<FOOLISH WORKSHOP>

Shopping Teen Retailers with Rising Margins      

by Louis Corrigan (TMF Seymor)

Atlanta, GA (May 18, 1999) -- A bevy of retailers on our Rising Margins screen this week.

I'll start with The Buckle <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BKE)") else Response.Write("(NYSE: BKE)") end if %>, an apparel retailer with 231 stores in 31 states. It targets the 12-to-24 teen through college crowd, selling Doc Marten shoes and jeans from Polo Ralph Lauren <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RL)") else Response.Write("(NYSE: RL)") end if %> and Tommy Hilfiger <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TOM)") else Response.Write("(NYSE: TOM)") end if %>. Now trading for around $24, the stock has barely budged since March 9 when I highlighted the company's strong Q4 results and deemed it worth watching for a dip.

The stock did trade down to around $18 just a few weeks back, but it's jumped 20% since the Q1 earnings came out. Clearly, investors liked the numbers. Revenue rose 18.9% to $79.7 million on a 6.9% jump in same-store sales. Earnings per share (EPS) notched a 33% gain to $0.28 versus $0.21 a year ago. While gross profit margins increased slightly to 34.0% from 33.9%, selling expenses as a percent of revenue declined by 0.7 percentage points to 18.6% as general and administrative expenses dipped to 3.1% of sales from 3.3%

The story here is steady growth in a segment prone to some volatile fashion trends and overbearing competition from the Gap <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GPS)") else Response.Write("(NYSE: GPS)") end if %>. The Buckle has managed to grow same-store sales by 7.5% in FY95, 11.1% in FY96, 18.6% in FY97, and 15.4% in FY98. That's amazing.

Trailing twelve-month results look like this: revenues of $350.6 million, net income of $35.5 million (10.1% margin), and EPS of $1.56. So even now, the stock trades for just 15.4 times trailing earnings or 14 times the consensus
FY99 (January) estimate of $1.71. Back out some $4 per share in cash, and the current P/E drops to just 12.8 versus 18.5% long-term growth projections. The company didn't release a balance sheet in its press release, but return on equity last year was a sparkling 26.8%.

Retail stocks can get bashed by interest rate fears, and teen retailers tend to be especially volatile. Nonetheless, The Buckle is still shining, meaning it's still worth getting to know. For more, see this Fool on the Hill column.

Next up, Pacific Sunwear <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PSUN)") else Response.Write("(Nasdaq: PSUN)") end if %>, another apparel retailer tackling the teen/college market but with a bent towards surf clothes. The company operates 338 Pacific Sunwear stores plus 13 related outlet stores and 23 d.e.m.o. stores, which market an urban look to young suburban men.

First quarter sales hit $81.4 million, up 33.2%. Comp-store sales increased 7.2%. Gross margins were virtually flat, but selling, general and administrative (SG&A) expenses declined to 24.2% of sales from 24.8%. That was enough to boost EPS by 46% to $0.19 from $0.13.

The company has announced plans to open 108 new stores this year while relocating or expanding 15 others. That will increase square footage by a fat 42%, which is one reason analysts are so optimistic, looking for earnings to soar 31% to $1.45 per share for the fiscal year ending next January. Long-term growth is pegged at 26%.

Even so, the Fool Snapshot shows that, compared to The Buckle, Pacific Sunwear has less cash (just about 50 cents per share), a lower net margin (7.2%), and a lower return on equity (actually 20.6%). With its $341.4 million in trailing 12-month revenues, Pacific Sunwear falls just shy of The Buckle in revenues. Yet, at $38 5/8, Pacific Sunwear now sports a market capitalization of $820 million, or 2.4 times sales, versus The Buckle's market cap of $529 million, or 1.5 times sales. And that's before backing out The Buckle's cash.

Moreover, Pacific Sunwear is now priced at 33.3 times trailing earnings and 25.8 times even the high-side FY99 estimate of $1.50 per share. Yes, analysts expect Pacific Sunwear to grow at a faster clip, but this huge price disparity seems unwarranted. Such comparisons don't tell the whole story, but they are suggestive. Either the analysts calling for Pacific Sunwear to hit $50 a share are gaga, or The Buckle may represent quite a bargain. My guess is that the answer is a little of both.

Finally, we'll look at the Gap, which is the nation's #2 specialty retailer with 1,138 Gap stores, 676 GapKids stores, 295 Banana Republic locations, and 420 Old Navy stores. I love the Gap, but I've been skeptical of the company's ability to follow up last year's phenomenally successful "Khaki Swing" basics promotion. That's because you don't really need to buy more khakis after you've loaded up. The Gap's challenge has been to add a little more fashion to the mix without getting stuck with a bunch of inventory you have to mark down to move.

To some extent, this has been a problem. A trip to the mall this weekend revealed that the whole cargo pocket fetish seems to be playing itself out with a kind of frenzy that would make nice fodder for some aspiring graduate student schooled in postmodern Marxist critiques of consumer capitalism. It's like differences are allowed to proliferate, but only within a very narrow spectrum of acceptability.

Even that narrow spectrum, though, led to problems, as I found a bunch of heavily discounted merchandise. Along with the earlier Easter, that may explain why same-store sales for April at the Gap chain actually fell by an estimated 4% as overall same-store sales increased just 1% (some analysts were looking for a 6% increase) for the month.

However, Old Navy has actually become the retailer's major growth engine, with some projecting this discount unit could match the flagship chain's revenues within two years. While same-store sales rose in the mid-single digits for the Gap chain and actually declined for GapKids, comps increased about 21% for Old Navy and 13% for the upscale Banana Republic. So the price segmentation strategy appears to be working well.

First quarter results tell the story. Sales soared 32% to $2.278 billion on an 11% increase in overall same-store sales (atop a 17% gain last year). EPS shot up 55% to $0.34 versus $0.22 per share a year ago. On the other hand, inventories increased 45.6% to nearly $1.2 billion while retail square footage rose just 22% to 19.5 million. Even with the still strong overall same-store sales gains, inventories seem a little high. That's especially true since the 19% same-store sales increase in 1998's second quarter means the Gap has another high hurdle this quarter.

Still, some analysts raised their earnings targets, pushing the consensus for the year ending next January to $1.71 per share. Using the high-side estimate of $1.80, the stock, at $61, now trades for 34 times forward estimates, a stiff premium to the company's projected 19% long-term growth rate. Then again, the Gap is the premier retailer in this space, and nothing seems likely to change that anytime soon.

Here are links to recent articles about other companies on this week's Rising Margins screen: a Fool on the Hill on Abercrombie & Fitch <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ANF)") else Response.Write("(NYSE: ANF)") end if %>, a Fool Plate Special on Children's Place <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PLCE)") else Response.Write("(Nasdaq: PLCE)") end if %>, and a Fool Plate on Gemstar <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GMST)") else Response.Write("(Nasdaq: GMST)") end if %>. Happy shopping.