It’s never been harder to be a stepchild.
In a sequence of store closings, layoffs, huge promotions, inventory reductions and stalled expansion plans, specialty retailers hoping to survive the economic crisis may have to use more than a scalpel to cut costs. With no signs of a letup in the recession and many secondary brands failing to gain traction with consumers, some retailers may be forced to wield an ax and sever their spin-offs, analysts said.
“In this kind of economic climate, with cash being king and [inventory] liquidation being essential, each business has to pay for itself,” said Dana Telsey, president of Telsey Advisory Group.
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The fate of the spin-offs is certain to come under scrutiny now that retailers have finished their fiscal years and are preparing to release fourth-quarter and full-year results.
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“Anything’s up for discussion,” said retail analyst Amy Wilcox Noblin of Pali Capital. “Retailers are seriously cutting back. No one knows when demand comes back.”
Intolerance for weak offshoots was building even before the recession hit with its full fury. An example is Pacific Sunwear of California Inc.’s departed urban-inspired spin-off, D.e.m.o. The brand shed 74 stores in spring 2007, before shutting down the remaining 154 stores in January 2008.
The closures followed a string of weak financial performances. For fiscal 2007, the retailer posted a net loss of $30.4 million on $1.45 billion in sales. The company said the PacSun division had an income from continuing operations before taxes of $218.6 million, on revenue of $1.31 billion, while D.e.m.o. put up a net loss from continuing operations of $106 million on sales of $148.3 million. For the year, D.e.m.o. reported a 19.6 percent comparable-store sales decline, while PacSun specialty and outlet stores posted a 3.4 percent comp increase. PacSun also elected to abandon its fledgling One Thousand Steps concept during the fourth quarter of fiscal 2007.
Pali’s Noblin said Bebe Stores Inc.’s athletic apparel concept, Bebe Sport, is a “business that has never proven itself” and may suffer a fate similar to D.e.m.o.’s. The recent departure of corporate chief executive officer Gregory Scott makes the situation “uncertain,” she added.
“It is no secret that Bebe has struggled with product and second concepts for some time in addition to a weak consumer,” Noblin said, noting that, over time, the retailer’s apparel has seemed to target a 30-plus customer, instead of its younger, core contemporary customer, making the management change “not necessarily negative.”
Retail analyst Eric Beder of Brean Murray, Carret & Co. said Scott’s decision to double the Bebe Sport chain over the past three years hurt the retailer, and that company founder Manny Mashouf, who has returned to the ceo role, should “aggressively reduce Bebe Sport, by either closing stores or converting them to Bebe or Bebe accessory stores.”
Beder described Bebe Sport as “outdated and unfocused, at best, and not worthy of management’s limited time right now.”
No new store openings are slated for the 63-store chain, company management said, as Bebe focuses on its newer outlet concept, 2b Bebe.
Although Bebe does not break down earnings by division, the company said it will continue to evaluate the marketing dollars for Sport, and will “reduce the total dollar spend if sales do not show improvement.”
Abercrombie & Fitch Co.’s 26-unit “post-collegiate” Ruehl is another struggling spin-off with no plans for new stores. Instead, A&F said it intends to focus on fine-tuning the concept, which generated $39.1 million of the parent firm’s $2.54 billion in sales in the first nine months of fiscal 2008. Ruehl’s comparable-store sales declined 22 percent during the nine months. Even the once-expansive Hollister was off 12 percent during the same period.
“I remain unconvinced that there is a market for Ruehl,” said Citigroup retail analyst Kimberly Greenberger, who observed that it is “very easy to target an age group,” or to let age “define a demographic,” but once a consumer is out of college that effort becomes more difficult.
Although her complaint can be applied to any retailer trying to box in 20- to 40-somethings, she said Ruehl’s “problem” is that it feels “meaningfully younger” than its rivals.
Eric Cerny, Abercrombie’s manager of investor relations, disagreed. “We think Ruehl is a viable concept,” he said. “We know the market is there.”
Cerny said J. Crew Group has been able to target the post-Abercrombie demographic with much success, and the creation of Ruehl has been a way to recapture their clientele.
“If someone’s going to capitalize on the Abercrombie customer, why shouldn’t we?” he said.
To accomplish this, Cerny said Ruehl will continue investing in marketing, new products and the store experience.
“It takes years to get brands going,” he said, noting that Ruehl has only been around since 2004. “But it is a very difficult time to start new concepts.”
In January, comps at A&F’s Abercrombie and Hollister spin-offs both fell 24 percent. Ruehl’s slipped 17 percent.
The track record for spin-off brands is less than stellar, and the deteriorating economy only exacerbates these “flawed” concepts, said retail analyst Jeff Van Sinderen of B. Riley & Co. Van Sinderen cited American Eagle Outfitters’ Martin + Osa brand, launched in Sept. 2006, as an example.
Targeting 28- to 40-year-olds, mall-based M+O in 2007 lost $50 million, or 15 cents a share. Last year’s loss, which will be announced with fourth-quarter earnings, will be “higher,” said Joan Holstein Hilson, American Eagle executive vice president and chief financial officer.
American Eagle said it would not be adding to M+O’s 28-store count in 2009.
“In my opinion, if Martin + Osa does not improve by the end of the year, they will be gone,” Van Sinderen said, adding that the company has set “very tight” guidelines for 2009, one of which he said includes cutting its operating loss in half.
While M+O did not offer a detailed projection, M+O president Laura Dubin-Wander indicated in an interview that she hopes the store brings in at least $375 a square foot, but declined to comment on how much it currently generates.
A similar experiment by Gap Inc., Forth & Towne, was shuttered in February 2007 after an 18-month, 19-unit effort.
Dubin-Wander said M+O produced a comparable-store sales rise of more than 40 percent for November-December.
Some analysts said the increase could be misleading because the store marked down merchandise in order to clear out inventory during the holiday period, but M+O’s management sees the results as a positive sign.
“We are thrilled they [consumers] see such an appetite for this brand,” Dubin-Wander said, while acknowledging there are significant challenges for mall-based retailers.
“We want head-turning prices,” she said, adding that M+O has factored higher quality fabrics, such as cashmere, into the price-value equation.
Although this may be a good move, Van Sinderen said retailers offering higher price points aren’t going to motivate people to shop.
“The aspirational customer isn’t so aspirational anymore,” he said. “Their aspirations have gone down a few notches.”
Van Sinderen said retailers are looking at their concepts’ level of profitability and their lease contracts.
The Wet Seal Inc.’s contemporary women’s apparel concept, Arden B., has seven to nine leases up in the next few years, he noted. Instead of the retailer incurring an expense from closing down Arden B. stores outright, it would be beneficial to either renegotiate the leases, convert the stores to Wet Seal nameplates or shutter them once the leases have expired, he said.
However, Van Sinderen said it might be too early to forecast Arden’s death because the company has lowered its inventory and has had fewer promotions, allowing it to sell more merchandise closer to full price.
In 2007, Arden B. had an operating loss just under $15 million and sales of $132.8 million, while Wet Seal had operating income of $69.2 million on revenue of $478.4 million. For the nine months of this fiscal year, Arden B. cut its operating loss to $2.1 million and brought in sales of $77.2 million, while Wet Seal recorded operating income of $51.9 million on sales of $360.3 million.
“We recognize that we need to stabilize sales at Arden B. to achieve profitability in the business,” president and chief executive officer Edmond Thomas said during the company’s third-quarter earnings call. “We do not feel comfortable, though, that we can operate at a much smaller operating loss than that incurred in fiscal 2007, at just about any reasonably foreseeable sales level.”
Thomas noted that Arden B. had a 20.2 percent fall in comps last quarter, and said the company’s “best current option is to continue efforts to turn around the Arden B. business, even with running the business at a nominal operating loss for at least in near term.”
There are some bright spots in the secondary brand business. Rock-inspired Hot Topic Inc.’s Torrid, a plus-size concept aimed at teens and young adult women, has tapped into a unique market.
At a time when the dominant plus-sized retailer, Lane Bryant parent Charming Shoppes Inc., is cutting jobs and costs, Torrid is a “complete standout,” having “substantially outperformed” its rival, said Citigroup’s Greenberger.
Not only is Torrid grabbing share from other plus-size retailers, Greenberger said it is succeeding at a time when most women’s businesses in the teen space are struggling. Torrid has a 1.7 percent comp decline for the year, while older sibling Hot Topic has had a 6 percent gain.
In this environment, a “modest comp decline” is good, said Greenberger, who added that Torrid is doing well because it is “fashion-focused.” Although most retailers and vendors have moved toward basics during this period of economic stress, Torrid “did the opposite, and it has paid off,” she said. The company posted $197.3 million in third-quarter sales, $37.6 million from Torrid. This was a 13.3 percent increase in third-quarter revenue for the concept, which registered sales of $33.2 million a year earlier.
Greenberger noted that the economy has allowed some retailers to capitalize with fresh fashion and new concepts.
In the fall, for example, teen value-oriented Aéropostale Inc. plans to launch a promotional children’s concept.
“It will highlight the best characteristics of Aéropostale’s core line and will also mirror the strengths of Aéropostale’s operating model,” executive vice president and chief financial officer Michael Cunningham said at the ICR XChange Conference in Dana Point, Calif.
But Citigroup’s Greenberger said her expectations for the still-to-be-named concept were “low.” The children’s market is already established with several value-oriented players like Wal-Mart Stores Inc., Old Navy and The Children’s Place Retail Stores Inc., she said. “Who are they going to take share from?” she asked. “I don’t see a lot of room for them to be the low-pricer.”
Nonetheless, B. Riley’s Van Sinderen sees the weak environment as more than just an opportunity. With rivals going out of business and real estate prices dropping, “retailers have to keep trying,” he said. “They have to keep introducing new concepts.
“You have to keep looking forward,” he said.