Pacific Sunwear ( PSUN) has established itself as retail force to be reckoned with, lately garnering huge momentum among its teen shopper-base. But is it time for the company to think about an expansion into new concepts before its surf model gets stale with its sometimes fussy fans? The company, which carries about 10 brands of guys and girls surf and skate apparel, footwear and accessories, posted four quarters of year-over-year profit increases on a 23% jump in total 2003 sales. The company's same-store sales have been on a tear, in the positive double digits since the third quarter of 2002. The stock has responded in kind, roughly doubling over the last 12 months. But PacSun, whose 680 namesake stores cater to shoppers aged 12 to 22, hasn't ventured into a new store concept for six years. In 1998, it started its second concept: 15 hip-hop fashion stores called d.e.m.o. tailored to 16- to 24-year-olds. The company now has about 120 d.e.m.o. stores as well as about 80 PacSun factory stores. Richard Hastings, retail sector analyst at the credit rating firm Bernard Sands, thinks the loyalty of PacSun's customers is a good foundation for expansion and said now is the time to do it. He likened PacSun's growth opportunity to that of the Gap ( GPS) in the 1990s when it expanded into Gap Kids, Baby Gap and Old Navy. Gap also moved into mall-based and non-mall-based locations in both urban and suburban areas. PacSun is capable to do a similar move, though on a slightly smaller scale, Hastings thinks. "When a store is this successful, it's important to experiment," he said. The company, for now, seems wedded to its surf/skate category with no immediate plans to change, even with questions surfacing about the staying power of the surf category.
"There are guys that are out there that think this surf trend is about to end," a buy-side analyst who preferred not to be named recently said. "There has been a surf trend for so long that people take for granted that it's the new look. It's probably not going to last." With PacSun already offering surf-related accessories and casual footwear, the company could be limited to the other types of merchandise to offer should it choose to expand to bigger stores. Still, Hastings called PacSun's opportunity a "lifecycle phenomena," meaning that younger shoppers tend to stay loyal to a store as they get older. "It makes it possible to have improvements in the junior's or children's line," he said. Because PacSun is currently emphasizing its merchandise to impressionable teenagers, brand loyalty is built. "They lock in the lifecycle," Hastings said. As a result, he thinks, PacSun has the potential to "get
current customers to purchase other things when they're in college, and when they're planning a family." "If the momentum appears to be as strong as it looks, management should start to think about a variation on PacSun," Hastings continued. He thinks the company could also stand to move into selling higher margin merchandise, similar to what the Gap does at Banana Republic. Still, the company had gross margins of 35.47% in the most recent fourth quarter, which was up 70 basis points over the same period last year. Meanwhile, Craig Johnson, president of the retail consulting company Customer Growth Partners, said expansion has perils. PacSun already has "great growth opportunities in their own space," and Johnson said he would "feel uncomfortable if they departed from their niche." Johnson thinks the challenge to intense expansion is twofold. First, "If they try to expand mainstream into more adult merchandise , they'll lose their edginess," he said. "If they try to move the rubber band upward on age and play in the Gap or Banana Republic space, I'd see them alienating their franchise."
Conversely, if PacSun moves in the kids market, Johnson thinks the retailer's current teenage customers would be put off by seeing their younger siblings wearing similar clothes. "That's going to really scotch it," he said. Carl Womack, PacSun's CFO, said the company has no plans to expand in any way other than to grow its current store count of PacSun and d.e.m.o. stores to 1400 by 2007, which would be about 500 more stores than it now operates. Total square footage would grow 13% to 15%. "Our plan right now is simple," Womack said. "We feel a focused effort on the two concepts we have that are working incredibly well is our strategy." He noted that usually about 70% to 80% of all second concepts fail. "Our d.e.m.o. concept is going to be in the 20% that succeeds. That's where we're at." The company plans to develop its Lilu brand into a surf and active wear line with a junior's line called Tilt, UBS analyst Richard Jaffe said. The company also said its new men's strategy will focus on retro-surf brands. Jaffe also noted that in its most recent quarter, PacSun benefited from the expansion of its girl's apparel, where he sees the potential for more. "Women are more likely to purchase complements to their apparel purchases than their male counterparts," he said. (UBS has an investment banking relationship with PacSun.) Yet, risks remain within the company's PacSun and d.e.m.o. concepts. Jaffe noted that the juniors market is "fickle," possibly complicating development of its Lilu and Tilt brands. Additionally, Jaffe thinks the recently expanded women's merchandise within d.e.m.o. is "more volatile than the surf-apparel business" and is "more dependent on the current trends and brands and as such carries more fashion risk than the core brand."
Nevertheless, PacSun's first quarter is looking strong already, with February same-store sales reported up 14.1% with a 28% increase in total monthly sales. Analysts expect earnings 14 cents a share in its upcoming quarter, which would compare to 10 cents a share in the prior year. For full-year 2004, the consensus is $1.24 a share, which would compare to $1.01 a share in the prior year. "It could be that location becomes more important than finding a variation," said Hastings. "They could open small stores in neat, complicated locations that younger people enjoy going to."