Nervous investors and aggressive short sellers continued to sell off Vera Bradley (Nasdaq:VRA) shares Monday, bringing total loss to a shocking 15.6% in just three trading sessions. The selloff occurred on huge volume, following a consensus-beating 4Q12 and FY12 (ended 1/28/2012) earnings release.
Many attributed the panic selloff to a 1Q13 outlook that is on the low end of market expectation. Management guided Q1 revenue to be $115-117 million and EPS to be $0.27-0.29. This compares to street expectation of $117 million and $0.30, respectively.
I find this explanation less than satisfactory because the numbers given above can hardly be called a miss. Moreover, management’s outlook for the full fiscal year (ending Jan. 2013) appears to be actually exceeding street expectation. It appears to me the recent share reduction by FMR LLC (or Fidelity Investments) and one of the company cofounders to be the more convincing reason behind the panic selling.
FMR recently reduced its holding from 5.1 million (or 12.64%) to 3.1 million (or 7.6%) shares. Company co-founder Mrs. Patricia Miller (along with her husband Mr. Michael Miller) sold 266K shares (via a 10b5-1 plan) during last two months, including 91.4K shares sold in the two days leading to the earnings release. VRA currently has about 40.5 million shares outstanding.
(When examining the Millers’ SEC filings or online insider transaction report, remember not to double count their transaction size. Indeed I have recently read reports that exaggerated their sales by a factor of two. Note that Mr. and Mrs. Miller are beneficial owner of each other’s holding. They both serve as directors of the company. So any transactions are reported in duplicates, one under each person’s name.)
FMR disclosed its change of ownership on March 12, two days before the earnings release. The Millers filed their share sales (on Form 4) on the same day (March 14) as the earnings release (also “filed” on 8-K). It appears to me it is this timing of the share divestiture, filing, and the seemingly weak quarterly outlook that together send this stock into total tailspin.
In particular, traders might have interpreted the share sales by the Millers as portending weak future quarters. If that is indeed a major factor, I think this is an unjustified concern. A little closer look at the Millers’ recent sales reveals that all recent sales were transacted at $38 or $38+. This might be an indication of a sales price limit of $38 in their 10b5-1 plan. Moreover, the size of sales is not quite significant compared to Millers’ remaining holding of 7,016,173 shares.
Also do not neglect the fact that Ms. Barbara Baekgaard, the other company co-founder still holds 8,810,469 shares. And since last April’s secondary offerings, she has not sold any shares. The two co-founders together still hold 39% of company’s current shares outstanding.
The size of the Millers’ transactions, the apparent price limit of the divestiture and the fact that Ms. Baekgaard has not sold shares since April 2011 hardly convey a picture in which insiders are in a rush to exit.
If history can be any guide, company insiders sold 6 million shares (at $43.5) last April in a follow-on offering. Yet, the company has beaten the street view in each subsequent earnings release. Clearly, the take away from the offering is that insider reduction of holding is not any indication of worsening fundamental. Rather, it looks more like simple asset management needs from the insiders. This might applies to FMR’s reduction of holding as well.
Management is particularly good at managing street expectation. If you peruse company’s past quarterly earnings releases, you will find a consistent pattern in which management consistently gave quarterly projection that they would handily exceed when actual result became available. In other words, they under promise and over deliver, and they have done so consistently.
Take a look at how they projected their FY12 (ended Jan. 28, 2012) operating result. In June 2011, they put revenue and EPS at $430 to $435 million and $1.27 to $1.30, respectively. In late August, the numbers were raised to $438 to $443 million and $1.32 to $1.35. In December, they were raised yet again to $451 to $456 million and $1.37 to $1.40. Then when the actual result was released last Wedsday (March 14), revenue came in at 460.8 million and EPS hit $1.43 per share.
So it should not surprise you if they are “doing it again,” i.e., low balling Q1 and FY13 numbers for now so they can be sure to beat their own estimate in the next 12 months.
Another thing that might have fooled investors is their EPS growth in FY12. VRA achieved revenue growth of 25.9%, operating income growth of 80.4%, net income growth of 25.4%, whereas the diluted EPS growth came in at only 14.4%. But note that the result was distorted by its IPO in late 2010. The lower EPS growth was a result of the lower diluted share count in FY11. FY12’s diluted weighted average shares outstanding increased by 10% relative to FY11 due to the timing of IPO in late FY11.
Since Q4 of FY11, VRA’s diluted weighted average shares outstanding have stood basically flat at 40.5 million. To be more precise, the quarterly diluted shares increased only slightly from 40.53 million in 4Q11 to 40.56 million in 4Q12. For FY12 whole year, the diluted shares were 40.54 million. When giving FY13 outlook, management was still assuming the diluted shares to be 40.5 million. This indicates that the company expects no significant share dilution in the next fiscal year.
As a result of this stable share count, FY13’s top line growth will translate nicely to bottom line growth down to the level of EPS growth. Actually, if you take management’s midpoint estimate revenue will grow 18.5% while EPS will grow 17.7%.
Should company’s “low ball and beat” pattern continue through FY13, you should not be surprised to see revenue and EPS growth of 25% when actual result is released in March 2013. Why? Again take clue from last year. In only three quarters, projected revenue growth increased from 18.2% (by taking management’s midpoint guidance in June 2011) to actual result of 25.9%. Now, you can argue that we have got a whole year to go this time.
VRA is in a highly profitable business of lifestyle and fashion products. So, its investment returns are amazingly high (just like other major plays in this industry). For FY12, its ROE, ROIC and ROA came out to be 61.5%, 41.3%, and 27.2%, respectively. Past history has proved that investing in a steadily growing company in this space would eventually bring in phenomenal long-term returns to investors. So, if you are one of those who have missed COH, RL, and more recently KORS, VRA could very well be just another opportunity to catch up in this space, particularly after VRA’s recent massive selloff.
There appears to be a lot of room for this company to grow in the future. The company traditionally sold its products mainly through independent specialty retailers and other “indirect” (third-party) entities. In the past five or six years, company has begun to introduce “direct” sales channel, which include e-commerce and their own retail stores (full-price and discount outlet stores). Direct sales have been growing much faster than indirect sales. For FY12, direct sales grew 49% compared to indirect sales which grew 10%.
Direct sales now accounted for 48.9% of total revenue. Yet, the growth appears to be just beginning.
Company believes that the U.S. market can support at least 300 full-price stores. Yet, as of now, company has only operated 48 full-price stores plus 8 outlets. Management plans to open 15 to 18 full-price and outlet stores in FY13. Management ‘s general intention is to open 14 to 20 retail stores each year in the next five years.
Furthermore, management is not content to be limited to the U.S. market. So, the company recently has entered the Japan market. Once their model is well received in Japan, some expect them to expand to other international markets as well. How about South Korea and China? The company has already sourced raw materials from those countries. It also has an office in China for the purpose of supply chain management. Of course, entering these markets is a different story and should be treated as pure speculation at this point.
In the past quarters there were concerns about inventory growth. These concerns were put to rest with the FY12 result out now. Year-end inventory and accounts receivable turnover both improved compared to prior year. Management has set a goal of limiting inventory growth to be in line with revenue growth going forward. Company has also reduced debt by 62% in the past year, bringing debt/equity ratio down to 0.2 from prior year end’s 1.04.
On valuation metrics, using market close of $31.33 on Monday (March 19), VRA is trading at 21.9x EPS of the last fiscal year, and only 18.5x management’s midpoint forward EPS estimate of $1.695. But if company could actually achieve EPS growth of 25% for next fiscal year (the “beat” scenario mentioned above), the forward P/E would be 17.5. VRA’s P/B now stands at 10.2. This compares quite attractively to an arguably more convincing early growth story (recent IPO) in KORS, which has a forward P/E of 47.7 and P/B of 23.6 per Yahoo! Finance.
Bottom line, a management team with savvy financial management skill and clear vision of long-term growth make VRA an attractive candidate in the highly rewarding fashion and lifestyle space. VRA appears to have a lot of room to grow in the U.S. market, while its international expansion is only beginning.
Disclosure: I'm long VRA.
