A Tough Break for Tween Brands

Shares of the girls' apparel retail got hammered Wednesday after it reported a sharp drop in quarterly earnings

by Karyn McCormack

Tween Brands (TWB) looks like it's joining a crowd of retailers suffering from a spending meltdown. The company -- which sells apparel, footwear, and lifestyle and personal care products to girls aged seven to 14 at Limited Too and Justice stores -- reported disappointing second quarter results and lowered its outlook for the third and fourth quarters and full fiscal year 2008.

The retailer blamed its shortfall on schools moving their back-to-school start dates to later in September, as well as the shift of Texas and Florida sales tax holiday. All of this made the decline in store traffic and transactions even worse.

Treating Tween Brands like an out-of-style sweater, investors dumped the shares fast. The stock tanked 27% to $28.05 -- just a shade above a fresh 52-week low of $28.04 hit during trading on Aug. 22.

Tween Brands operates about 550 Limited Too stores in malls, while its newer chain Justice has about 111 stores in strip malls. Justice carries a somewhat narrower assortment than Limited Too and its prices are about 25% below Limited Too on apparel. Both stores cater to the fickle lot of fashion-aware young girls and carry trendy products. The company considers its direct competitors to be Claire's (only in accessories), Wal-Mart (WMT), J.C. Penney (JCP), Kohl's (KSS), Old Navy (GPS), and Target (TGT), according to a Standard & Poor's report.

For its second quarter, Tween Brands reported second quarter earnings per share of 7 cents, down from 18 cents a year ago and well below analysts' forecast of 15 cents. Same-store sales dropped 2% and total sales rose 15% to $213.7 million in the quarter ended Aug. 4.

"Our sales for the quarter failed to meet our expectations in large part because we underestimated the impact of so many schools in our markets moving their back-to-school start dates later, as well as Texas and Florida shifting their state sales tax holidays from July to August," said Tween CEO Mike Rayden in a release. "These shifts aggravated what had been a decline in retail traffic and lower store transactions throughout the quarter."

In addition, the New Albany, Ohio company said sales trends look less appealing in the months ahead. Tween Brands sees EPS of 40-45 cents in the third quarter and 94 cents to $1.04 in the fourth quarter. It noted that Limited Too plans to take markdowns earlier in the season compared to last year to better position inventory going into fourth quarter.

Tween Brands also lowered its $2.10-$2.25 fiscal year 2008 (ending January) EPS forecast to $1.80-$1.95. (The company reported EPS of $1.95 for fiscal 2006.)

"While we are projecting positive comparable store sales for the third quarter at both of our brands, we remain cautious regarding the current trend in retail traffic and the continuing uncertainties in the U.S. economy," Rayden said.

Wall Street wasn't too pleased with the downward trend either. Wachovia Capital Markets LLC analyst John Morris lowered his recommendation on Tween Brands to market perform from outperform on Aug. 22. According to news reports, Morris suspects that the company might be facing stiffer competition. He assumes there is "something more structural and ongoing, such as escalating competition from other players in discount and chain-store channels, resulting in a pronounced market share battle in the tween sector."

Jason Asaeda, equity analyst at Standard & Poor's, said in an interview that he was surprised by the fact that the company didn't know when schools around the country were opening. "They say they do market research," he said. Meanwhile, the shift in tax-free weeks in Texas and Florida would affect 18% of its stores in those markets.

Fashion mistakes also contributed to weak second quarter sales at the company, Asaeda said. On a conference call, the company noted that it had weakness in denim and casual bottoms in the quarter, as the trend of wearing denim miniskirts over leggings has faded, Asaeda said. Plus, Limited Too used more markdowns and promotional activity to try to lure shoppers at malls.

"Given heavy markdowns needed to clear inventory, and our concerns over merchandising risk for the critical holiday selling season, we are cutting our fiscal year 2008 EPS estimate by 46 cents to $1.80," Asaeda said in an Aug. 22 note. He also slashed his discounted cash flow-based 12-month target price by $7 to $33.

Susquehanna Financial Group analyst Thomas Filandro downgraded his opinion on the stock to neutral from positive and cut his earnings estimates, citing the challenging environment, weak store traffic, accelerated promotional activity, and higher marketing costs. He added: "We see the higher anticipated level of promotional activity at Limited Too as an incremental headwind facing the shares over the fall selling season and possibly into holiday 2007."

The "contra case" for Tween Brands, according to Filandro's Aug. 22 note, is that "Limited Too’s premium pricing strategy has limited growth beyond the current store base, and its new Justice concept is cannibalistic." But he says the company's lowered earnings outlook "may be viewed as conservative, providing upside if the consumer environment improves."

Indeed, the big drop in the price could make the stock a bargain. Asaeda at S&P upgraded Tween Brands shares to hold from sell based on valuation on Aug. 22. Asaeda said that he's positive on the company's Justice stores, as it continues to meet the needs of fashion-seeking tween girls and their savings-savvy moms outside of the mall, without cannibalizing the Limited Too brand. (S&P, like BusinessWeek, is owned by The McGraw-Hill Companies.)

McCormack is senior producer for BusinessWeek.com's Investing channel.