Vera Bradley Stock: Not My Bag (NASDAQ:VRA)

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Fashion and home accessories brand Vera Bradley (NASDAQ:VRA) has seen an almost 15% increase over the past month. The market mood in general has improved over the past month, with a 3.3% rise in the S&P 500 (SP500). While inflation still stays elevated, the first signs of cooling off in price rises in the US are probably a key reason for some optimism. It’s no surprise really, that a stock like VRA has benefited disproportionately. It’s a consumer discretionary stock, which can be sensitive to price changes. With operating margins at sub-10% levels for the past five years, it has limited pricing power too. It’s to be expected then that at a time of scorching inflation, these margins will get squeezed even more. So with some hope of softening in price increase, it might also see better times ahead.

Will it, though? Consider the fact that 2023 is expected to be a poor year for the global economy as such and the US economy in particular. Some forecasters are even predicting a recession in the year. Even if inflation does start declining steadily, as is expected (see chart below) it would be at the cost of demand. And that’s another challenge from the macroeconomic perspective for the US-based company. When consumers are spending less in general, demand for the likes of bags and apparel is likely to be compromised.

Inflation

Source: Bloomberg

Weak sales

It doesn’t help that Vera Bradley’s sales are weak already. For the second quarter of its current financial year (Q2, ending July 30, 2022) its sales were down 11.3% year-on-year (YoY), making it the second consecutive quarter of shrinking sales. For the first six months of its current financial year, the company has seen a 10.6% YoY drop in revenues.

The company’s Q2 revenues also came in below its own expectations, which at least for the full year are pessimistic to start with. It expects revenues to decline between 9.3% to 11.2%. It cites a drop in consumer spending because of inflationary pressures as the reason for its current revenue weakness. It also expects macroeconomic conditions to weigh on revenues in 2023. Essentially, the sales picture looks bleak for the foreseeable future.

Mixed profit picture

Vera Bradley’s profit picture looks a shade better, though. On a reported basis, it has clocked both an operating loss and a net loss, also a trend seen during the first quarter of the year. On a non-GAAP basis as well, for the first six months of the year, it’s still loss-making. However, this is because of a drag from the first quarter. In the second quarter, it has managed to show profits on this basis.

The big difference between its reported and non-GAAP measures is because of expenses due to the acquisition of bracelet manufacturer Pure Vida. While it bought the company in 2019, goodwill and intangible asset impairment charges on its account have still had a sizeable impact on the earnings this year. Other charges like an exit from products and inventory write-off along with severance charges and other employee costs have also affected earnings.

High inventory levels

On the face of it, the company’s liquidity as measured by the current ratio looks good at 2.6x. However, dig a little deeper and the issues surface. Its quick ratio, which takes inventory out of the picture, is much weaker 0.7x as inventory levels increased by 21.3% YoY in Q2. This is the biggest rise in inventory levels seen in nine quarters (see chart below). It was also cash-negative. With the near future looking challenging, these are red flags and significantly take away from the otherwise strong balance sheet, with low debt levels.

Inventory

Sources: Seeking Alpha, Author’s Estimates

What the market multiples say

But here’s the real rub. It’s still trading at a forward price-to-earnings (P/E), where earnings are non-GAAP, at around 18x, considering analysts’ consensus EPS estimates at $0.2. This is over 38% higher than that for the consumer discretionary sector as a whole. When the average of the company’s own forecasts for diluted EPS range between $0.35-$0.5 is considered instead, which admittedly, is now just the next six months’ numbers and not the full 12-month picture, the forward P/E looks [GAAP] far more reasonable at 8.5x. However, going by the fact that the company has recorded losses for the first six months of the year, I’m not entirely confident that this is achievable.

To be fair, Vera Bradley is on a cost reduction drive by no less than $25 million. This is almost 5% of its total revenues for the last year. These cuts that are being made across marketing, logistics and operational costs, payroll and others, are with the goal to offset both “inflationary expense pressures and the recessionary spending behavior”. In other words, they are being done keeping in mind the difficult macroeconomic context for next year.

However, if its sales continue to fall, its trailing twelve months [TTM] price-to-sales (P/S) ratio, which is currently at 0.2x compared to the 0.9x for the consumer discretionary sector, might not look as appealing. Its P/E is already high at worst and unconvincing at best.

What next?

All taken into account, Vera Bradley isn’t a stock for me to buy now. Its low debt and cost reduction measures are impressive. But it’s functioning in a macroeconomic environment where the odds are stacked against it. Its weak sales numbers don’t inspire confidence either, even less so considering that they are expected to fall. Its earnings could still look better in the months ahead, but there’s a risk that they might not meet the company’s outlook going by the results so far.

I believe that the stock is one bad news away from dipping again. A poor report on either inflation or the economy, a surge of coronavirus cases, a poor set of earnings or just general market bearishness can drag it down. Its share price has climbed up recently and could indeed continue to do so as long as the markets are buoyant, but it’s hard to overlook the clear risks. It’s probably a good time to Sell the stock after its recent gains and reconsider it once the overall situation looks more stable.

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