and the Facebook page of Tilly's. I have also included Facebook's statistic called "People Talking About This."




Facebook Likes Around May 21, 2012

1.77 Million

1.04 Million

334 K

Current Facebook "Likes"

2.00 Million

1.17 Million

380 K

Change (%)




"People Talking About This"




Investors in youth-oriented retailers face the tricky challenge of determining whether a brand is gaining or losing popularity with potentially fickle customers. However, when reading headlines declaring any company to be finished, investors may want to do additional research to see if there are other factors that one should consider before drawing such a conclusion.

In PacSun's case, investors may want to consider management's comments, insiders' actions, and what the actual potential customers think of the brand. Furthermore, when the company announces earnings, investors might want to keep an eye on any guidance for the back-to-school season, and see how the company expects to perform compared to any guidance provided by its competitors.

PacSun and Tilly's have both recently announced that they will report earnings on Aug. 22, 2012. At the time of writing this article, Zumiez does not have its Q2 earnings release date on its investor relations' events calendar. However, it has already reported a same-store sales increase of 9.5% on its second quarter compared to the prior year.

Disclosure: I am long PSUN.

Disclaimer: The commentary expressed in this article is not legal advice, nor investment advice, and is subject to Seeking Alpha's Terms of Use.

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