Tuesday, October 13, 2009

Pacific Sunwear of California (NASDAQ:PSUN): Upgraded to Outperform at FBR Capital; $9 target

FBR Capital is out with a major call on Pacific Sunwear of California (NASDAQ:PSUN) upgrading the shares to Outperform from Market Perform with a $9 target (prev. $3).

According to the analyst the upgrade is based on:

1) product focus returning to an emphasis on brands, 2) controlled inventory, 3) guidance and consensus that they believe could be sufficiently conservative, and 4) opportunities in the company’s store base to close underperforming stores. FBR's store checks during the quarter have shown an increase in branded product, with a return to better showcasing “heritage” brands as well as introducing newer brands. They also noted less breadth and depth of markdown than last year. Firm further believes the company’s 3Q09 guidance for negative high teen to low 20% comp and LPS of ($0.16) to ($0.23) should be sufficiently conservative. With a new CEO, easier compares in 2H09, and new brands that could attract an incremental customer, they believe deep-value investors should begin to look at PSUN.

However, on the conference call, it was clear that many of the initiatives of the past 12 to 18 months would be reversed, including a deeper penetration of branded product, reintroduction of footwear and accessories, and returning to the company's core heritage brands. FBR believes uncertainties remain, and they are early to the fundamental turn in the name. Nonetheless, they believe downside in shares is limited, and they believe deep-value investors are likely to support the stock at or close to current $6 levels, as there is potential for open-ended upside if we begin to see improving top-line trends.

Due to their belief that the quarter is sequentially improving, the firm is increasing their 3Q09 comp estimate from –20.5% to –17% and LPS from ($0.19) to ($0.15). FBR's FY09 estimate goes from ($0.64) to ($0.60); FY10 estimate goes from ($0.19) to ($0.15). Price target increases from $6 to $9, which represents an EV/sales multiple of 0.5x FBR's FY10 sales estimate of $1 billion.

Focus on staff training and real estate opportunities. Through their checks, FBR has noted an improved attention to the customer by sales associates. They believe that the company is impressing upon its staff the importance of attention to customer, which they expect will result in increased conversion rates. Additionally, the firm believes approximately 100 leases will come up for renewal over the coming year, and they believe the company continues to take a close look its real estate strategy, as it negotiates better terms.

New CEO is introduced to the Street. The 2Q09 earnings call was the first time that investors and analysts were introduced to the new CEO, Gary Schoenfeld. FBR believes that his prior knowledge of the active sports industry from his time at Van’s should prove advantageous in developing the go-forward strategy for PSUN. They believe that Mr. Schoenfeld will use the 3Q09 conference call as an opportunity to further highlight details of the turnaround strategy going forward, which could serve to generate incremental investor interest in the story.

Tennant curve methodology. Despite the weak top-line sales and margin contraction, they believe we should begin to see sequential comp and margin improvement in 3Q09. FBR believes downside in shares should be limited, with open-ended upside if the company begins to see improvement in top-line trends. As such, they believe shares warrant an Outperform rating

Notablecalls: I suspect PSUN can trade up 10%+ today on this upgrade. Here's why:

- Take a look at what the stock did when Pali Capital upgraded the stock to a Buy back in August (stock was up 15% on the day). Note that Pali was one of the few firms positive on PSUN. I'd like to believe FBR Capital carries way more weight than Pali, especially when it comes to Speciality Apparel.

- As I mentioned, most firms are still farily cautious on PSUN which means expectations coming into the quarter are low. PSUN is scheduled to report on Nov 18.

- The new CEO, Gary Schoenfeld kept expectations low (possibly intentionally) as like most new CEO's he does not want to overpromise and underdeliver. His tone may me more positive this time around.

- The chart looks great. The $9 target from FBR offers 50% upside and there is no way to stop this one here.

- Most small retailers have been on fire lately.

How to play it?

Well, people will drive this one nuts in the pre-market action. Nothing wrong with participating but just remember you can't get decent size until the market opens. Use the open dip (if there is one) to buy.

I see this one trading towards $7 level (or possibly even higher).

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