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Wet Seal Pinned at Neutral

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On Apr 3, 2013, we maintained our Neutral recommendation on Wet Seal Inc. , a specialty retailer of fashionable and contemporary apparel and accessories for women. This was in view of the consecutive losses reported by the company for the last three quarters, owing to lower revenues and the pressure put on the margins by the higher merchandise expenses. However, we are optimistic about several turnaround strategies undertaken by the company.

Why the Reiteration?

Wet Seal reported an adjusted loss of 6 cents per share in the fourth quarter of 2012 compared to the adjusted earnings of 3 cents per share recorded a year ago. Sales came down 10.9% in the quarter, due to lower sales at both Arden B and Wet Seal stores.

Moreover, Wet Seal has been suffering a steady decline in its comparable store sales for the past several quarters due to lower same-store sales at both Wet Seal and Arden B Stores. During the recently concluded 2012-fourth-quarter, same-store sales were a negative 8.3% compared to an increase of 5.5% in the prior-year quarter. The company also reported a decline of 13.5% in sales in the previous quarter.

The significant decline in total sales and comparable sales from the year-ago period is due to the slower pace of economic recovery and lower spending by domestic customers.  Transactions per store declined, although traffic was on the rise, implying that window shoppers increased. Since e-commerce sales increased significantly, this could also be an indication of show rooming by customers.

The gross margin shrank 560 basis points to 24.8% from 30.4% in the prior-year quarter, due to increased spending on improving merchandise and occupancy deleverage. Operating loss was $25.5 million in the quarter compared to an operating income of $2.2 million in the prior-year quarter.

The company has taken several initiatives in order to turn around the consistent negative same-store sales. It has embarked on a new marketing strategy with higher investment in advertising. It is also shifting focus from its struggling tops business to make available a variety of garments in its stores. The company’s redesigned assortments according to color themes provide an easy shopping experience to shoppers.

Wet Seal has put an emphisis on visual merchandising to attract shoppers to its stores. Moreover, it has redesigned its stores, as per the convenience of the young women, with the colorful and attractive assortments kept at affordable levels. We expect this to improve traffic in stores. Upgrading of sales technology and the use of tablet computers by the sales team will facilitate such visual merchandising for improved same-store sales. It is also working to increase its penetration into the e-commerce business and transit into full-price online selling.

Other stocks to consider
Wet Seal currently retains a short-term Zacks Rank #4 (Sell). Other favorable stocks in the retail and wholesale sector that are worth considering include Macy’s Inc. (M - Free Report) , Sears Holding Corporation , both holding a Zacks Rank #1 (Strong Buy) and Safeway Inc. holding a Zacks Rank #2 (Buy).

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