3 Reasons to Sell Pacific Sunwear

Pretend you're in the market for a used car. You've got a bit of cash tucked away, and you just need to go out there and get one. When you get to the dealer's lot, there's a little junker sitting in the back on cement blocks. The paint is peeling and the owner looks you in the eye and tells you that the thing hasn't run for years. Then he says, "But if the thing ever starts, think of what a deal you'd be getting." That's Pacific Sunwear (NAS: PSUN) in a nutshell.

A cash bonfire
In the middle of the last decade, PacSun was doing pretty well for itself. American teenagers were reaping the benefits of their parents' easy credit and a good job market. Then the financial crisis hit and kids had less cash. Suddenly 24% of teenagers are unemployed, and just opening a store no longer cuts it. Kids now put a little thought into what they buy.

PacSun hasn't been able to figure this new system out. The last time the company posted an annual profit was in 2007, when the company reported earnings of $40 million. Last year, the fall continued unabated and the company's net loss came in at $106 million. While it's tempting to see this as a function of teenage finances, it's not just that.

Other young apparel retailers have managed to continue growing during the crisis. Mall standard Abercrombie & Fitch (NYS: ANF) hit hard times with the crash as well; from 2008 to 2010, annual revenue dropped to $2.9 billion. But the company recognized its weaknesses and started turning things around. Revenue has risen since 2010, and last year the company turned in $4.2 billion. Clearly the problem isn't just cash-strapped teens.

Poor resource management
Since 2008, revenue for Pacific Sunwear has dropped 22% but inventories carried on the balance sheet have only declined 17%. That means that even though sales are falling, PacSun is holding on to more stuff. The obvious problem with that is that having excess stuff means the stuff has to go on sale, which results in lower revenue again. That's a vicious cycle if ever there was one.

Again, competitors are showing the company how this should be done. Jeans retailer Buckle (NYS: BKE) has done a fantastic job with inventory. The company has a reactive inventory system that orders for stores based on trends in those stores. Instead of flooding a store with a few of everything, the company can focus in on what's selling. Due to its diligence, Buckle has the luxury of needing to grow inventory.

But it's not just inventory problems that plague PacSun. The company is also getting less and less out of its people. PacSun has trimmed back its store count in order to fight rising costs, but the remaining stores have performed poorly. Average sales per square foot have dropped from $369 in 2009 to $273 last year. It seems like the company is trimming muscle instead of fat.

Lackluster branding
In my mind, PacSun's biggest hurdle to being a great turnaround story is its inability to define itself. Abercrombie has become synonymous with its consumers, so much so that the stores can just put a few half naked people out front and bring in huge crowds. PacSun isn't synonymous with anything interesting.

Let's go back to the competitive pool one more time. In the early 1990s, Guess? (NYS: GES) was associated with acid-washed jeans. All through the early part of this century, the company has had to fight that impression. But recently, the brand has started to mean "fashionable" again, and sales have climbed. Last year, revenue increased a solid 8% to $2.7 billion. Being down doesn't have to mean being out, but PacSun can't seem to crawl back.

The bottom line
Pacific Sunwear doesn't have much going for it. It can't make money, the money it spends isn't paying off, and the branding it desperately needs just isn't there. The prospect of a turnaround seems so far-fetched that it doesn't even make sense. I'd get out of PacSun and into something that's clearly got a plan for the future.

Even if the company manages to turn things around, it will still just be a small, generic fish in a huge pond. The Fool has searched far and wide to come up with its Top Stock for 2012. This retailer understands pricing, inventory, and branding in a way that PacSun never will. You can get your free copy of this report here.

The article 3 Reasons to Sell Pacific Sunwear originally appeared on Fool.com.

Fool contributorAndrew Marderdoes not own any of the stocks mentioned in this article. The Motley Fool owns shares of Buckle and Guess?.Motley Fool newsletter serviceshave recommended buying shares of Guess? and writing covered calls on Guess?. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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