Sealed With a Profit

10/13/2009 9:08 am EST


George Putnam

Editor, The Turnaround Letter

George Putnam III, editor of The Turnaround Letter, says teenage and young women’s retailer Wet Seal is well-managed and in good shape to gain from an economic rebound.

Wet Seal (Nasdaq: WTSLA) operates moderately priced fashion-oriented clothing stores. The company has 409 Wet Seal stores, aimed at teenage girls, and 87 Arden B stores, which target young women.

Wet Seal expanded rapidly in the late 1990s, but as often happens, the company could not sustain its profitability as it grew. Large losses in 2003 and 2004 put the company in dire financial straits. It was bailed out by several prominent hedge funds who injected new capital in early 2005.

The company closed unprofitable stores, brought in a new management team, and was showing signs of a rebound until the economy cratered in the latter half of 2008. The stock, which had climbed from a low of 69 cents in 2004 to $7.60 in late 2006, sank below $2.00 again late last year before beginning to recover in 2009.

Wet Seal continues to suffer, along with most other retailers, as the economy staggers. However, we believe that the company is positioned to perform well when the economy recovers.

While recent comparisons with prior quarters have been negative, Wet Seal has managed to remain profitable. Management has run the business conservatively during the downturn. It has reduced expenses, tightly managed inventories, and held back on capital expenditures.

As a result of this prudent management, the company has a very strong balance sheet. At the end of its latest fiscal quarter (ending August 1st), Wet Seal had more than $143 million in cash and only about $3 million of long-term debt. This strong balance sheet not only assures the company’s viability, but also could allow it to scoop up some weaker competitors if the retail environment remains challenging.

Wet Seal has been able to maintain a successful niche over the years by providing more fashion-oriented clothing than denim/khaki-based competitors like The Gap and American Eagle. In addition, its merchandise is more affordable than comparable clothing in department stores.

While appealing to the ever-shifting tastes of teenage girls and young women is challenging, it can also be very profitable. If Wet Seal gets its merchandising right as its customers get more disposable income, its profits could soar.

Wet Seal’s shareholder base includes several of the savviest hedge funds, some of whom helped bail the company out in 2005. They’ve generally been patient with the company so far, but they are undoubtedly anxious to get the stock price up.

Investing in a young women’s fashion retailer is not for the faint of heart, but we believe that in this case it should be very profitable. We recommend buying Wet Seal stock up to $6. (It traded below $4 Monday—Editor.)

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