This article covers Tilly’s (NYSE:TLYS) 1Q24 results and earnings call.
Tilly’s is an apparel retailer from the US. I started covering the company in February 2024 with a Hold rating. The rating was based on the company’s consistently negative comparable sales and operational losses. The company trades at a low valuation if we assume it can return to pre-pandemic profitability levels, but that is uncertain.
The 1Q24 results did not change the thesis above. The company posted negative revenue comparables of 9.4%, with negative operating margins of almost 18% and close to $20.8 million in operating losses. So far, there seems to be no indication that the current downward trend has reversed.
The company’s stock price has decreased more than 30% since my last article. Again, the valuation is attractive only if we consider that the company can recover, but I have no evidence to support that belief. Further, as the company consumes its cash reserves, its risk of going into debt increases. For that reason, I keep my Hold rating on the stock.
Bad results for 1Q24
TLYS’s 1Q24 results were not good. Comparable sales were down 9.4% YoY and 6.4% on an absolute basis, thanks to calendar shifts compared to a year ago. The print is better than 4Q23’s 13.5% YoY comparable decrease, but it is still down by a big margin.
The company’s only positive point was shown in gross margins, which were up 130 basis points YoY, based on lower markdowns and higher initial prices, according to the quarter’s 10-Q. Management also commented on the call that they are trying to change their promotional strategy. The company’s founder, Chairman, and interim CEO commented: ‘In the past, unfortunately, we gave the merchandise away, it’s way under cost. There was no reason for that, but it happened.’
Unfortunately, the sales decrease led to SG&A deleveraging by 400 basis points. SG&A also grew in absolute terms YoY, pushed by higher wages (5% up YoY and 30% up since the pandemic, acc. to the call) and store asset impairments.
The result was an operating loss of almost $20.8 million for the quarter. Although Q1 tends to be the smallest in sales and can generally lead to operational losses, the trend continues to deteriorate, as seen below. This is the sixth consecutive quarter of negative operating margins for Tilly’s.
Small signs of change
In January, the company’s CEO resigned and was temporarily replaced by the founder, Chairman, and largest shareholder. 1Q24 is the first quarter under the new management.
The new CEO commented on the last call that the company made operational changes. It is trying to be more innovative in marketing and implementing new orders and warehouse management systems. As mentioned, it reduced promotions and increased prices.
One quarter is too early to judge whether these initiatives will improve Tilly’s performance. It is unclear to me how much of the current situation is caused by the broader macroeconomy and how much is caused by the company’s past mistakes. Other retailers targeting a similar demographic have also been challenged, but not as much. One example is Zumiez (ZUMZ), which posted positive comps for 1Q24 in North America.
On a positive note, one analyst commented on the call that she had seen innovations in the company’s storefronts: ‘The front of your stores already looks so much better. The merchandise is turning so fast. I wish I could just bring it in myself. It looks great.’
Valuation
Since my last article, TLYS’ share price has fallen more than 30%.
In my previous article, I commented that the valuation would be attractive if one could forecast a recovery to pre-pandemic profitability.
For example, with TTM revenues of $615 million, even assuming a further 5% deterioration in yearly sales and operating margins of 2%, the company could post an operating income of $12 million. Compared to an EV of $90 million, this would result in an EV/NOPAT multiple of 10x. If the company grows from the current levels (driven by higher store productivity and a better economy) and posts higher margins, the multiple would be lower (conversely, the upside potential higher).
However, I do not believe Tilly’s is an opportunity because it has not yet shown any signs of turnaround. The positive signs above are insufficient to forecast where the bottom might be.
Further, if the economy deteriorates further, Tilly’s does not have a lot of room left to improve. The company has already been operating at a loss for more than a year, and it has consumed more than half of its cash reserves in the past two years.
Even if the price continues to drop, I don’t know if Tilly’s can become an opportunity. It is difficult to think of a price at which a company generating significant operating losses would become attractive without signs of improvement. The value of a business is the value of its future cash flows, so if it cannot generate operating cash flows, it is challenging to value. Even a liquidation-based valuation would need the business to conserve cash and not lose it like it’s happening now.
On the other hand, I am not recommending shorting the stock; I only think it is not opportunistic to buy it. Shorting a micro-cap stock that has potential under a turnaround scenario is extremely risky.
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