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Get Four
|  | NOVEMBER 9, 2004
 FOCUS STOCK By Marie Driscoll, CFA Pacific Sun's Golden Glow [Page 2 of 2] FEW COMPETITORS. This is a fragmented market with few national competitors. Genesco (GCO; not ranked; $26), with its 148 Underground Station stores, appeals to the same demographic. However, its merchandise assortment is primarily footwear (in excess of 80%), and in our view, is a good co-tenant for the d.e.m.o. chain, as the hip-hop shopper can find the appropriate depth of apparel brands at d.e.m.o. and cross the mall for an array of footwear choices at Underground Station. Department stores (not the retailer of choice for d.e.m.o.'s 16- to 24-year-old target customer) are another source for urban apparel brands, as are independents. We envision economies of scale will result from d.e.m.o.'s growing store count. Additionally, we believe the proportion of women's apparel in d.e.m.o.'s merchandise mix is less than that of PacSun, and thus see ample opportunity to increase penetration and expand margins as well. We note that d.e.m.o's store productivity is superior to PacSun's at approximately $405 in annual sales per square foot (vs. the company's $363 consolidated figure). Seth Johnson, former chief operating officer of Abercrombie & Fitch, assumed the COO role at PacSun on Nov. 1 and will assume the CEO role in April, 2005, at which time Greg Weaver will become executive chairman and focus on developing the next retail concept. Johnson brings extensive Gen Y retail experience to the company and adds valuable retailing acumen to the executive team, in our opinion. The search for a new CFO is in the final stages, and we believe an announcement is imminent. This will round out the executive suite, and we expect it to alleviate investor uncertainty. BRIGHTER EARNINGS. For PacSun's fiscal third quarter, we look for 29% EPS growth, to 40 cents from 31 cents one year earlier, on 2.3% fewer shares outstanding, to accompany the already announced 17% sales gain. Consolidated same-store sales rose 6.6% to 6.8% at PacSun stores and 4.8% at d.e.m.o. during the most recent quarter. Importantly, we estimate that gross margin will expand by 70 basis points, benefiting from a favorable shift in the sales mix to higher-margin items and improved sourcing. We also look for selling, general, and administrative (SG&A) expense to improve by 30 basis points. For fiscal 2005, we project revenues of $1.2 billion, up 19.5% from the previous year, with margin expansion of approximately 140 basis points on top of the 270-basis-point improvement last year, and EPS of $1.37. Through the third quarter, same-store sales rose 8.4%, and we look for same-store sales to increase 5% in the fourth quarter, vs. a 12.6% rise one year earlier. For fiscal 2006, we are projecting revenue growth of 19.7%, based on a 15% increase in square footage as the company opens 120 new stores. Plans are for 70 new PacSun units, vs. the 67 planned for fiscal 2005, 10 new outlet stores (vs. five) and 40 new d.e.m.o. units (vs. 41). We project sales of stores open one year or more to post a mid-single digit percentage gain. NICE DISCOUNT. We have modeled gross-margin expansion of 17 basis points as the environment for apparel sourcing is affected by changes in trade quotas. This will be offset by an estimated 15-basis-point increase in SG&A expense, resulting in a modest expansion of the operating margin to 13.8% from 13.7%. Our $1.62 fiscal 2006 EPS estimate is based on a 0.6% increase in the average number of shares outstanding. We project Standard & Poor's Core Earnings per share of $1.29 in fiscal 2005 and $1.54 in fiscal 2006. Our fiscal 2005 S&P Core EPS estimate includes estimated stock-based compensation expense of approximately $6.1 million (8 cents per share). Our 12-month target price of $29 assumes some expansion in PacSun's price-to-earnings multiple. We expect investors to reward what we view as the company's sales and earnings momentum. On a p-e multiple-to-growth (PEG) basis, incorporating our five-year projected earnings compounded annual growth rate of 20% and the p-e on estimated fiscal 2006 earnings, PacSun has a PEG ratio of 0.75, vs. 0.97 for its peer group. At about 15 times our fiscal 2006 EPS estimate, the shares are trading at about a 10% discount to the S&P MidCap 400 and a 15% discount to the teen-apparel retail peer group. Risks to our recommendation and target price, in our view, include adverse monthly same-store sales comparisons, and merchandise, inventory, and fashion risks. In our opinion, PacSun also faces key personnel risk amid the transition to new leadership and a protracted search for a new CFO.
 Analyst Driscoll follows stocks of specialty apparel retailers for Standard & Poor's Equity Research Services All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report. Standard & Poor's Regulatory Disclosure Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc. Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | |
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