These days, times are tough in the middle market of the retail business. Luxury companies like Louis Vuitton (OTCPK:LVMUY) are doing just fine, as the rich keep spending regardless of the economic climate. And discount retailers like Wal-Mart (NYSE:WMT) are benefiting big-time from tight budgets in the lower and middle classes as consumers look to cut costs on discretionary items as their gas and food bills soar. But the middle men - companies like American Eagle Outfitters (NYSE:AEO), The Gap (NYSE:GPS), and Tween Brands (TWB) - are suffering as their customers choose low-cost alternatives, or make do with last year’s wardrobe.
On Tuesday, Tween Brands announced that it will shift its focus from its more established Limited Too stores to its newer, cheaper Justice Brand. In response, investors crushed Tween’s stock price - it fell 17% in that day’s trading. Tween, which is focused on selling to the 7-14 year old girls that are its namesake, will shift 560 of its Limited Too stores to the Justice brand name by first quarter 2009. The company says that it will take a charge of $18 million in the second half of the year after making this move. But it hopes that the conversion will lead to annual savings of $20 to $25 million in 2009 and beyond, after laying off Limited Too staff and shaving marketing and store expenses.
Tween was spun off from Limited Brands (LTD) (the parent company of Victoria’s Secret and Bath & Body Works) in 1999 on the strength of the Limited Too chain, which started as an in-store department of The Limited and then grew into its own brand as it captured the imaginations of fashion-conscious pre-teen girls. Sales have grown every year since 2003, boosted by the debut of the Justice brand in 2004, which targeted a less sophisticated, younger group of customers but charged lower prices for its merchandise. Buoyed by Justice, the company’s revenue has nearly doubled since 2003, surpassing $1 billion in 2007.
But as spending tightened across the retail industry in 2007 and 2008, thanks to rising food and gas costs and plummeting residential property values, Tween has felt the pinch. The pain has been most acute at its Limited Too stores, where sales growth has been completely flat. But Justice has thrived - 21% growth in 2007 compared to 0% at the Limited Too - thanks to its low prices and emerging brand recognition among the “tween” demographic.
And so the company has made a radical shift in its focus, deciding to close its Limited Too stores to focus on its newer, upstart brand. It’s a risk - while Justice has proven successful in its current niche, there will be a lot more pressure to perform as its reach (number of stores) increases by 200%. But if the move is successful, it could pay off big time. Why? Combine the $25 million in cost savings mentioned above, with the double-digit sales growth Justice has seen in recent quarters. TWB is already trading at a P/E under 5, more than respectable in the retail business (compare with The Gap at 16 and Aeropostale at 18). If Justice is served, look for earnings to grow, and TWB’s stock price to follow.