Wet Seal the Deal?

 | Sep 08, 2013 | 6:00 AM EDT
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Girl and women's apparel retailer Wet Seal (WTSL) filed its 10-Q for the second quarter of its fiscal year (the quarter ending in early August) at the end of last month. Reported EPS for the quarter were a penny, and profits in its first quarter had been low as well. This was still an improvement from the losses that the company had recorded in the previous fiscal year. The market response was muted, so Wet Seal remains down nearly 25% from its 2013 highs this past summer (though it is still up more than 30% year-to-date).

New CEO John Goodman (appointed in January), who has previous experience at Sears (SHLD), took advantage of the decline in the stock price to buy over 13,000 shares on Aug. 30 at an average price of $3.70 per share. He now owns over 900,000 shares directly. Our database of insider trading filings shows that he was buying heavily at prices of around $3 in February, although it is possible that this was more of a courtesy purchase upon his taking over the company.

Another Wet Seal insider was also buying the stock in late August, purchasing 10,000 shares at an average price of $3.82 per share. Studies generally show a small outperformance effect for stocks bought by insiders, particularly if multiple insiders are buying. We'd attribute this to the fact that, according to economic theory, insiders should tend to diversify their wealth and only buy stock when they are particularly confident in the company.

Taking a closer look at Wet Seal's recent results, same-store sales grew by 4% for the quarter compared with the prior-year period, with the company reporting that both transaction volume and sales per transaction were up at the core Wet Seal brand. (It also owns a smaller number of Arden B. stores.) The rise in same-store sales, combined with lower cost of goods sold than a year ago, has been quite good for gross profit. Still, this figure remains essentially even with what Wet Seal spends on selling, general and administrative expenses.

Going forward, the company plans to shift some of its store count toward outlet centers rather than malls, having concluded that outlet locations tend to be more profitable. We'd also note that the company has dipped into its cash holdings to buy back some shares. It is still in a fine cash position, with $80 million in cash and short-term investments on the balance sheet and over $50 million on other current assets, compared with about $60 million in current liabilities.

While Wet Seal's recent performance is not exactly strong, it is far preferable to what is happening at some similar companies. American Eagle (AEO), for example, saw declines in same-store sales in the 7%-8% range, with pretax income at about half of what it had been a year earlier as a result. The fact that Wet Seal has been able to gain traction in what American Eagle claimed was a "highly competitive" market suggests that the brand is rebounding. Wall Street analysts expect improvements to continue, and the stock's forward price-to-earnings ratio is a somewhat reasonable 16. Also, with a market capitalization of only $320 million (about 1 million shares are traded per day on average), the company's excess cash is a significant portion of its market cap.

With multiple insiders, including the CEO, buying the stock, there certainly seems to be a good bit of internal confidence that Wet Seal will perform in line with analyst expectations next year, and we have seen that the retailer easily outperformed peers last quarter. While absolute improvements in same-store sales are not that high, recent reports show that selling, general and administrative costs are at least held in check. In theory, any further improvements in gross income should drop straight to the bottom line.

Wet Seal would certainly be a somewhat risky buy, but investors interested in apparel retailers may want to take a closer look at the company or keep an eye on further results.

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