Zumiez (NASDAQ:ZUMZ) Beats Q2 Sales Targets

Clothing and footwear retailer Zumiez (NASDAQ:ZUMZ) reported Q2 FY2023 results topping analysts' expectations, with revenue down 11.6% year on year to $194.4 million. However, next quarter's revenue guidance of $213.5 million was less impressive, coming in 1.99% below analysts' estimates. Turning to EPS, Zumiez made a GAAP loss of $0.44 per share, down from its profit of $0.16 per share in the same quarter last year.

With store associates called “Zumiez Stash Members”, Zumiez (NASDAQ:ZUMZ) is a specialty retailer of street and skate apparel, footwear, and accessories.

Customers can also find skateboards, snowboards, and related equipment such as wheels and bindings. The core Zumiez customer is typically a teen or young adult who skates, snowboards, or surfs and wants to reflect these interests in their clothing and footwear choices. Unsurprisingly, brands focused on these subcultures such as Vans, Thrasher, Volcom, and Element are featured in Zumiez stores.

Zumiez stores tend to be small–roughly 3,000 square feet on average–and located in suburban malls and shopping centers. There are various merchandise zones dedicated to apparel, footwear, and hard goods such as skate decks. Two unique aspects of Zumiez stores are video screens or televisions featuring endless loops of action sports as well as interactive areas where customers can handle and lightly try out equipment.

In addition to its physical store footprint, Zumiez also has an e-commerce platform, which was launched in 2005. It allows the company to reach customers that may not have a physical store near them, and it allows customers with access to a store to buy online and pick up physically.

Apparel sales are not driven so much by personal need but by seasons, trends, and innovation, and over the last few decades, the category has shifted meaningfully online. Retailers that once only had brick-and-mortar stores are responding with omnichannel presences. The online shopping experience continues to improve and retail foot traffic in places like shopping malls continues to stall, so the evolution of clothing sellers marches on.

Competitors that offer street or skate apparel and footwear include Tilly’s (NYSE:TLYS), Genesco’s (NYSE:GCO) Journeys banner, Foot Locker (NYSE:FL), and private company PacSun.

Sales Growth

Zumiez is a small retailer, which sometimes brings disadvantages compared to larger competitors that benefit from economies of scale.

As you can see below, the company's revenue has declined over the last four years, dropping 2.61% annually despite opening new stores and expanding its reach.

This quarter, Zumiez's revenue fell 11.6% year on year to $194.4 million but beat Wall Street's estimates by 2.25%. The company is guiding for a 10.1% year-on-year revenue decline next quarter to $213.5 million, an improvement from the 17.9% year-on-year decrease it recorded in the same quarter last year. Looking ahead, Wall Street expects revenue to decline 4.7% over the next 12 months.

Number of Stores

When a retailer like Zumiez keeps its store footprint steady, it usually means that demand is stable and it's focused on improving its operational efficiency to increase profitability. Since last year, Zumiez's store count increased by 8 locations, or 1.06%, to 761 total retail locations in the most recently reported quarter.

Taking a step back, the company has only opened a few new stores over the last eight quarters, averaging 2.39% annual growth in new locations. Although it's expanded its presence, this sluggish store growth lags other retailers. A flat store base means that revenue growth must come from increased e-commerce sales or higher foot traffic and sales per customer at existing stores.

Gross Margin & Pricing Power

As you can see below, Zumiez has averaged a mediocre 34.1% gross margin over the last two years. This means the company makes $0.34 for every $1 in revenue before accounting for its operating expenses.

Zumiez's gross profit margin came in at 31.7% this quarter, marking a 2.4 percentage point decrease from 34.1% in the same quarter last year. One quarter of margin contraction shouldn't worry investors as a retailers' gross margins can often change due to factors such as product discounting and dynamic input costs (think distribution and freight expenses to move goods).

Operating Margin

Operating margin is a key profitability metric for retailers because it accounts for all expenses that keep the lights on, including wages, rent, advertising, and other administrative costs.

In Q2, Zumiez generated an operating profit margin of negative 5.4%, down 7.6 percentage points year on year. We can infer that Zumiez was less efficient with its expenses or had lower leverage on its fixed costs because its operating margin decreased more than its gross margin.

From an operational perspective, Zumiez was profitable but held back because of its large expense base over the last two years. Its average operating margin of 3.16% has been paltry for a consumer retail business.

EPS

Earnings growth is a critical metric to track, but for long-term shareholders, earnings per share (EPS) is more telling because it accounts for dilution and share repurchases.

In Q2, Zumiez reported EPS at negative $0.44. This print beat Wall Street's estimates by 34.6%, a welcome development that should delight shareholders.

Cash Is King

Although earnings are undoubtedly valuable for assessing company performance, we believe cash is king because you can't use accounting profits to pay the bills.

Zumiez burned through $17.8 million of cash in Q2, representing a negative 9.17% free cash flow margin. The company increased its cash burn by 180% year on year.

Over the last two years, Zumiez's capital-intensive business model and demanding reinvestment strategy have consumed many company resources. Its free cash flow margin has averaged negative 1.4%, weak for a consumer retail business. Furthermore, its margin has averaged year-on-year declines of 5.9 percentage points. We'll keep an eye on this as almost any movement in the wrong direction is undesirable given its already low free cash flow margin. The company will need to improve its free cash flow conversion if it wants to survive (and ultimately thrive).

Return on Invested Capital (ROIC)

Zumiez's subpar returns on capital may signal a need for future capital raising or borrowing to fund growth. Its five-year average return on invested capital (ROIC) is 14.4%, somewhat low compared to the best retail companies that consistently pump out 25%+ returns.

We argue ROIC is one of the most important indicators of quality because it tells us how much return (profit) a company makes on the money it invests into its business, shedding light on its prospects and its management team's decision-making prowess. ROIC is also a helpful tool to benchmark performance versus peers, and just like how we focus on long-term investment returns, we care more about a company's long-term ROIC because short-term market volatility can distort results.

Key Takeaways from Zumiez's Q2 Results

With a market capitalization of $370.1 million, Zumiez is among smaller companies, but its more than $57.9 million in cash on hand and near break-even free cash flow margins puts it in a stable financial position.

Zumiez beat revenue and EPS expectations. However, guidance was below for revenue and EPS. Management called out "continued headwinds facing consumer discretionary spending combined with a heightened promotional marketplace". The company is down 4.18% on the results and currently trades at $17.87 per share.

Is Now The Time?

When considering an investment in Zumiez, investors should take into account its valuation and business qualities as well as what happened in the latest quarter. We cheer for everyone who's improving the lives of others but in the case of Zumiez, we'll be cheering from the sidelines. Its revenue growth has been weak, and analysts expect growth rates to deteriorate from there. On top of that, unfortunately its operating margins reveal poor profitability compared to other retailers and its operations are burning a modest amount of cash.

While we've no doubt one can find things to like about Zumiez, we think there might be better opportunities in the market, and at the moment, don't see many reasons to get involved.

Wall Street analysts covering the company had a one-year price target of $15.5 per share right before these results, implying that they didn't see much short-term potential in Zumiez.

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