Shares of Wet Seal ( WTSLA) haven't found a foothold since the stock climbed over $6 last summer, even though the mall-based teen-apparel chain has continuously posted mammoth monthly sales-growth figures. Its monthly comps, a key retail metric gauging sales at stores open at least a year, have shown year-over-year gains in the 30% to 60% range. Such success reflects the fruits of a massive turnaround orchestrated under merchandising guru Michael Gold, a part-time consultant to the retailer. Despite the numbers, comparisons will get tough in 2006, and the shares have been locked in a trading range. In the past few days, Wet Seal shares have dropped more than 3% since the retailer announced that its bid for bankrupt clothing retailer G&G Retail came up short. Investors, having expected the company to scoop up G&G at bargain-basement prices, came away disappointed. But with the stock trading lower, some analysts are unfazed, viewing the selloff as an opportunity to buy one of the last real growth stocks in specialty retailing's sweet spot. "With teen apparel chains in the mall being what they are these days, I think the best is yet to come in terms of results from this turnaround story," says Jeff Van Sinderen, analyst with B. Riley & Co. "We still haven't seen the full effects of their cost reductions reflected on their income statement. Behind all the charges and the financings, there's a big growth potential here." Van Sinderen holds a buy rating on Wet Seal with a $7 price target. He doesn't own shares, but his firm makes a market in the stock. Many Wall Street analysts have steered clear of Wet Seal since it barely avoided bankruptcy in 2004. The company's recent financial statements show a maze of one-time charges related to hundreds of store closings over the last year, and its capital structure consists of an unusual mix of preferred share classes and convertible debt offerings that allow for large amounts of dilution in its share count. This makes financial modeling and earnings forecasting a tricky balancing act on Wall Street, where trading is so often concentrated on EPS measures.
Off Wall Street, though, Wet Seal has garnered a cult-like following, starting with S.A.C. Capital -- a hedge fund run by renowned value investor Steven Cohen. The firm threw Wet Seal a lifeline in late 2004 with $40 million in financing after the company's sales and earnings plummeted to levels that appeared beyond repair. Cohen then brought in a new management team as well as Gold, a well-known figure in Canadian retailing who owns the discount apparel chain YM Inc. The disclosure of Gold's rich compensation generated some controversy last July when it was revealed that he would receive $2.8 million in cash last year, $1.2 million this year, and 2 million shares of restricted stock with two tranches of performance shares of 1.75 million each. Weeden & Co. analyst Kevin Starke says the scrutiny was unfounded. "People have to understand that without Michael Gold, there is no turnaround," Starke says. (He does not own shares of Wet Seal and his firm has no investment banking relationship with the company.) "They had a terrible merchandise problem, and he fixed it. People also need to realize that without all these financings and charges, there is no Wet Seal. The company would have gone bankrupt." For S.A.C., Wet Seal has proved to be a huge success. The shares have nearly tripled since the firm bought its stake over a year ago. The company posted an operating profit for the third quarter -- its first quarterly operating profit since the second quarter of fiscal 2002 -- and narrowed its net loss to $6.5 million, or 14 cents a share, from last year's $24.2 million, or 67 cents a share. The results included $2.5 million in stock-compensation charges and $6.9 million in interest charges. The results imply that S.A.C., which held a 9.9% stake in Wet Seal as of Dec. 31, found a cheap way to break in on the teen fashion specialty-retail business, where Wall Street darlings like Abercrombie & Fitch ( ANF), American Eagle Outfitters ( AEOS) and Pacific Sunwear ( PSUN) have been delivering some of the highest returns in the stock market in recent years. Wet Seal now operates about 300 namesake stores across the U.S. and Puerto Rico, as well as 93 under the Arden B nameplate.
"Wet Seal now looks like a fashion leader in this space," Van Sinderen says. Although it's unlikely Wet Seal will deliver the level of same-store sales gains it posted its turnaround year, January's results suggested that it will continue to grow comps even as the hurdles get higher. The company recorded a 51.5% same-store sales gain for the month -- more than twice the average analyst estimate reported by Thomson First Call. That compares to January 2005, when the merchandise transformation was already under way and Wet Sale posted an 8% comp-sales rise. "The January sales result is really quite remarkable," Starke says. "It's got people revisiting their models because it opens the door to big comps for much of the rest of the year." Starke predicts Wet Seal will generate a 20% rise in same-store sales in the first half of this year and a 15% gain in the second half. He thinks the company will end 2006 with sales of $387 per square foot. Meanwhile, at around $5.39, the stock is trading at roughly 17 times earnings estimates for 2006. That falls in line with the average for the specialty retail group, but a rejuvenated Wet Seal's growth prospects suggest that its valuation should be higher. "This is not a value play anymore," Starke says. "It's a growth story that hasn't really caught on yet. It's stuck in an in-between time where distressed players are done with it, but the plain-vanilla and institutional players haven't come back yet. If things keep going the way they've been going, they'll be back." On Wednesday, Wet Seal announced that its bid to acquire G&G was trumped by a better offer from BCBG Max Azria Group, a women's apparel supplier based in Vernon, Calif. Starke says Wet Seal shareholders should take heart in the fact that the company wanted to buy G&G in the first place. "They must have been real confident in their business model to feel they could pull off that turnaround," he says. "G&G was a real basketcase."